F4 Flashcards
Recording royalty expenses
The larger of minimum royalties or the percentage of sales agreed.
Accrued vacation pay
Employees’ compensation should be accrued if:
1 Services are rendered
2. Obligation relates to vested or accumulated rights
3. Amount can be reasonably estimated
4. Payment is probable
Accounting for short-term liability payments after year -end but before financials are issued
If the financials have not been issued and the actual amount of transaction is known, the company should adjust the current liability balance on the financials and include necessary disclosures.
Debit Short term liability
Credit Long-term liability
Footnote 2 of SFAS No 6, Classification of Short-Term Obligations Expected to Be Refinanced, states “if equity securities have been issued [after the balance sheet date but before the balance sheet is issued], the short-term obligation, although excluded from current liabilities, shall not be included in owners’ equity.”
Exit or disposal activities
A liability is only recognized when all of the following criteria is met:
- An obligation event has occurred
- Results in a present obligation to transfer the assets or provide services in the future
- Little to no discretion to avoid the future transfer of assets or providing services.
Costs associated with exit and disposal activities
Include costs related to involuntary (**Not voluntary) employee termination.
–Costs to relocate employees
–Include costs to terminate a contract that is NOT a capital lease. Capital lease termination costs are accounted for separately.
-the cost of retiring a fixed asset is not considered an exit or disposal cost.
Recording accrued interest
Add each yearly interest payable to the principal amount to calculate interest payable for the following year.
Asset Retirement obligation (ARO)
Accretion Expense:
Beg. Asset retirement obligation X Risk-adjusted rate
When an ARO exists, the company debit an asset retirement cost (ARC) which increases the carrying value of the asset and credit an asset obligation (ARO) which is the liability recorded for the retirement.
The amount recorded for the ARC/ARO is equal to the fair value (determined by discounting the future cash flows).
ARC will be depreciated over the useful life of the related asset while the ARO will be “accreted” based on the relevant accretion rate (risk-adjusted rate).
The expense related to the ARO will be captured through depreciation expense over the estimated useful life of the asset, rather than recorded in total on the date the asset is placed into service.
Current/Long-term liabilities
Short term debt refinancing with long-term debt is long-term liability.
Deferred tax liability and tax assets are reported as non-current liability/asset.
Payroll taxes
-FICA
-Federal income taxes are not payroll tax
Escrow liability at year end
Escrow liability is increased by escrow payments and interest paid on escrow funds (net of fees). It is reduced by real estate taxes paid
Recognizing liability for termination benefit
Calculate the liability based on how many employees a company expects/estimates will receive the termination benefit, not based on the population of terminated employees.
Treatment for reasonably possible contingency
Disclosed but not accrued.
Only footnote disclosure is required for a “reasonably possible” (not “probable”) loss.
The disclosure should include the range of $250,000 − $500,000 and indicate that the best estimate is $400,000.
Treatment for probable contingency
Accrued and disclosed.
When a loss is “probable,” an amount must be accrued on the balance sheet. The amount to accrue is the best estimate of the loss, but if there is no best estimate, the lower bound of the estimated range is the appropriate amount to accrue.
When a loss is probable but not reasonably estimated, the liability should be disclosed in the notes to the financials but no liability entry is made; only disclosure.
Probable: An increase in both expenses and liabilities because it is probable and amount can be reasonably estimated.
Contingent liabilities are recorded when they are probable and estimable.
If the amount of the loss cannot be reasonably estimated, a probable loss cannot be accrued. In this situation, disclosure is still appropriate.
Contingency
Favorable judgement means a liability may not have to be paid so it is not probable, should not be accrued on balance sheet.
Appeal judgement is a contingent gain (or reduction of expense) and should not be recognized until realized.
Gain contingencies that are probable and reasonably possible and can be reasonably estimated are disclosed.
Conservatism Concept
Pertains to recording gain contingencies
“Anticipate all losses but no gains”
Remote contingency
No disclosure or accrual is necessary when a loss contingency is considered to be remote.
Gain Contingency
Gain contingencies are not recorded in the accounts once a gain is recognized but not before an appeal process is complete and award is collected.
gain contingencies are not recorded because to do so may cause recognition of revenue prior to its realization.
Reported as interest expense
-Imputed interest on non-interest bearing note.
Not reported as interest expense:
- Pension cost interest is a component of pension plan expense
- Interest incurred to finance construction of machinery for own use is capitalize as part of the cost of the machinery
- Post retirement healthcare benefits interest is part of post retirement benefit expense.
Recording cost of asset
100,000 note payable + 10,000 cash paid - 24,866 discount = 85,132
Noninterest bearing notes payable
reported at the present value of future cash flows.
Note payable’s present value on the balance sheet
Discount is a reduction from the face amount; premium is addition to the face amount.
Reporting financial instruments
Financial instruments in the form of shares that are mandatorily redeemable and represent an unconditional obligation is a liability and not equity according to GAAP.
Future amount of annuity in advance of 1 at 10% for # periods
Use this formula if problem is looking to figure out how much each deposit should be for a certain period. Divide that from the total they are looking to achieve.
Ex:
If you plan to have 1,000,000 by year 5 and plan to make four equal payments in a fund that will earn 10% annually, then they should:
1,000,000/5.11 (future amount of annuity in advance of 1 at 10% for # periods)
=195,695
Note receivable balance for installment notes in 24 equal monthly payments which include 12% interest.
The present value of the remaining monthly payments discounted at 12%.
current maturities of long-term debt
Current maturities of long-term debt in the balance sheet should include amounts due and payable within 12 months of the balance sheet date.
Accrued interest payable
Accrued interest Payable at Year 2 end:
Beg balance at Dec 31 year 1: 15,000
+ Interest expense 85,000
- Interest Paid -68,000
= Ending balance 12/31/yr2 32,000
Purchase commitment to buy inventory
At the end of the accounting period, the current market value of the inventory was less than the fixed purchase price, which of the following accounting treatments is most appropriate?
–Describe the nature of the contract in note to the financial statements, recognize a loss in the income statement, and recognize a liability for the accrued loss.
Types Of Bonds
Serial bonds: mature in installments (not all mature on the same date)
Bond sinking fund: company contributes cash to each period so that it has enough to pay the bond at maturity
Term bonds: Have single fixed maturity date
Debentures: Unsecured corporate bonds.
Bond issued at Discount
Debit cash
Debit Discounts on bonds payable
credit Bonds Payable
Straight-line amortization:
Journal entries are going to be the exact same each year because the amount is the same every period.
Effective interest:
the ending carrying amount of the bond is equal to the beginning carrying amount plus the amortized discount during each period.
Bond issuance price TBS
Company issued $1,000,000, five-year, 10% bonds, dated Jan 2, Year 1. The bonds provided for semiannual interest payments to be made on June 30 and Dec 31st f each year. Term of the bond indenture allowed to call the bonds at 102 after one year. Bonds were issued when the market interest rate was 8%. Use the effective interest method (GAAP).
Notes:
–Doesn’t matter if the bonds were called or not because the problem asks to calculate the present value of the principal and interest payments.
Compounding periods:
5 year bond paid semiannual is 10 periods for both principal and interest payments
Interest rate (discounting from the future value to present value):
–When calculating the present value of the principal payment/interest payment, we use the market rate on the date the bond was issued.
– Market rate is 8% so you would do 8/2= 4% (interest rate for both principal and interest)
Payment amount:
–When the bond matures, you have to pay the face amount of the bond which is 1,00,000. Principal = face amount.
—Payment amount for the interest: Based on the stated interest rate of the bond (semiannual). so, 1,000,000 x (10%/2) = 50,000
Factor: We’re looking for the present value, we already have the future value. So to calculate the present value from the principal amount use the “present value”.
– Use the “present value interest factor” to calculate the interest payment present value.
To calculate the present value:
Principal: multiply the principal payment amount (face value) by the present value factor
Interest: multiply the interest payment amount by the interest factor.
ordinary annuity: payment at the end of period
Annuity due: Beginning of the period
Interest expense for bond discount vs. Premium
- stated rate is less than effective rate (market) = discount
When bond is issued, discount is debited. When first payment is made, the bond discount is amortized by crediting the bond discount account. Discount amortization will increase interest expense for the period so that interest expense exceeds the interest payment to bondholders.
Interest expense will be greater than the cash payments made to bondholders (discount)
Bond amortization for a premium
– Interest expense decreases each period over the life of the bond using the effective interest method because the amortization of the premium increases each period.
– the overall amortization is the same using both the straight-line and the effective interest methods.
–Interest expense is less than interest payable each period using the straight line and effective methods.
– An equal amount for premium on bond payable is debited for amortization each period under the straight-line method.
Interest expense
interest incurred on a bond issue is always for the period the bonds are outstanding. In this question, the bond will be outstanding from June 1st until December 31st, seven months. Not when the payments are due.
For example, if payment is due Nov 1st, interest expense will still be seven months and not two.
To calculate interest payable
Face value of the bond x the stated rate of interest.
For premium bonds: the amortization of the premium is added to interest expense to derive interest paid.
For discount bonds: The amortization of the discount is subtracted from the interest expense to derive interest paid.
Stated vs effective
Stated rate (nominal): face value x stated rate.
to find the rate: interest payment/ face value
Bond liability
Bond liability is shown on the balance sheet net of unamortized discount.
Land lease
Depreciable property constructed on leased land is depreciated over the life of the property or the term of the lease, whichever is shorter.
Annual depreciation= building cost 840,000/ remaining term of the land lease 20= 42,000
Early retirement of debt
Gains or losses on early retirement of debt must be recognized at the time of the transaction.
The gain (retirement price less carrying amount of the old debt) is not reported net of income taxes
Part of continuing operations
Gain on restructuring (debt modification)
Total future cash payment vs. the carrying amount of the debt
carrying amount - total future cash payments = Gain
Gain (loss) on transfer of real estate
when assets are transferred in a troubled debt restructuring, the asset is adjusted to fair value and a gain or loss is recorded.
Carrying amount of the asset transferred - fair value of the asset transferred.
Bond retirements
A gain or loss on bond retirement is reported in income from continuing ops, not OCI.
Realized loss= original issue price is less than par and retirement cost is above par.
If you retire bonds at more than you issued it far than it is a loss.
If a bond is issued above par (premium) and redeemed below par (result in gain) in continuing ops.
Discount bond redeemed at a premium
gain(loss) = reacquisition price - carrying value. (Anu unamortized bond issuance costs will be deducted from the carrying value at the time the bond is redeemed)
The greater the discount at issuance, the lower the carrying value, the greater the loss upon extinguishment.
Bond payable will be debited at par with the bond is redeemed.
Both gains/losses on bond redemptions are booked on income statement.
Callable bonds
The call price is set at a premium to par.
A callable bond provides an option for the issuer (not bondholder), a puttable bond provides an option for the bondholder.
The issuer has the option of calling the bond, a bondholder will typically require a higher rate of return for callable bonds as a means of compensation for the risk that the bond is called early.
A debtor is relieved of its obligation to pay
only:
1. by paying the creditor
2. Being released of the debt judicially or by the creditor.
Finance lease term
- Ownership transfers at the end of the lease
- Written purchase option the lesseee is reasonably certain to exercise
-PV of minimum lease payments = fair value of asset (approximately 90% of FV of leased property) - Lease Term = Major part (75%) of asset useful life
- Asset is specialized such that it no alternative to use to the lessor
Lessee should amortize the leased property over the economic life of the asset if it meets the ownership transfer or written purchase option criteria.
If not, it should be amortized over the term of the lease.
Recognition of lease expense
Lessee should begin recognizing lease expenses from commencement date (the date the asset is made available to the lessee for use).
Liability for a finance lease is reduced periodically by
the minimum lease payment less the portion of the minimum lease payment allocable to interest.
Minimum lease payment is allocated between principal and interest. Portion allocated to principal reduces the remaining lease liability.
Report lease liability
The implicit rate is used to calculate a finance lease to find the present value rate.
Operating lease expense
Lease expense is not the amount of cash paid. Must be recognized evenly over the life of the lease.
Amortization of leasehold improvements
should be over the life of the improvements or the remaining life of the lease, whichever is shorter.
Calculating lease payments
lease payments include:
- required contractual fixed payments
- exercise price of an option that is reasonably assured
- purchase price at the end of the lease.
- residual guarantees likely to be owed
- termination penalties reasonably assured
lease expense when lease rates fluctuate, and reduced costs are given
The average lease rate must be computed (add all the lease payments and divide by number of payments).
