F5 Leases, Liabilities & Bonds

Question 1

Define in-substance defeasance.

Answer 1

An arrangement in which a company places purchased securities into an irrevocable trust and pledges them for the future principal and interest payments on its long-term debt

The Co. remains the primary obligor; therefore, the liability is not considered extinguished.

Question 2

Outline the accounting by the seller-lessee in a sale-leaseback transaction under IFRS.

Answer 2

If sale-leaseback results in a finance lease, defer profit and amortize over the lease term

If sale leaseback results in an operating lease, profit or loss is recognized based on the relationship between the leased asset’s carrying amount, fair value, and selling price.

Question 3

Name two methods of amortizing bond premiums (discount).

Answer 3

Straight line - premium (discount) / # of periods outstanding

Interest (effective rate) method (GAAP/IFRS)

• Premium (discount) amortized = (carrying value * effective rate) - (face value * stated rate)
• Interest expense = (face value * stated rate) + discount amortized
• premium amortized = carrying value * effective rate.

Note: straight line is permitted under GAAP if not materially different from effective interest method. It is prohibited under IFRS.

Question 4

When is a bond issued at a discount? a premium?

Answer 4

A bond is issued at a discount when the coupon/stated interest rate is less than the market/effective rate

Premium - when the bond interest rate is greater than the market rate of interest

Question 5

What is the difference between an ordinary annuity and an annuity due?

Answer 5

timing of payments: ordinary annuity - payments are at the end of each period

annuity due - payments are at beginning of each period.

Question 6

ID three classifications used with respect to the seller-lessee’s rights retained in a sale-leaseback under US GAAP

Answer 6

Substantially all rights retained

• PV of rent payments is equal to or greater than 90% of the FV of the property
• gain is deferred and amortized

Rights retained are less than substantially all but greater than minor:

• PV of rent payments is less than 90%, but greater than 10% of the FV of the property
• gain deferred up to the present value of lease payments (operating lease) or capitalized asset (capital lease); excess is recognized immediately.

Minor portion of rights retained

• PV of rent payments is 10% or less of the FV of the property
• entire gain recognized

In all cases, losses (NBV>FV) are recognized immediately

Question 7

Name the criteria for determining if a lease is a capital lease for the lessee under GAAP (OWNS)

Answer 7

Ownership transfer
Written bargain purchase option
Ninety - PV of minimum lease payments is equal to or greater than 90% of FMV of assets
Seventy five - lease term equals or exceeds 75% of estimated useful life.

Question 8

Name the criteria for determining if a lease is a capital lease for the lessor under GAAP (LUC)

Answer 8

Lessee “owns” the leased property
Uncertainties do not exist regarding any nonreimbursable costs incurred by the lessor
Collectibility of the lease payments is reasonably predictable

Question 9

How are convertible bonds accounted for when issued under IFRS and GAAP?

Answer 9

GAAP - like nonconventional bonds; no separate recognition of the conversion feature

IFRS - both a liability (bond @ FV) and equity (difference between proceeds and FV recognized.

Question 10

How is the bond selling price computed?

Answer 10

= sum of PV of the future principal payments + the PV of periodic interest payments discounted using the market/effective rate on the date the bonds are issued.

Question 11

In an operating lease, give the treatment of a lease bonus, from both the lessor’s and the lessee’s perspective.

Answer 11

Lessor - lease bonus is deferred and amortized as income over the life of the lease

Lessee - lease bonus is capitalized and amortized as an expense over the life of the lease

Question 12

What is the preferred method of accounting for bond issue costs under US GAAP and IFRS?

Answer 12

GAAP - capitalized as a deferred charge (asset) and amortized to expense over the period the bond is outstanding using the straight-line method

IFRS - deducted from the carrying amount of the liability and amortized using the effective interest method.

Question 13

Describe the two methods of accounting for the conversion of convertible bonds

Answer 13

Book value method (GAAP) - no gain/loss is recognized

Market value method (Not GAAP) - gain/loss is recognized for the difference between market value stock and book value of bond

Question 14

What is the difference between sales-type and direct-financing leases (lessor finance leases)?

Answer 14

Sales type - gives rise to manufacturer’s or dealers P&L, FV differs from cost or carrying value

Direct-financing - FV is same as cost or carrying value @ beginning of the lease term

Question 15

How is the G/L on early extinguishment of debt treated?

Answer 15

Ordinary G/L on I/S shown as separate line item, if material, in income from continuing operations, unless it meets the criteria of unusual in nature and infrequent in occurrence, in which case it is treated as an extraordinary item and reported net of tax below income from continuing operations.

G/L is difference between net carrying value (including unamortized bond issue costs asset (GAAP only) and premium or discount) and the reacquisition price.

Question 16

Identify the types of leases from the lessor’s perspective under IFRS and GAAP

Answer 16

Capital (Finance) leases - sales type; gives rise to manufacturer’s or dealers P&L, FV differs from cost or carrying value.

Direct financing; FV is the same as cost or carrying value @ beginning of lease term.
IFRS does not use terms “sales type” and “direct financing”

Operating - all other leases are simple rental agreements in which the lessor debits cash/rent receivable and credits rental income

Question 17

Name the criteria for determining if a lease is a financing lease for the lessee and the lessor under IFRS

Answer 17

Lessee and lessor classify a lease as a finance lease if the lessor transfers substantially all the risks and rewards of ownership to the lessee

Question 18

Define stock warrants

Answer 18

Option contracts that are issued with, and are usually detachable from, bonds and notes. Give the bondholder the right to buy stock at a fixed price within a specific time period.

Question 19

When is a liability considered extinguished?

Answer 19

If either one of the following conditions is met:

• if the debtor pays the creditor and is relieved of its obligations for the liability
• if the debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor.

Question 20

Describe the two methods of accounting for bonds with detachable stock purchase warrants.

Answer 20

Warrants only method - warrants are valued at FV in stockholders equity; residual of bond proceeds is assigned to the bonds

Market value method - bond proceeds are allocated to the bonds and warrants according to their relative fair values

Question 21

How does the lessee record the capital lease?

Answer 21

At lower of FV or PV of minimum lease payments, using the lower of lessee’s incremental borrowing rate or the rate implicit in the lease, if known by the lessee.

Note: minimum lease payments include payments, bargain purchase option and guaranteed residual value. They do not include executory costs or an optional purchase

Question 22

Name two methods of accounting for the conversion of convertible bonds

Answer 22

Book value method (GAAP) - no G/L is recognized

Market value method (Not GAAP) - G/L is recognized for the difference between the market value of stock and book value of bond.

Question 23

What period of benefit does the lessee use to depreciate the leased asset under a capital lease?

Answer 23

The estimated economic life of the asset is used if the lessee takes ownership or there is a bargain purchase option

Otherwise, the lease term is used.

Question 24

What are the lessee’s major footnote disclosures for capital leases under US GAAP?

Answer 24

1- gross amount of assets capitalized by major property categories
2- future minimum lease payments in the aggregate and for each of the next five years.
3- Amount of imputed interest to reduce net minimum lease payments to present value

Question 25

Identify two types of leases from the lessee’s perspective under IFRS and US GAAP

Answer 25

Capital (GAAP)/Finance (IFRS)
- transfers substantially all of the benefits and risks inherent in ownership of property to the lessee. In substance, an installment purchase; the lessee accounts for the lease as an acquisition of an asset and a related liability

Operating (GAAP & IFRS)
- all other leases are simple rental agreements in which the lessee debits rent expense and credits cash/rent payable

Question 26

What are the major disclosures for long-term debt?

Answer 26

1- maturity dates
2- interest rates
3- Call and conversion privileges
4- Assets pledges as security
5- Future sinking fund payments
6- maturities for each of the next five years.