F6 - Leases, Derivatives, Foreign Currency Accounting, and Income Taxes Flashcards
M1 - Leases: Part 1
For a lessee to account for a lease as a finance lease under U.S. GAAP, the terms of the lease must meet at least one of the finance lease criteria:
- Title transfer at end of lease
- Bargain purchase option (reasonably certain to exercise)
- PV = 90% of FV of asset
- Economic life = 75% of estimated useful life
- Specialized use
M1 - Leases: Part 1
When should a lessee begin recognition of expenses?
- The lessee should begin the recognition of lease expenses on the commencement date.
- The commencement date is the date the underlying asset is made available to the lesee for use.
Lease expense is recorded over the lease term.
M1 - Leases: Part 1
Assuming no direct costs are involved, what are the components of the lease receivable for a lessor involved in a direct-financing lease?
The minimum lease payments plus residual value.
- Lessors recording a lease receivable for a direct-financing lease should include the minimum lease payments PLUS any residual value.
- The reason for this is because the lessor can also expect to collect this residual value from the lessee at the culmination of the lease.
M1 - Leases: Part 1
How should lessee recognize lease payments?
The lessee calculates lease payments at commencement of the lease based on the present value of the following items:
- fixed payments
- variable payments
- exercise price of purchase option
- termination penalties
- probable amount owed of the guaranteed residual
M1 - Leases: Part 1
If the underlying lease in a sale-leaseback is a finance lease..
it is considered equivalent to a repurchase and will therefore be considered a “failed sale”.
M1 - Leases: Part 1
If Sale-leaseback is less than FV of property at the time of sale
GAAP requires that a loss to be recognized immediately in a sales-leaseback transaction when the fair value of the property at the time of the sale-leaseback is less than book value.
FV < BV
M2 - Leases: Part 2
Amortization of leasehold improvements
should be over the life of the improvements or the remaining life of the lease, whichever is shorter.
M2 - Leases: Part 2
What rate should the Lessee use?
Lessee should use the rate implicit in the lease (if known by the lessee) to discount cash flows.
M2 - Leases: Part 2
How should Finance leases be recorded?
Finance leases should be recorded as both an asset and liability at the present value of the minimum lease payments.
- The asset is depreciated.
- The liability is amortized using the interest method.
Each payment is allocated between principal and interest.
The liability is reduced by the amount of principal reduction.
The lease liability should be segregated between current (due within one year) and non-current (due beyond one year).
Accordingly, the reduction in lease liability each year is equal to the current liability at the end of the previous year.
M2 - Leases: Part 2
How should a LESSEE amortize a finance lease?
- over the economic life of the asset when there is a written purchase option or when the lessee takes ownership of the asset at the end of the lease term.
M2 - Leases: Part 2
the liability for a finance lease would be reduced periodically by?
- A minimum lease payment less the portion of the minimum lease payment allocable to interest.
Minimum lease payments less the portion of the minimum lease payment allocated to interest represents the liability for a finance lease.
- 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.
M2 - Leases: Part 2
Amortization of Leasehold improvements
should be over the life of the improvements or the remaining life of the lease, whichever is shorter.
M2 - Leases: Part 2
Variable lease payments not included in the lease liability
are treated as cash outflows from operations and will therefore have a negative impact on bottom-line cash flow from operations.
M3 - Derivatives and Hedge Accounting
Derivative
A derivative is a financial instrument that derives its value from the value of some other instrument and has three characteristics:
1. it has one or more underlyings, and one or more notional amounts or payment provisions, or both;
2. it requires no initial net investment or one that is smaller than would be required for other types of similar contracts; and
3. its terms require or permit a net settlement, or it can readily be settled net outside the contract or by delivery of an asset that gives substantially the same results.
M3 - Derivatives and Hedge Accounting
What is considered a derivative financial instrument?
- futures
- forwards
- options
- swaps
A bank certificate of deposit is not a derivative financial instrument.
M3 - Derivatives and Hedge Accounting
In order for a financial instrument to be a derivative for accounting purposes, the financial instrument must:
- Have one or more underlyings.
- NOT requiring an initial investment
M3 - Derivatives and Hedge Accounting
The determination of the value or settlement amount of a derivative involves a calculation which uses:
- An underlying
- A notional amount
M3 - Derivatives and Hedge Accounting
Put options
Put options on stock lock in the sale price of the stock;
- if the stock decreases in value, the put option holder will have locked in the now higher price.
M3 - Derivatives and Hedge Accounting
What is an interest swap agreement?
An interest swap agreement is a financial instrument that is both a contractual right and a contractual obligation to both parties.
Such agreement has an off-balance-sheet risk of accounting loss resulting from both credit and market risk.
- Credit risk results from the risk of nonperformance by the counter-party to the agreement.
- Market risk is the risk of exchaning a lower interest rate for a higher interest rate.
M3 - Derivatives and Hedge Accounting
What is a fair value hedge?
A fair value hedge is an instrument designed to hedge the exposure from changes in the fair value of a recognized asset or liability.
- Gains and losses on both the fair value hedge itself and the hedged item are recognized in earnings in the same accounting period
M3 - Derivatives and Hedge Accounting
What is a perfect hedge?
A perfect hedge results in neither gains or losses.
- In a perfet hedge, the gain or loss on the derivative instrument exactly offsets the loss or gain on the item or transaction being hedged.
M3 - Derivatives and Hedge Accounting
How should gains or losses from fair value hedges be recognized?
Gains or losses on fair value hedges as well as the offsetting gains or losses on the hedged item are recognized in earnings in the same accounting period.