F6 Flashcards
Lessor
Owner
Lessee
Renter
Leasehold Improvement
Something permanently affixed to rental property that reverts to the lessor when lease is finished
Lease Bonus
Prepayment for future expenses (down payment on rent) amortized using the strait-line method over the life of the lease
Rent kicker
Premium rent payment, like a % of sales
Refundable security deposit account (lessee)
Refundable deposits
Nonrefundable security deposit account (lessee)
Prepaid expense
Refundable security deposit account (lessor)
Liability
Nonrefundable security deposit account (lessor)
Unearned revenue
Lease bonus (lessor account)
Unearned revenue amortized strait line over the life of the lease
Who recognizes depreciation under an operating lease?
Lessor
When does rent income begin to be recognized?
When the lease period begins, even if the first months of the lease the rent is waived
Rent Kicker is a ____ expense
Period
Operating Lease does not require what transactions?
Does NOT require the following for the lessee: Depreciation, asset, interest expense,
What is deferred rent expense?
The accumulated difference between rent expense and rent payable - confusing terminology. Does NOT increase rent expense (which will stay the same throughout the life of the lease)
For an operating lease, what do you need to calculate lessee lease expense?
(Total lease cost / months of lease) + depreciation of leasehold improvements + amortization of lease bonus + lease kicker if applicable
Is the rent kicker disclosed in the notes of the lease?
No - only the minimum required lease payments are disclosed
What are the first two things you must answer on a lease MC question?
Is it a capital lease or an operating lease?
Am I dealing with the lessee or the lessor?
IFRS calls a capital lease a ___ lease
Financing
Two types of capital leases in the US
Sales-type and direct financing lease
Capital vs operating lease concept difference
Capital lease is treated as a sale on credit
Lessee records asset / liab / Depr / interest
Type types of capital lease methods for lessor
Sales-type and direct financing
OWNS
If meets one of these four conditions, it’s a capital lease
Ownership transfers at lease end
Written bargain purchase option
Ninety percent rule
Seventy-Five Percent Rule
Ninety percent rule (lease)
PV of lease payments is >= 90% of fair value of leased property
75% rule (lease)
If lease term is >= 75 % of useful life, capital lease
N and S tests of OWNS cannot be used if a lease begins within the last ___ of the original estimated economic life of leased property
25%
Which test in OWNS takes the longest to calculate?
90% test
Is it possible for the lessee to classify a lease as a capital lease while the lessor classifies the SAME lease as an operating lease?
Yes! But ONLY in GAAP
IFRS, lessor copies lessee
Two additional criteria that a lessor must meet to classify a lease as a capital lease
No uncertainties exist regarding unreimbursable costs and
collectibility of the lease payments is reasonably predictable
LUC (lease)
Lessee “owns” the property (meets one of OWNS)
Uncertainties do NOT exist regarding unreimbursable costs to be incurred by lessor
Collectibility of the lease payments is reasonably predictable
IFRS difference from GAAP on capital leases (whether to capital lease or operating lease)
Lessor accounting follows the lessee accounting - if capital lease for lessee, then capital lease for lessor
Sales type lease accounting treatement
Profit
Income on note
FV > CV
Direct financing lease
No profit, just interest income
FV of a lease
The selling price (unless indicated otherwise)
Copy cat rule (IFRS)
If lessee meets criteria of capital lease, lessor accounts the same way
A capital lease is recorded by lessee as the lesser of
Fair value at lease inception
- or -
Present value of minimum lease payments
What is included in the PV of the minimum lease payments?
- Required payments (annuity)
- Bargain Purchase Option
- Guaranteed Residual Value
Exclude from PV of minimum lease payments:
Executory costs (insurance, maintenance, taxes)
Optional Buyout (Not required and Not a bargain)
IFRS difference when calculating PV of minimum lease payments
IFRS includes INITIAL direct costs
Executory costs
Insurance, maintenance, taxes
Optional buyout is neither a
Bargain purchase nor required
If the O or W in OWNS is satisfied, what period to depreciate over?
Asset useful life
If the O and the W are NOT satisfied, but the N and the S are, what period to depreciate over?
Lease life
Will lease asset and lease obligation always have the same balance?
No. They will amortize at different rates as the depreciation rate will be different than the effective interest rate
When is principal reduced?
On payment. Not when interest is accrued.
If there is an annuity due what is the first thing you need to think
First payment is a direct reduction to the principal
Any time there is a profit on sale for a capital lease, lessor records as a
Sales type lease
Unearned interest income for a sales type lease is what kind of account?
Special account:
Contra-lease Receivable
Lessor gross payment calculation
Sum of the lease payments (undiscounted cash flows) + unguaranteed residual value
LUG
Lessor records AR of sales type lease at
Gross Receivable (undiscounted cash flows)
The unearned interest revenue is calculated at
[ Minimum lease payments + Unguaranteed residual value ] * PV
LUG * PV
Sales type lease JE
AR (gross)
Unearned Income
Sales
Cost of Goods Sold
InventoryWhat do the minimum lease payments include?
Periodic lease payments
Bargain purchase option -or-
Guaranteed residual value
Will there ever be a bargain purchase option AND a guaranteed residual value?
No - mutually exclusive
How many JEs for a sales type lease and a direct financing lease?
Sales type = 2
Direct financing = 1
Direct Financing Lease JE
Lease Receivable
Unearned Interest Revenue
Asset
What is the carrying amount of the Receivable for a direct financing lease at signing date?
Cost of the asset sold
Carrying amount of Receivable for direct financing lease vs sales type lease at signing date
Direct financing lease - cost of asset
Sales-type lease - sale price
What are the three lessers do lessee accounting?
Depreciation: lesser of the lease life or the asset life (operating)
Interest Rate: lesser of the implicitrate or the borrower’s rate (capital)
Initial carrying value: lesser of FV or PV of min lease pmts (capital)
With the PV factor and the PV, how do you solve for annual pmts?
PV / PV factor for annuity = annual pmts
Algebra
Lessor - PV of lease Receivable is equal to the
FV of asset if profit
CV of asset if no profit
Difference between interest expense and interest payment for bonds is broken down between
Cash paid and amortization of discount / premium
Difference between cash paid for a note and interest expense is
Reduction in principle
Are taxes used in calculating the PV of minimum lease pmts?
No
In a capital lease, the interest revenue recognized by the lessor changes over time how?
Over time the carrying value of the lease goes down and therefore the interest revenue goes down along with it
Think about it: as principal balance goes down, interest expense / income decreases
If the fair value at the end of the lease term is double the cost of a purchase option, is that abnormal purchase option or a bargain purchase option
FV > purchase option = bargain
The PV of the minimum lease payments is equal to the FV of the asset, do we classify as operating or capital lease?
Capital
For the lessee, does principal reduction of the leased asset affect the carrying value of the asset?
No, only depreciation expense
CV of lease asset and lease obligation affected by the following
Asset: depreciation expense
Liability: principal payment
Lessee keeps in current liabilities for their capital lease the
Amount of principle to be REDUCED in the next year
Is residual amount to be paid by a third party included in the PV of the min lease pmts by the lessor?
No!
The fair value at the end of the lease should be used to calculate what?
Salvage value for calculating depreciation
COGS for a sales-type capital lease lessor side is equal to the
Cost of asset LESS PV of unguaranteed residual value
What are the first three things you must determine for a lease problem?
- Lessor or lessee?
- Operating or Capital?
- OA or AD?
IFRS, PV of minimum lease pmts includes
Initial direct costs
PV factor for an ordinary annuity can also be used for an annuity due to find
PV of min lease pmts LESS the first immediate pmt
So you can find the PV of min lease payments by:
PV of AD for n payments = PV of OA for n - 1 payments + first payment
PV of min. Lease pmts = 10% of FV means lease is ____
Operating
Does the 10-90 rule apply to IFRS?
No, unique to US GAAP
Artificial loss
Sales Price < Fair Value
Real Economic Loss
FV < BV
In a sales-leaseback if you are satisfying the S test, you are probably also satisfying the
N test, which means defer all gain
A sales-leaseback without PV factors, look at the
Term
> 80%? - probably defer all
<10% - recognize all immediately
For sales-leaseback, when to recognize a loss?
Immediately UNLESS
Sales Price < Fair value, then defer loss
Sales-leaseback, long term lease, PV of min lease pmt >= 90% of the FV
What to do with gain?
Defer all
Sales-leaseback, short term lease, PV of min lease pmt <= 10% of the FV
What to do with gain?
Fully recognize
10 to 90 Rule
For sales-leaseback, when PV of min lease pmts > 10% of FV and < 90% of FV, defer up to PV of min lease pmts and recognize any excess
Capital leaseback, life over which to amortize gain
Proportion to amortization of leased asset
Operating leaseback, life over which to amortize gain
Proportion to the gross rental expense over the life of the lease
Steps for Sales Leaseback
Step 1: Math - find gain or loss
Step 2: apply the rules
IFRS sales leaseback
Capital leaseback - defer
Operating leaseback - recognize unless SP > FV, in which case defer
Deferred gain from a sales-leaseback is put in what kind of account?
Asset valuation allowance
OFFS
Options, Forward, Futures, and Swaps
Of the OFFS, which has the cash outflow for initial investment?
Options, the others do not require any cash outlay at the start
Underlying
What we are gambling on that will change in value?
Interest rate
Security
Commodity
Foreign exchange rate, etc.
Buy a call, you hope Price goes which direction?
Up
Buy a put, hope price goes which direction?
Down
Strike price
Exercise price
Call option
Option holder can BUY from the seller at a predetermined price (strike price) during a specified period of time
“It’s your call”
Put option
Holder has the right to SELL the option writer at the strike price during the specified period
“Put” someone else up to
What derivatives have no initial costs?
Forwards, Futures, and Swaps
What is the difference between futures and forwards
Futures - Public
Forwards - Private
Futures has ‘u’s in it like public has a ‘u’
Derivative instruments are measured at
Fair value
Fair value hedge
Hedge against the risk that the FV of an asset you have’s fair value will decrease
What is a long position?
Agreement to buy the underlying at the strike price
What is a short position?
Agreement to sell the underlying at the strike price
How do you “win” on a long position?
If price goes up, you get to buy less than FV, thus saving money
How do you “win” on a short?
If price goes down, you get to sell higher than FV
How do you win on a swap?
You hope what you receive is greater than the value of what you have to pay
Spot price
Price of underlying at measurement date
Fair value hedge - risk
You are worried about the change in value of an asset or liability
Cash flow hedge - risk
Worried about the change in actual cash in or out
When will the gain in AOCI be recognized in Earnings?
When the inventory associated with the hedge is sold to customers (matching principle).
The gain from the hedge offsets the cost of inventory and thus is recognized when the cost of inventory hits the income statement
What kind of account is a cash flow hedge or a fair value hedge
Similar to an estimated / actual loss contingency
Either a Receivable (if winner) -or- a liability (if loser)
Where do Hedges typically appear on cash flow statement?
Same category as whatever is being hedged
Speculation
Derivatives that aren’t a hedge, but are a TS, AFS, or HTM investment
Fair value hedge implies what?
Already have asset or liability on the books
A fair value hedged must be specifically identified to a
Hedged asset / liability / or unrecognized firm commitment
Sell side derivative is called a
Put / short
Buy side of the derivative is called the
Call option
Long
How to make money on a swap
Hope what you receive is greater than what you will pay
Cash flow hedges can be associated with a / an
Asset, liability, or forecasted transaction
An option contract is measured at fair value via
Difference in time value of the option plus difference in market value of the underlying
Do NOT ignore the time value of the option
If calculating a gain or loss on a forward contract use
Use the change in the forward rate to determine gain or loss b/c this is calculated based on the spot rate
Historical Exchange Rate
Used for Equity accounts
Weighted average exchange rate
Used for IS accounts
And
Inventory acquired evenly throughout the year
Functional currency
- Use that country’s currency
- Self contained (do own banking)
- Not hyperinflationary
Hyperinflationary
Exchange rate doubled in last 3 years
Remeasurement gain / loss
Income statement
Translation gain / loss
Balance sheet - AOCI
Cumulative translation adjustment
Monetary item
Fixed - immune to changes in price like AR
Nonmonetary
Fluctuate
A/D - monetary or nonmonetary?
Contra accounts use same category as their parent account
Dysfunctional
Hyperinflationary or dependent on parent or in general doing something crazy (books not in functional current etc.)
Remeasurement steps
- Convert BS - find RE plug
2. Convert IS - currency exchange is plug for net income
For remeasurement, expenses related to balance sheet items like the following use what exchange rate?
Depr / Fixed assets
COGS / inventory
Amortization / bonds & intangibles
Historical rate
Remeasurement BS exchange rates
Monetary - spot rate
Non-monetary - historical
Remeasurement and Translation income statement exchange rates
Weighted average
- Except remeasurement uses historical for BS related expense accounts. Translation does not
Translation steps
- Income statement
- Balance sheet
More logical - we do it backwards for remeasurement because remeasurement is dysfunctional and kuhrazy!
Translation b/s exchange rates
Assets and liabilities - spot
Equity - historical
Does translation have an impact on income?
No
What account does translation adjustment DR or CR?
Cumulative Translation Adjustment and OCI
IFRS hyperinflation rules
Restated for effects of inflation then converted to reporting currency
For a payable if exchange rate goes up - gain or loss?
Loss
Are bonds monetary or nonmonetary?
Monetary
Are fixed assets monetary or nonmonetary?
Nonmonetary / they fluctuate in value
Inventory - monetary or non-monetary?
Non-monetary, value depends on FV
When are foreign currency transactions adjusted?
Mark to market each period and recognize gain or loss
Functional currency definition
Environment subsidiary primarily generates and expends cash
Stockholders equity contra account example
Cumulative foreign exchange translation loss
For remeasurment, marketable securities should use what rate?
Spot rate. This is because marketable securities are carried at FV, not carried at HC
Remeasurement Income Statement exchange rate exception
COGS will be historical if inventory is historical
For remeasurement, what balance sheet accounts use the historical rate?
Non-monetary items carried at cost
A balance arising from the translation or remeasurement of a sub’s foreign currency financials is reported in the consolidated income when the sub’s functional currency is the
Reporting currency
When picking the exchange rates to record a gain or loss for foreign currency TRANSACTION, which to pick?
DELIVERY DATE - not PO date
And
Payment date
(Or year end and payment date)
1 dollar = x foreign currency
Convert foreign currency to dollars
N / X
Since the exchange rate is in the denominator, if the dollar to foreign rate increases, the value gets smaller
If the dollar to foreign rate increases, the value gets larger
Calculate value of Receivable from spot rate
Receivable * spot rate
Current Liability on tax return =
Tax return * current tax rate
Deferred tax liability is calculated how?
Temporary differences * Future enacted tax rate
+ deferred liability
- deferred asset
Investment interest expense is deductible up to
Only up to investment income
Tax exempt interest
Municipal, state
Permanent differences between tax net income and financials (7 examples)
- Tax exempt interest
- Life insurance proceeds on officers key main policy
- Life insurance premiums when corporation is the beneficiary
- Certain penalties, bribes, kickbacks
- Nondeductible portion of meal and entertainment expense
- Dividends-received deduction for corporations
- Excess percentage over cost depletion
Installment sales vs % Completion method differences
Recognize revenue as paid
vs
recognize revenue as earned (Accrual)
Tax expense is solved for how?
Owe now + owe later
Revenue / gains to be included in tax later
Deferred tax liability
Revenue / gains included in tax in advance of financials
Deferred tax asset (prepaid tax)
Expenses / losses to be included in tax later
Deferred tax asset
Like having a future credit in your pocket for overpayment
Expenses or losses included in tax in advance of financials
Deferred tax liability
Like an accrued expense or a credit taken in advance on a payment. Will have to debit memo (owe) later
How are taxes owed on permanent differences paid
Paid now - never paid later
How the cpa exam likes to trick you with deferred tax
They will provide incorrect calculations - be careful!
Examples of revenue / gains on financials, but not YET on taxes
Installment sales
Contractors accounting (% completion)
Equity in investee incomes
Examples of revenue / gains on tax, but NOT yet on Financials
Unearned rent (IRS calls "prepaid") Unearned interest Unearned royalties
Examples of expenses / losses taken in ADVANCE on taxes, but not yet on financials
Depreciation expense
Amortization of franchise
Prepaid expenses (cash basis for tax)
Examples of expenses / losses on financials, but NOT yet on taxes
Bad debt expense
Estimated liability / warranty expense
Start up Expense
Deferred Tax Liability =
Owe later
Future taxable income > future (now) net income
Deferred tax asset
IOU - gift card
Future net income > now (future) taxable income
Valuation allowances and IFRS
Deferred Tax Asset
Not permitted
Valuation allowances and GAAP
Deferred Tax Liability
If more likely than not (50% rule) that part or all of deferred tax asset will not be realized (no net income in future)
Valuation allowance is recognized to lower asset value
What line items must be shown on IS for taxes
Taxes owed now (current)
Taxes owed later (deferred)
Why would we pay taxes on revenue that hasn’t hit the income statement?
Unearned revenue for financial accounting purposes - but not for tax purposes
Why would we use expenses / losses now on taxes that haven’t hit in the income statement?
Prepaid expenses are cash basis for tax purposes, also sometimes amortization / depreciation is accelerated for tax purposes
Why would we have a deduction owed to us later on taxes?
Taxes doesn’t allow you to take bad debt expense until write off or warranty expense until warranty cost occurs
Why would we owe taxes later on revenue or gains on our financials?
Some revenue we can recognize now, but can’t recognize yet for taxes:
Installment sales
% completion method for contracts
Equity in investee income
Valuation allowance for deferred tax asset JE
Tax benefit (deferred)
Deferred Tax Asset Valuation AllowanceWhen calculating effect of temporary differences, what is the starting point?
Income before tax related differences for both tax and financials. Permanent differences are not “tax owed later”. Temporary are
Two types of differences between pretax GAAP financial income and taxable income
Permanent and temporary differences
Name of GAAP income tax expense approach
Asset and liability approach
Estimated tax payments made previously on MCQ - what to do with them?
Reduces current tax liability but has NO effect on current tax expense
Justification for the method of determining periodic deferred tax expense is based on the concept of
Recognition of assets and liabilities
If entity reports deferred tax asset, did they make a profit or loss?
Profit because if there was a loss, a full valuation account would be recorded against it
This is b/c a current net operating loss is evidence that more likely than not the company will NOT have income to offset with the future tax deductions
Make sure when calculating tax benefit or expense to
Apply the tax rate
Private company accounting alternative for swaps
Record the swap as if you received the interest rate you wanted in the first place
Current Tax Expense where DTA beg and end balance are given
The delta is the taxes from temporary differences for that year
DTA = tax benefit and thus subtracted
Are DTA and DTL pretax or post tax
Post tax amounts
Valuation allowances change of estimate is realized where on income statement
Income from operations
What is the primary objective of accounting for income taxes?
Recognize the amount of deferred tax liabilities and deferred tax assets reported for future tax consequences
What column headers do you need to calculate income tax expense?
Taxable income (owe now) Temporary differences (owe later) Pretax income (not used for calculation)
Uncertain tax positions
Aggressive tax positions
Test before reflecting any tax benefit on entity’s financials
More likely than not test (50% test)
What tax rate to use for temporary differences?
Enacted rate in effect when temporary difference reverses itself
NOT anticipated
NOT proposed
NOT unsigned
Operating losses
Create deferred tax benefit (savings - reduces tax expense)
How long can operating losses be carried back and forward?
2 back and 20 forward
“Hindsight is 20/20” 2 x 20
Are there valuation allowances for operating loss carrybacks?
No, tax refund
Tax refund Receivable
Tax benefit
When a DTA is realized, what happens to total tax expense
It INCREASES
Tax Expense (current)
DTA
It is an offset
When a DTL is realized, what happens to total tax expense?
It DECREASES, it’s a tax benefit
DTL
Tax Benefit
It is an offset
At the end of Q2 what tax rate is used for income tax provision?
Effective tax rate expected to be applicable for the full year at the end of the second quarter
How to determine interim income tax provision?
JTD income * estimated effective tax rate for the year less other quarters income tax expense
Can a DTA and a DTL be created in the same year?
No, they are netted together
How does a loss carry forward affect net income?
In general it won’t because any tax benefit from the loss is immediately negated by the valuation account. This is b/c a net operating loss usually satisfies the 50% more likely than not test that there be no income to offset with the carry forward
What regarding deferred taxes do NOT have to be disclosed?
Permanent differences
Be very careful of what in deferred tax questions?
Are they asking for the CURRENT or the DEFERRED tax?
Operating vs Capital lease impact on cash flow statement
Operating = all in operating area Capital = principle in investing area
Capital lease has higher cash flows in operating area by the amount of the principle paid
Higher cash flows means
Either more inflows or less outflows
When a valuation account is created, what is the debited account?
Deferred tax asset
Tax expense
Permanent difference for dividends received deduction
Ownership
0-19% - 70% exclusion
20-80% - 80% exclusion
>80% - 100% exclusion
A landlord collects rents in advance. Rents are taxable in the period of receipt.
How is the timing difference accounted for?
Deferred Tax Asset
Royalty revenue received temporary tax difference account
Deferred tax asset
Prepaid - unearned revenue
If the tax rate goes up in year 2, how does that effect temporary differences in year 1
It may increase the temporary differences depending on the enacted tax rate that they were recorded with. If the tax rate is greater than the enacted rate, than a change in estimate is required and an increase in their balances would be necessitated
Underlying is the
Thing you are selling…but in one sim it was the Exercise / strike price!!
What is the notional amount?
The amount / units that can be purchased or can / will be sold at the strike price
If a cash flow hedge results in a loss, does it hit earnings or OCI?
Effectiveness != guaranteed gain
So a loss WOULD be recorded to OCI as long as long as it was effective (you are just the loser even if you made a decent bet)
How is the impact of a hedge reported in earnings?
Netted against the hedged item
Report net impact
JE for the settlement of a cash flow hedge
Cash
Cash Flow Hedge
When does the gain or loss from a cash flow hedge get recognized?
In the period of the loss / gain of the hedged item
OCI
Gain in cash flow Hedge
AR - hedged item
Sales
What is the journal entry for an unrealized gain on a cash flow hedge?
Cash Flow Hedge
OCI
If you SELL a put option, what is your max gain?
Any premium on the put option because the buyer will not exercise the option if FV dips below the strike price
If you sell a put option, how to calc loss?
Loss netted with premium
IFRS vs GAAP difference, pension on BS
Plan asset cannot exceed present value of future economic benefits
-and-
IFRS does not specify if current or non-current
APBO
Accumulated postretirement benefit obligation
PBO equivalent for postretirement benefits
EPBO
Expected Postretirement Benefit Obligation
APBO vs EPBO
EPBO = APBO + PV of expected future benefits that have NOT yet vested
Differences in SIR AGE between pension and post retirement benefits
Only in existing transition obligation
Two options
- Expense immediately -or-
- Accrue over GREATER of 20 years or remaining service period
Funded status for APBO calc
FV of plan assets less APBO
When a gain or loss for a pension plan is recorded to AOCI, when does it affect PBO?
Immediately. The amortization of the gain / loss does NOT affect the PBO. Amortization adjusts the cost on the IS only.
