F4 Liabilities

Question 1

Contingent Liability

Answer 1

A contingent liability that is probable and can be reasonably estimated must be recognized.

If all amounts within a range of values are equally likely, then the lowest the lowest amount in the range is the measurement amount.

Question 2

Gain contingencies

Answer 2

Gain contingencies are recorded when the gain is realized.

Contingencies that might result in gains are not accrued per the principle of conservatism. As this potential favorable outcome is probable, the amount and nature should be disclosed in the notes to the financials.

Question 3

in-substance defeasance

Answer 3

An in-substance defeasance does not extinguish the liability itself; it merely “freezes” the payments of principal and interest until a later time. The debtor is still the primary obligor, so the liability remains on the debtor’s books.

Question 4

Right-of-use (ROU) Asset

Answer 4

A right-of-use asset, also known as an ROU asset, is a key component of lease accounting under accounting standards such as ASC 842 and IFRS 16. It represents the lessee’s right to use a leased asset over the lease term.

Question 5

Employees compensation for future absences

Answer 5

Employees compensation for future absences should be accrued if:

1)The employees’ right to receive compensation is attributable to services already rendered.
2)The liability relates to vested or accumulated rights.
3)Payment is probable.
4)The amount can be reasonably estimated.

Question 6

Vested benefits

Answer 6

A vested benefit is a financial package granted to employees who have met the requirements to receive a full, instead of partial, benefit. Vested benefits include cash, employee stock options (ESO), health insurance, 401(k) plans, retirement plans, and pensions.

Question 7

Employees’ compensation for future absences (mostly vacation) should be accrued if:

Answer 7

1.Services have already been rendered, and
2.The obligation relates to vested or accumulated rights, and
3.The amount can be reasonably estimated, and
4.Payment is probable.

Question 8

Journal Entry - Debt is issued at a discount

Answer 8

Dr: Interest expense
Cr: Amortization of bond discount
Cr: Cash (or interest payable)

Question 9

Types of bonds

Answer 9

Secured Bonds: It has collateral associated with it.

Unsecured Bonds: It has no collateral and interest rates are high. The are called DEBENTURE.

Question 10

Stated Rate of Interest

Answer 10

There are synonyms:
Stated Rate
Face Rate
Coupon Rate
Contract Rate

This is interest rate which is paid during the period.

Question 11

Market Rate of Interest

Answer 11

There are synonyms:

Yield
Effective Interest Rate

Question 12

Annuity

Answer 12

Payment of interest.

Two types of Annuity:

Ordinary Annuity: Payment of interest at end of period

Annuity Due: Present value of maturity value. Paid at the beginning of the period.

Question 13

Common Stock Consolidation

Answer 13

100% of a purchased subsidiary’s shareholders’ equity (including common stock) as of the date of acquisition is eliminated in consolidation.

Question 14

Voting Shares

Answer 14

The key to determining what method to use is to look at the voting shares. The equity method is the most appropriate method to use when the ownership percentage for the voting common stock is 30 percent, regardless of the percentage ownership in non-voting preferred stock.

When the ownership percentage of voting common stock is 15 percent, the cost method is the most appropriate choice.

When the ownership percentage of voting common stock is 10 percent, the cost method is the most appropriate choice.

With 55% ownership of voting common stock, consolidation will be the most appropriate choice.

Question 15

Acquisition Method

Answer 15

When using the acquisition method, 100% of the subsidiary equity accounts are eliminated in consolidation.

Question 16

Fair market value of assets

Answer 16

Assets contributed by partners to a partnership are valued at fair market value of the assets, net of any related liabilities.

Question 17

Credit Risk

Answer 17

An entity should disclose all significant concentrations of credit risk arising from all financial instruments.

Question 18

Bond Investments

Answer 18

The bond investments are classified as trading securities because the bonds are held for the purpose of selling them in the near term. Trading securities are reported at fair value on the balance sheet.

Question 19

Tangible assets (inventory and real estate)

Answer 19

Upon the formation of a partnership, tangible assets (inventory and real estate) would be recorded at fair market value at the date of the investment.

Question 20

Cash flow from operations

Answer 20

Under the indirect method, cash flow from operations increases when current assets decrease and when current liabilities increase. Cash flow from operations decreases when current assets increase and when current liabilities decrease.

Question 21

Trading Debt Securities

Answer 21

Reported at fair value on the Balance Sheet.

Question 22

Bond Investments

Answer 22

Bond investments which are intended to be held until the maturity date are classified as held-to-maturity securities and are reported at their amortized cost.

Question 23

Differences between depreciation for financial reporting purposes and tax purposes

Answer 23

If book basis of asset is greater than tax basis (resulting from different depreciation methods), a deferred tax liability should be established for the tax effect of the difference. In future years the taxable income will be higher than book income when the temporary difference reverses.

Question 24

Temporary Taxable Differences

Answer 24

Under U.S. GAAP, deferred tax liabilities and assets should be classified and reported as a non-current amount on the balance sheet. All deferred tax liabilities and assets must be offset (netted) and presented as one amount (a net non-current asset or a net non-current liability), unless the deferred tax liabilities and assets are attributable to different tax-paying components of the entity or to different tax jurisdictions.

Question 25

When accounting for income taxes, a temporary difference occurs

Answer 25

A temporary difference arises in situations where items of revenue and expense enter into pretax GAAP financial income in a period before or after they enter into taxable income.

Question 26

Trading Debt Securities

Answer 26

Trading debt securities are reported at fair value with unrealized gains and losses included in earnings. Held-to-maturity debt securities are reported at their amortized costs.

Question 27

How are loan origination fees treated in income tax basis accounting?

Answer 27

Loan origination fees are typically deferred and recognized over the period they are deductible for tax purposes.

Question 28

Depreciation (Amortization) expenses - Lease

Answer 28

Depreciable base = Capitalized value of lease (lease payments present value) - Estimated salvage value

Depreciation (amortization expenses = Depreciable base / Estimated life (years)

Question 29

Leased asset depreciation

Answer 29

The asset should be depreciated over the period of expected benefit. Since Besser intends to exercise the purchase option, the depreciable period is four years.

Question 30

Amortization of leasehold improvements

Answer 30

Amortization of leasehold improvements should be over the life of the improvements or the remaining life of the lease, whichever is shorter.

Question 31

Operating lease characteristics

Answer 31

Operating lease characteristics include:

Ownership: Retained by the lessor during and after the lease term.
Bargain purchase options: Operating leases cannot contain a bargain purchase option.
Terms: Less than 75% of the asset’s estimated economic life.
Present value: The PV of lease payments is less than 90% of the asset’s fair market value.
Risks/benefits: Right to use only. Risks/benefits remain with the lessor.

Question 32

Finance lease characteristics

Answer 32

• Ownership transfers at the end of the lease.
• Written purchase option the lessee 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 has no alternative use to the lessor

Question 33

Finance Lease

Answer 33

For a finance lease, the minimum lease payment is allocated between principal and interest using the interest rate inherent in the lease. The portion allocated to principal reduces the remaining lease liability. The process is similar to a home mortgage.

Question 34

Amortization of Lease (Formula)

Answer 34

= Leasehold Improvement / Remaining Life of Lease

Question 35

Amortization of leasehold improvement

Answer 35

Amortization of leasehold improvements should be over the life of the improvements or the remaining life of the lease, whichever is shorter.

Question 36

Bond issued

Answer 36

When a bond is issued, the price is computed as the sum of the present value of the future principal payment plus the present value of the future periodic interest payments. Both cash flows are discounted at the prevailing market rate of interest on the date of issuance.

Question 37

What type of bonds in a particular bond issuance will not all mature on the same date?

Answer 37

Serial bonds are bonds that mature in installments.

Question 38

Employee compensation accrual

Answer 38

Employees’ compensation for future absences (mostly vacation) should be accrued if:

1.Services have already been rendered, and
2.The obligation relates to vested or accumulated rights, and
3.The amount can be reasonably estimated, and
4.Payment is probable.

Question 39

Note payable be presented in the statement of financial position

Answer 39

The correct presentation of a note payable is to show the face amount, less a discount on the liability itself at the imputed interest rate.

Question 40

Bond carrying value rule

Answer 40

Discount or premium on the sale of bonds as well as the bond issuance costs are included in the carrying value of the bonds on the balance sheet.

Question 41

Serial Bonds

Answer 41

Serial bonds are bonds that mature in installments.

Question 42

Term Bonds

Answer 42

Term bonds are issued with a single fixed maturity date.

Question 43

Company issued a financial instrument that unconditionally requires the company to settle the obligation by issuing common stock on the settlement date.

Answer 43

As a liability on the balance sheet.

Certain financial instruments have characteristics of liabilities and equity. Financial instruments in the form of shares that are mandatorily redeemable and represent an unconditional obligation of the issuer to satisfy the obligation by transferring assets at a specified date are presented as liabilities and not equity according to U.S. GAAP.

Question 44

Bond interest and amortization

Answer 44

Amortization over the life of the bond (and per period) will be lower when the coupon rate of the bond is closer to the market rate of comparable bonds at the time the bond is issued.

Question 45

The market value of a bond issued at a discount (or a premium) is the present value of two cash flows.

Answer 45

1.The present value of the principal amount, plus,
2.The present value of all future interest payments,
3.Both at the market (effective) rate of interest.

Question 46

Asset Retirement Obligation (ARO)

Answer 46

An asset retirement obligation (ARO) exists when an asset is constructed and there are legal requirements to incur removal-type costs related to the constructed asset.

Question 47

Callable Bond

Answer 47

Many bonds issued today are callable, which means they can be redeemed by the issuer before the listed maturity date.

An issuer will usually call the bond when interest rates fall

Question 48

Gain or Loss after bond is redeemed

Answer 48

The gain or loss once the bond is redeemed will be booked in income from continuing operations.

Question 49

Deferred revenues’ balance on unperformed service contracts was significantly less in year 2 than the balance for year 1

Answer 49

If Year 2 contracts were signed earlier in the year than before, more warranty work would have been performed by year-end, thus reducing the deferred revenue balance more than in prior years.

Question 50

Warranty recognition and warranty expense

Answer 50

At the date of sale, the warranty costs are probable and estimable and must be recognized.

Warranty expense is incurred because of sale and must be matched with the associated revenues. Warranty liability is reduced as warranty services are performed.

Warranty expense must be recognized on the accrual basis rather than on a cash basis.

Warranty expense is incurred because of the sale and must be matched with the associated revenues rather than allocated over a period of time.