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A312 > Exam 2 > Flashcards

Exam 2 Flashcards

1
Q

Lease

A

An agreement conveying the right to use the property, plant, or equipment usually for a stated period of time

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2
Q

Lessee

A

The party paying for the right to use the asset for a specified period of time

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3
Q

Lessor

A

The party that legally owns the asset and is receiving payment from the lessee for use of that asset for a specified period of time

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4
Q

Why would you lease rather than buy? (Lessee)

A
  • Fixed rate with no down payment
  • Only want part of an asset
  • Protection against obsolescence
  • Flexibility
  • Tax benefits
  • Off-sheet financing for operating leases
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5
Q

Why would you lease rather than buy? (Lessor)

A
  • Generate proceeds from an asset not in use

- Financing income

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6
Q

Operating leases

A
  • Recognizes lease payments as an expense

- Risks and rewards of ownership NOT transferred

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7
Q

Capital Leases

A

Leases transfer to the lessee the risks and rewards of ownership

  • Recognizes leased item and payment obligation on the balance sheet
  • Depreciates the leased item
  • Lease payments are allocated between reduction of the outstanding liability and finance charge
  • More like the sale of property with periodic payments (financing or economically like a bank loan)
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8
Q

4 Criteria

A

If lease meets ANY 1 of the criteria, it is capital:

1) Transfer ownership at the end of the lease? (strong)
2) BPO? (strong)
3) Lease term >= 75% of useful life? (weak)
4) Present value of minimum lease payments >= 90% of fair value? (weak)

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9
Q

BRO

A

Bargain Renewal Option: allows lessee to renew the lease for a period of time at a rent lower than the market rental price

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10
Q

BPO

A

Bargain Purchase Option: lessee has the option to purchase the asset at a specified time for a price substantially below the asset’s fair market value at that point in time

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11
Q

Residual Value

A

Estimated fair market value of the leasaed asset at the end of the lease term

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12
Q

GRV

A

Guaranteed Residual Value: amount lessee is obligated to pay for the asset at the end of the lease term

  • amount lessee guarantees the lessor will receive for the asset
  • To prevent lessee from abusing the asset and returning it with very low or even 0 residual value
  • Unguaranteed part is a risk the lessor takes
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13
Q

Lease term

A

Fixed, non-cancelable term of the lease

-lease term does not extend beyond date a BPO becomes exercisable, is extended for renewal periods

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14
Q

Minimum Lease Payments Include:

A
  • Rent payments the lessee is obligated to make under terms of lease (excluding any executory costs paid by the lessor)
  • Amount of BPO
  • Guaranteed residual value
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15
Q

Minimum Lease Payments do NOT include:

A
  • Executory costs (if lessee pays these, expensed in the period incurred)
  • Payments contigent on future performance (expensed if conditions are met)
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16
Q

Discount rate

A

The rate used to find the present value of the future minimum lease payments . Rate for LESSEE is the lesser of:

  • Lessee’s incremental borrowing rate (if lessee went to bank, the rate they would get)
  • Lessor’s implicit interest rate (if it is known)
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17
Q

Amortization Strong v Weak form

A 
Strong form:
-Useful life
-Net salvage value
Weak form:
-Lease term (depreciated to 0 if no GRV)
-Expected value to lessee
18
Q

Inception of lease

A

asset and liability both are recorded at lower of:
-fair market value of leased asset
-present value of minimum lease payments
Asset and liability starts out the same

19
Q

Termination of Capital Lease

A

Strong:

  • Transfer leased equipment and accumulated depreciation accounts to “owned” equipment
  • Liability will already be at 0 or will be 0 after BPO

Weak:

  • Leased equip, accum, and liability are zeroed out
  • Cash paid to lessor if FMV is less than GRV
  • Gain/loss recognized if actual FMV different from original expected FMV
20
Q

Capital lease - Lessor

A
  • Either direct financing (lessor’s only income is interest revenue) or sales type (lessor has profit on trasnfer as well as interest revenue)
  • Must meet BOTH group 2 criteria
    1) Collectibility of lease payments is reasonably assured
    2) No important uncertanties about unreimburseable costs
21
Q

Discount rate for lessor

A
  • Lessors implicit interest rate

- The discount rate could differ from rate used by lessee

22
Q

BPO effects

A
  • BPO is considered part of the minimum lease payments (last payment)
  • Asset depreciated over life of the asset rather than lease term
  • Salvage value subtracted at the end to calc depreciation
  • changes the term of depreciation
  • potetially changes the term of lease and final payment amt
  • must reclassify asset at “owned”
23
Q

Operating v Capital Effects

A
  • The total expense over the life of the lease is the SAME for both methods
  • No cash flow implications
  • Operating leases = lower assets and liabilities (lower annual expense) early in the life of the lease
24
Q

Off-balance sheet financing

A
  • 1/3 of all capital expenditures are done through leasing

- For many companies, off balance sheet lease obligations (operating) are many times higher than reported debt

25
Q

GRV effects on Lessee

A
  • ONLY the GRV is considered part of minimum lease payments (considered last payment made)
  • Depreciation schedule based on PV of minimum lease payments - GRV and depreciated over the life of the lease
26
Q

GRV effects on Lessor

A
  • End of lease, if true residual value is < GRV, the lessee returns the asset and pays cash to make up the difference, Lessee records a loss
  • Entire residual value (guaranteed and unguaranteed) is considered part of the lease receivable
  • May record a loss for unguaranteed, but if the true value is greater than GRV, does NOT record a gain
27
Q

Sales type lease - lessor

A
  • FMV > seller’s cost

- Recognize 2 types of revenue; Profit on sale (selling price or FMV - seller’s cost) and interest revenue

28
Q

Taxes Payable

A
  • Tax term (based on IRC)
  • Taxable revenue - deductions * tax rate
  • Usually not the same as tax expense
29
Q

Tax expense

A

US GAAP revenue - US GAAP expenses = net income

Depends on timing differences of revenue and expenses

30
Q

Income taxes for businesses

A
  • Proprietorships, Partnerships & S-corporations: Net income of business is divided among the owners, the taxes are paid and income is included on the owners’ individual tax return
  • Corporations: separate taxable entity, corporation must file tax return and pay taxes on income, pay taxes on dividends
31
Q

Taxable income

A
  • Used to calculate taxes payable
  • Tax rules set by Congress and enforced by the IRS
  • Goals include: raising revenue for gov’t and encouraging social goals
  • Often closer to modified cash basis
32
Q

Accounting income

A
  • Used to calculate tax expense
  • Rules set by FASB and enforced by SEC
  • Goals include transparent reporting of the financial position of the company
  • Accrual basis
33
Q

Comprehensive Interperiod tax allocation

A

The full tax consequence of an event is recognized in the period in which event is recognized

34
Q

Permanent differences

A

Pretax accounting items that will never be included for taxable income or vice versa (NEVER will have to pay or deduct)

  • Interest gained on municipal debt
  • Fines/ expenses associated with violation of the law
  • Amounts paid for key officer life insurance
35
Q

Temporary differences

A
  • Items that are recorded in taxable income in a difference year than pretax income (will eventually be recorded in both, so the difference is temporary)
  • Bad debt expense, warranty expense, advances from customers, accelerated depreciation
36
Q

Deferred tax asset

A
  • Taxable income > accounting income
  • Assets: book value is less than tax basis
  • Liabilities: book value is greater than tax basis
  • Carryforwards
37
Q

Deferred tax liability

A
  • Accounting income > taxable income
  • Assets: book value is greater than tax basis
  • Liabilities: book value is less than tax basis
38
Q

Net operating loss

A
  • Occurs for tax purposes when tax deductions exceed tax revenues
  • Loss carryback - a corporation may carry a loss back and receive a refund for taxes previously paid
  • Loss carryforward - use NOL to offset future taxable income
39
Q

Tax expense calculation

A

Taxes payable + change in DTL - change in DTA

40
Q

Tax rate changes

A
  • Valuation of deferred tax assets and liabilities are based on new tax rates
  • Tax expense in year of enacted rate change is affects
  • Example: Net asset position in DTA, then increase in tax rates will cause greater tax expense to decrease, so the benefit of the future deduction is greater

A312 (4 decks)

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