F5 - Liabilities Flashcards
M1 - Payables and Accrued Liabilities
Accrued liability
A liability that requires the periodic payment of interest.
classified as an accrued liability or debt.
M1 - Payables and Accrued Liabilities
Loan payable
A liability that is secured by collateral.
classified as a loan payable.
M1 - Payables and Accrued Liabilities
Deferred Tax liabilities
All deferred tax liabilities are classified as non-current.
M1 - Payables and Accrued Liabilities
Current liabilty
Long-term debt that matures within one year.
unless retirement is to be accomplished with other than current assets.
M1 - Payables and Accrued Liabilities
Short-term obligation scenario
A short-term obligation may be excluded from current liabilities and included in non-current debt if the company has both the intent and the ability to refinance the debt on a long-term basis, as evidenced by an actual refinancing before the issuance of the financial statements, or by the existence of a noncancelable financing agreement from a lender with the financial resources to accomplish the refinancing.
M1 - Payables and Accrued Liabilities
Footnote 2 of SFAS No 6, Classification of Short-Term Obligations Expected to Be Refinanced
“if equity securities have been issued (after the BS date but BEFORE the BS is issued), the short-term obligation, although excluded from current liabilities, shall not be included in owners’ equity.”
Disclosure is necessary for the financial statements not to be misleading.
M1 - Payables and Accrued Liabilities
Matching principle
Expenses are recognized when an entity’s economic benefits are used up.
M1 - Payables and Accrued Liabilities
Employees’ compensation for future absences (mostly vacation) should be accrued if:
- Services have already been rendered, and
- The obligation relates to vested or accumulated rights, and
- The amount can be reasonably estimated, and
- Payment is probable.
These are the reporting requirements for post-employment benefits.
M1 - Payables and Accrued Liabilities
Accrued compensated absences
generally includes “vacation pay” but not “sick pay.”
- Sick pay usually does not vest.
M1 - Payables and Accrued Liabilities
Vacation liability
must be recorded for employees who have earned vacation where rights accumulate and they have not taken the vacation time at year-end.
M1 - Payables and Accrued Liabilities
Vacation expense
is recorded to reflect the amount of vacation earned for a given period, regardless of whether it was taken or not.
M1 - Payables and Accrued Liabilities
Vacation pay
is accrued if it vests or accumulates
M1 - Payables and Accrued Liabilities
Sick pay
is accrued only if it vests
M1 - Payables and Accrued Liabilities
Costs to relocate employees
costs associated with exit and disposal activities
M1 - Payables and Accrued Liabilities
A liability is only recognized when:
- An obligating event has occurred.
- The event results in a present obligation to transfer assets or to provide services in the future.
- The entity has little or no discretion to avoid the future transfer of assets or providing of services.
An entity’s commitment to an exit or disposal plan, by itself, is not enough to result in liability recognition.
M1 - Payables and Accrued Liabilities
When an Asset Retirement Obligation (ARO) exists
the entity should record an asset retirement cost (ARC) which increases the carrying value of the long-lived asset as well as an asset retirement obligation (ARO), which is the liability recorded on the BS related to the retirement.
The amount recorded to both the asset and liability will be equal to the FV of the ARO (which is determined by discounting the future cash flows required).
M1 - Payables and Accrued Liabilities
Asset Retirement Cost
(ARC)
The ARC will be depreciated over the useful life of the related asset while the ARO will be “accreted” based on the relevant accretion rate.
M1 - Payables and Accrued Liabilities
When an Asset Retirement Obligation (ARO) exists
An ARO exists when an asset is constructed and there are legal requirements to incur removal-type costs related to the constructed asset.
- The discounted value will be recognized in the financial statements on the date the asset is placed into service.
It will be recorded as a libaility when the asset is put into service.
- No expense is recognized initially.
- The ARO will increase the value of the asset and depreciation expense will be recorded over the life of the asset, which will include the expense related to the ARO.
M1 - Payables and Accrued Liabilities
Change in value of the liability
Change in liability
should be booked as a profit/loss on the Income Statement rather than going into OCI on the BS.
after the property has been fully depreciated will be recognized in P&L.
The change in the liability will be booked as profit/loss regardless of whether it increases or decreases
M1 - Payables and Accrued Liabilities
Accretion expense
is the increase in the ARO liability due to the passage of time.
M1 - Payables and Accrued Liabilities
The credit adjusted interest rate is used to calculate the ARO
Beginning ARO x Risk-adjusted rate
M2 - Contingencies and Commitments
Contingency
is an existing condition, situation, or set of circumstances involving uncertainty as to possible gain (gain contingency) or loss (loss contingency) that will ultimately be determined when a future event occurs or fails to occur.
The resolution may result in the acquisition of an asset, the reduction of a liability, the loss or impairment of an asset, or the incurrence of a liability.
M2 - Contingencies and Commitments
Gain contingencies
are not reflected in the financial statements because to do so may cause recognition of revenue prior to its realization.
An entity should disclose a contingency that might result in a gain in the notes to the financial statements, but should be careful to avoid misleading implications about the likelihood of realization.
M2 - Contingencies and Commitments
Gain contingencies
are claims or rights to receive assets whose existence is uncertain but may become valid upon the occurrence of future events.
Gain contingencies are recorded when the gain is realized.
M2 - Contingencies and Commitments
Gain contingencies
Gain contingencies which are reasonably possible (or probable) and for which an amount can be reasonably estimated, should not be “accrued” but should be disclosed in a note to the financial statements in a manner that does not give the impression that realization of a gain is likely.
M2 - Contingencies and Commitments
What is the underlying concept governing the generally accepted accounting principles peratining to recording gain contingencies?
Conservatism
The accounting concept of conservatism applies: “anticipate all losses but not gains.”
M2 - Contingencies and Commitments
Gain contingencies
should be disclosed in the notes unless the likelihood of the gain being realized is remote.
The full range of possible settlements should be disclosed.
M2 - Contingencies and Commitments
Loss contingencies
the recognition in the financial statements depends on the likelihood that future events will confirm the contingent loss.
M2 - Contingencies and Commitments
Likelihood of Loss contingencies
GAAP classifies the likelihoof as follows:
- Probable - likely to occurr. (Record)
- Reasonably possible - more than remote, but less than likely. (Disclose)
- Remote - slight chance of occurring. (Ignore)
M2 - Contingencies and Commitments
Loss is Probable and can be Reasonably Estimated:
DR: Expense
CR: Liability
Record Journal Entry
M2 - Contingencies and Commitments
Loss is Probable and can be Reasonably Estimated:
if both conditions are met:
1. It is probable that as of the date of the financial statements an asset has been impaired or a libaility incurred
2. The amount of loss can be reasonably estimated
M2 - Contingencies and Commitments
Loss is Probable and can be Reasonably Estimated:
- The amount of loss can be reasonably estimated:
- In the event that a range of probable losses is given, GAAP requires that the best estimate of the loss be accrued.
- If no amount in the range is a better estimate than any other amount within the range, the minimum amount in the range should be accrued,
- and a note disclosing the possibility of any additional amount of loss should be presented.
M2 - Contingencies and Commitments
Loss is Reasonably Possible
If reasonably possible that a loss or an additional loss may have been incurred, disclose:
- the nature of the contingency
- an estimate of the possible loss or range of loss, or a statement that an estimate cannot be made.
Footnote disclosure (do NOT record JE)
M2 - Contingencies and Commitments
Loss is Remote
No disclosure is necessary, however, disclosure should be made for “guarantee-type” remote loss contingencies, such as:
- Debts of others guaranteed (officers/related parties)
- Obligations of commercial banks under standby letters of credit
- Guarantees to repurchase receivables (or related property) that have been sold or assigned
Neither Record nor Disclose (Ignore)
D O G - Exception = Disclosure
M2 - Contingencies and Commitments
Provision of a loss contingency
Even if a pending litigation is not known to management until after the financial statement date (a subsequent event), as long as the financial statements have not been issued, the contingency should be recorded to fairly reflect the financial statements at year-end, assuming that the liability existed at year-end.
M2 - Contingencies and Commitments
What method should a company use to account for a contigent liability when the loss is probable but not reasonably estimated?
The liability should only be disclosed in the notes to the financial statements.
A contingent liability that is probable but CANNOT be reasonably estimated should be disclosed in the financial statements but not recorded as an adjustment in the financial statements.
M3 - Long-Term Liabilities
non-interest bearing note
- should be recorded at its present value calculated using the prevailing market interest rate.
- the market interest rate is then used to calculate interest on the note.
M3 - Long-Term Liabilities
Annuity due
payments occur at the beginning of each period.
M3 - Long-Term Liabilities
Ordinary annuity
payments are made at the end of each period.
also called “annuity in arrears”
M3 - Long-Term Liabilities
Present value of $1
The present value of $1 is the amount that must be invested now at a specific interest rate so that $1 can be paid or received in the future.
M3 - Long-Term Liabilities
How to calculate Present Value
Method 1
Present value = Future value x Present value of $1 for appropriate n and r
- PV factor = 1 / (1 + r)^n
n = Number of periods (quarterly)
r = Periodic interest rate (quarterly)
M3 - Long-Term Liabilities
How to calculate Present Value
Method 2
PV = FV x 1 / (1 + r)^n
n = Number of periods (quarterly)
r = Periodic interest rate (quarterly)
M3 - Long-Term Liabilities
How to calculate Future Value
- FV = PV x FV of $1 for appropriate n and r
- FV = PV x (1 + r)^n
n = Number of periods (quarterly)
r = Periodic interest rate (quarterly)
M3 - Long-Term Liabilities
Present value of Ordinary Annuity
= Annuity payment x Present value of ordinary annuity (end) of $1 for appropriate n and r
PVFOA
M3 - Long-Term Liabilities
Present value of an Annuity Due
= Present value of ordinary annuity x (1 + r)
M3 - Long-Term Liabilities
Future value of an Ordinary Annuity
= Periodic payment x Future value of an ordinary annuity of $1 for appropriate n and r
M3 - Long-Term Liabilities
Trade notes and accounts receivable with customary trade terms
Trade notes and accounts receivable with customary trade terms not exceding one year may be recorded at face amount.
M3 - Long-Term Liabilities
The discount resulting from the determination of a note payable’s present value should be reported on the BS as a (an):
The discount on a note payable should be reported on the BS as a direct reduction from the face amount of the note.
M3 - Long-Term Liabilities
How should a note payable be presented in the statement of financial position?
The correct presentation of a note payable is to show the face amount, less a discount in the liability itself at the imputed interest rate.
M3 - Long-Term Liabilities
Bonds or notes due within one year:
- are shown as “noncurrent” if the issuer has the intent and ability to refinance with a new issuance of long-term debt.
- This intent and ability must usually be demonstrated through refinancing of the debt after the balance sheet date, but before the issuance of the financial statements.
Separate disclosure of the refinancing is required.
M3 - Long-Term Liabilities
Normally, interest is imputed when no (or an unreasonably low) rate is stated.
An exception exists for receivables and payables arising from transactions with customers or suppliers in the normal course of business when the trade terms do not exceed one year.
M3 - Long-Term Liabilities
Certain financial instruments have characteristics of liabilities and equity.
Financial instruments in the form of shares that are mandatory 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.
M3 - Long-Term Liabilities
Loan origination fees
shall be deferred and recognized over the life of the loan as an adjustment of interest income (similar to the treatment of bond discount amortization).
M4 - Bonds: Part 1
Serial bonds
- are pre-numbered bonds that the issuer may call and redeem a portion by serial number.
- are issued with scheduled maturities at various dates.
M4 - Bonds: Part 1
Debentures
are unsecured bonds.
M4 - Bonds: Part 1
Term bonds
are bonds that have a single fixed maturity date.
M4 - Bonds: Part 1
Variable rate bonds
have interest rates that change.
M4 - Bonds: Part 1
Bond sinking fund
is a fund that a company contributes cash to each period so that it has enough to pay of the bond at maturity.
M4 - Bonds: Part 1
Bond liability
is shown on the balance sheet net of unamortized discount.
M4 - Bonds: Part 1
The market value of a bond issued at a discount (or a premium) is the present value of two cash flows.
- The present value of the principal amount, plus
- The present value of all future interest payments,
- Both at the market (effective) rate of interest.”
M4 - Bonds: Part 1
To determine the market price of a bond
the present value of the principal is added to the present value of all interest payments, using the market interest rate.
M4 - Bonds: Part 1
Interest expense on a bond payable
- is the combination of interest paid and the amortization of either the discount or the premium.
- ## The interest payments (assuming a fixed-rate bond) will be the same every period.
M4 - Bonds: Part 1
Interest expense
Interest expense is calculated by multiplying the market interest rate at the time of issuance by the beginning carrying value of the period.
M4 - Bonds: Part 1
The bond premium is amortized
- The bond premium is amortized over the life of the bond with amortized amounts decreasing interest expense each period.
- If interest expense is not appropriately decreased, then interest expense will be overstated.
- The overstating of interest expense will lead to understatement of net income, which is then closed to stockholder’s equity.
M4 - Bonds: Part 1
Bond issuance costs
- are deducted from the carrying value of the liability and included in the debit entry to bond discount upon issuance.
- As part of the discount from par, bond issuance costs are amortized over the life of the bond using the effective interest method.
M4 - Bonds: Part 1
Costs associated with the issuance of bonds
All costs associated with the issuance of bonds should be amortized over the “outstanding” term of the bonds.
M5 - Bonds: Part 2
How would the carrying amount of a bond payable be affected by amortization of..?
- Discount - Increase
- Premium - Decrease
- Over time, the carrying amount of a bond sold at a discount will increase, whereas the carrying amount of a bond sold at a premium will decrease.
- The carrying amount of a bond liability on the balance sheet is the face plus unamortized premium or less on amortized discount.
- Amortization causes the carrying value to approach the face value.
M5 - Bonds: Part 2
Amortization of premium on bonds payable
- The amortization of premium on bonds payable reduces both interest expense and carrying value.
- If the amortization were not done, both interest expense and carrying value would be overstated.
M5 - Bonds: Part 2
Interest payable on a bond
is calculated by taking the face value of the bond at the beginning of the period and multiply this amount by the contractual ineterest rate.
M5 - Bonds: Part 2
When a discount on a bond or note is amortized
the discount amortization increases interest expense for the period.
M5 - Bonds: Part 2
When debt is issued at a discount
interest expense over the term of the debt equals the cash interest paid plus amortization of the discount.
M5 - Bonds: Part 2
When debt is issued at a discount
DR Interest expense
CR Amortization of bond discount
CR Cash (or interest payable)
- An easy way to remember whether to add or subtract is that the discount is a reduction (DR) of the bond’s face value or par amount (CR).
- Since the discount is a debit, the way to reduce (amortize) it is to credit it.
M5 - Bonds: Part 2
effective interest amortization method
When the effective ineterest amortization method is used to amortize a bond issued at a discount, the ending carrying amount of the bond is equal to the beginning carrying amount plus the discount amortized during the current period.
M5 - Bonds: Part 2
Stated Rate < effective rate
the bond is issued at a discount
M5 - Bonds: Part 2
Effective rate > Stated Rate
the bond is issued at a premium
M5 - Bonds: Part 2
Unamortized discount on bonds payable
The unamortized discount on bonds payable is a contra to bonds payable
- It is presented on the BS as a direct reduction from the face value of the bonds to arrive at the bond’s carrying value of the bond increases.
- As the discount is amortized, the discount increases and the carrying value of the bond increases.
M6 - Troubled Debt Restructuring and Extinguishment
troubled debt restructuring
A troubled debt restructuring is one in which the creditor allows the debtor certain concessions to improve the likelihood of collection that would not be considered under normal corcumstances.
M6 - Troubled Debt Restructuring and Extinguishment
Concessions
could include items such as reduced interest rates, extension of maturity dates, reduction of the face amount of the debt, and reduction of the amount of accrued interest.
- The concessions must be in light of the debtor’s financial difficulty, and the objective of the creditor must be to maximize recovery of the investment.
- Troubled debt restructurings are often the result of legal proceedings or of negotiation between parties.
M6 - Troubled Debt Restructuring and Extinguishment
Recognize Gain/Loss
FV asset transferred - NBF asset transferred = Gain/Loss
M6 - Troubled Debt Restructuring and Extinguishment
Recognize Gain
Carrying amount of the payable - FV asset transferred = Gain
M6 - Troubled Debt Restructuring and Extinguishment
Transfer of Equity interest
The difference between the carrying value of the payable and the FV of the equity interest is recognized as a gain (gain on restructuring of debt) under U.S. GAAP.
Carrying amount of the payable - FV equity transferred = Gain
M6 - Troubled Debt Restructuring and Extinguishment
Gain
Carrying amount - Total future cash payments
M6 - Troubled Debt Restructuring and Extinguishment
A loan is impaired when?
- A loan is impaired when it is probable that a creditor will be unable to collect all amounts due (including both principal and interest) according to the contractual terms of the loan agreement.
- When a loan is impaired and foreclosure is not probable, the creditor should measure impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate.
M6 - Troubled Debt Restructuring and Extinguishment
How should the creditor measure impairment?
the creditor may measure impairment based on:
1. a loan’s observable market price, OR
2. the FV of the collateral if the loan is collateral dependent.
If foreclosure of a loan is probable, impairment must be measured based on the FV of the collateral.
M6 - Troubled Debt Restructuring and Extinguishment
M6 - Troubled Debt Restructuring and Extinguishment
How is a debtor relieved of its obligation?
A debtor is relieved of its obligation to the creditor only by:
1. Paying the creditor
2. Being released of the debt judicially or by the creditor
Considering debt as “extinguished” (defeasing debt) by placing cash in an irrevocable trust is not GAAP for “extinguishment of debt”.
