F6 Flashcards
How should I lease bonus be accounted for as a lessor?
Unearned Income, earned over the life of the lease.
Who is the lessor in a lease transaction?
The entity leasing the equipment out. (owner)
How should leasehold improvements be depreciated?
Over the lesser of:
- ) Life of lease
- ) Life of improvement
Under GAAP, on the lessee side, what is the criteria for finance leases?
(One must be met)
1.) Ownership
2.) Written option for bargain purchase
3.) Ninety % of leased property FV (Pv of lease payments)
4.) Seventy-five % or more of the asset life
Asset is specialized
Easy to remember = Lessee must OWNS it.
Under GAAP, on the lessor side, what is the criteria for fiance leases?
(Must meet all 3)
- ) Lessee owns leased property
- ) Uncertainties don’t exist for un-reimbursable costs
- ) Collectbility of payments is reasonably predictable
Who records depreciation on a finance lease?
The lessee, since they are carrying the asset on their books.
According to GAAP, how should the lessor treat the lease (operating or finance) if the lessee treats it as a finance lease?
It is possible the lessee treats as finance lease while lessor treats as operating lease under U.S GAAP.
See criteria for each to determine.
According to IFRS, how should the lessor treat the lease (operating or finance) is the lessee treats it as a finance lease?
Copy cat rule. If lessee treats as a capital lease, so does lessor.
When should a nonrefundable lease bonus paid by a lessee on signing be recognized by a lessor?
Over the life of the lease.
Can operating lease payments change in amount of the life of the lease?
No. Operating lease expense (rent) must be recorded equally over the life of the lease.
How should finance leases be depreciated by the lessee?
Depends:
If meet the: ASSET LIFE
1.) Ownership
(or)
2.) Written bargain purchase option
If meet the: LEASE LIFE
- ) Ninety % of FV (PV of lease pmts)
- ) Seventy-five % of useful life
**ASSET LIFE will supersede all if O or W satisfied.
What amount of interest should be recorded on an operating lease by a lessee?
No interest on an operating lease.
What is the difference between a Sales-Type lease vs. Direct Financing lease?
Sales Type = Profit on sale
Direct Financing = No profit, only interest income
How would you go about calculating “rent expense” for a finance lease?
No rent expense on a capital lease.
Only booking depreciation on the asset recorded, and interest on the liability recorded.
You have to allocate each payment made for a finance lease, what are you allocating to?
Allocate to interest expense &; liability principal reduction.
Principal reduction is the plug figure after you calculate amount allocated to interest.
At the inception of a finance lease, what amount should the lessee record as the asset & liability? (GAAP)
LESSER OF:
- ) FV of asset @ inception
- ) Cost (pv of minimum lease pmts*)
*3 PV’s to calculate:
a. ) Required pmts (PV of annuity)
b. ) Bargain Purchase Option (PV of $1)
c. ) Guaranteed Residual Value (PV of $1)
**exclude executory costs & optional buyouts
**IFRS includes initial direct costs to be capitalized
What interest rate is used to calculate the PV of the minimum lease pmts?
LESSER of:
- ) Rate implicit in the lease
- ) Lessee’s incremental borrowing rate (available in the market)
How is the effective interest method used to calculate interest expense on a capital lease?
CV @ beg. of period (liab) X Lower Rate = Interest Expense
How do you know how much to allocate as a principal reduction to the liability in a finance lease pmt?
Payment - Interest Expense = Principal reduction (plug)
How would you determine what amount to record a capital lease @ with a bargain purchase option?
Take the PV of all the lease pmts, and add it to the PV of the bargain purchase option.
Compare that to the FV of the asset @ inception, which is lower?
Use that amount.
The liability and asset that come with a capital lease on the lessee side are initially recorded at the same amount, but then the account balances change over time to no longer be the same. Why is that?
Because:
The asset is being depreciated over the asset life or lease life, depending on which criteria satisfied it as a capital lease (OWNS)
The liability is being amortized based on the pmts made. First the pmt needs to allocate to interest exp, and the left over amount will be a reduction of the liability principal.
EACH IS RECORDED INDEPENDENTLY, BUT INITIALLY RECORDED AT THE SAME AMOUNT.
DR: Leased Asset $
CR: Lease Obligation $
What is a sale-leaseback?
The owner sells the property and simultaneously leases it back from the purchaser.
What is the first step in attacking sale-leaseback question on the side of the lessee?
Figure out the mathmatical G/L.
SP - CV =G/L
Next issue becomes can you recognize that, or do you have to defer it.
In a sale-leaseback transaction, what is the treatment of a gain when the PV of rent payments is greater than or equal 90% of the FV of the property?
Defer all gain and amortize with the leased asset.
In a sale-leaseback transaction, what is the treatment of a gain when the PV of rent payments is less than 90% but greater than 10% of the FV of the property?
Operating Lease= Defer gain up to PV of minimum leaseback payments
Capital Lease= Capitalize asset, recognize excess gain immediately.
In a sale-leaseback transaction, what is the treatment of a gain when the PV of rent payments is 10% or less of the FV of the property?
Recognize gain immediately.
What is the significant rule to be mindful of when dealing with the treatment of sale-leaseback transactions? What does it mean?
The “between 10 & 90%” rule.
Provides rules on treatment of a gain if an entity sells something, then leases it right back.
The rules depend on how long they are leasing the leased property for, after they just sold it.
What is an artificial loss in regards to a sales-leaseback transaction, and how is it treated?
When the sales price is below the fair value (should equal if it was arms length)
Loss is deferred because it’s not “real”, and amortized over the lease period.
What derivatives require no initial investment?
Forwards, futures, & SWAPS.
Options require an initial investment.
What is the difference between a forward & a future?
Future = Public (Exchange traded)
Forward = Private (OTC)
What is credit risk in regards to derivatives?
The risk of the other party on the contract not performing according to the terms of the contract.
What is market risk in regards to derivatives?
Risk that the entity will incur a loss on the contract.
What is a put option?
Gives an entity the ability, but not the obligation, to sell at a strike price.
What is a call option?
Gives an entity the ability, but not the obligation, to buy at a strike price.
How do you calculate G/L on an option?
Strike - Price sold = G/L per share
G/L per share X # of shares = Total Proceeds
Total proceeds - Premium paid = Total G/L.
What does it mean to hedge?
To offset risk.
I sell wheat, the price keeps going up on me which is raising my COGS.
I buy a forwards contract (long) on the price of wheat to offset my building COGS with a gain on the contract.
When you buy an option, how is it presented in the FS?
As an asset, no contingent liability.
Ability, but not obligation to buy/sell.
What is the largest amount of loss you can have when entering into an option contract?
The cost of the premium.
No other cash outflows, no other losses can be incurred.
Where is the G/L on a fair value hedge reported? And what is it?
On the income statement.
Own a stock, worried about price dropping, get a put option to cover risk.
Where is the G/L on a cash flow hedge reported?
Effective = OCI
Ineffective = Income Statement
How are derivatives valued on the balance sheet?
@ Fair Value
What is the JE to record the purchase of a forward contract?
No JE recorded until G/L determined since there is no cash inflow/outflow initially.
For your understanding, what is an example of a notional amount?
of shares.
Which G/L gets plugged to OCI?
- ) Foreign Currency Translation G/L
- ) Foreign Currency Remeasurement G/L
Foreign Currency Translation G/L.
Which G/L gets plugged to the income stmt?
- ) Foreign Currency Translation G/L
- ) Foreign Currency Remeasurement G/L
Foreign Currency Remeasurement G/L.
What characterstics makes a currency functional and not need to be remeasured before being translated?
- ) Does their own banking
- ) Not hyper-inflationary
- ) Use that country’s currency (in which they do business in)
Which method (remeasurement or translation) is the balance sheet converted before the income statement?
Remeasurement method.
Which method (remeasurement or translation) is the income statement converted before the balance sheet?
Translation method.
What is the JE to record a translation gain?
DR: Cummulative Translation Adjust
CR: OCI
Which type of differences (perm or temp) between tax and GAAP cause deferred tax assets/liabs?
Temporary - represents a timing difference.
When you are asked what your “current” income tax expense is, what is it asking you for?
Not including deferred items, how much tax attributable to CY.
If 30% tax rate and $650k in taxable income = $195,000 current income tax expense.
Don’t take permanent differences into consideration.
What is the JE to record current tax expense, along with the recognition of a deferred tax liability?
DR: Income Tax Exp
ense $ (plug)CR: Income Tax Payable $ (current portion)
CR: Def. Tax Liab $ (later portion)
What is the JE to record current tax expense, along with the recognition of a deferred tax asset?
DR: Income Tax Expense $ (plug)
DR: Def. Tax Asset $ (later)
CR: Income Tax Payable $ (now)
What happens when you have multiple temporary differences in one year, that create both deferred tax assets & liabilities?
Use “net” amount to book CY income tax expense.
How do you determine income tax expense for the CY?
Current Tax (inc. tax pay)
(+/-) Def. Tax Asset/Liab
= Total Tax Expense for CY
What is an uncertain tax position, and what is the treatment?
An uncertain tax position is a risk position taken on reporting income/deductions to the IRS that might result in an unfavorable reversal by the IRS
Ex: You try to deduct something or allocate income to somewhere with a lower rate, IRS catches on and doesn’t allow it.
Treatment = Reserve account (in case). Acts as an increase to income tax expense as follows:
DR: Income Tax Expense
CR: Income Tax Payable (now)
CR: Deferred Tax Liability (later)
CR: Uncertain Tax Positions (liability)
How are changing tax rates in the future treated?
Reverse temporary differences for the tax rate enacted during the reversal (in future years). Treat as a change in estimate (prospective approach)
On an operating lease, if you make a leasehold improvement to a property as a lessee, what is the accounting treatment?
Capitalize and amortize over the lesser of the lease life or the asset life.
