FAR 11 Flashcards
What general kind of hedge, if any, is the hedge of a recognized asset or liability?
The hedge of a recognized asset or liability may be either a fair value hedge or a cash flow hedge, depending on management’s designation. However, the hedge of a recognized asset or liability denominated in a foreign currency generally will be a cash flow hedge.
Net investment in foreign operations hedges are recorded how?
The hedge of a net investment in foreign operations is a fair value hedge, but changes in the fair value of the forward contract (hedging instrument) that are equal to or less than the change in the translated value of the financial statements of the foreign operation are reported as a translation adjustment in other comprehensive income. The change in the forward contract reported as a translation adjustment offsets the change in the value of the translated financial statements of the foreign operation, which also are reported as a translation adjustment.
Which one of the following hedges using a forward contract will require the recognition of a new asset or liability if a gain or loss occurs on the hedging instrument?
Firm commitment hedge.
What is considered hyperinflationary for a foreign economy?
For determining a functional currency, a highly inflationary (hyperinflationary) economy is one that has experienced a cumulative inflation of 100% or more over the past 3 years. Inflation of 35% per year over the past three years is a cumulative 105% and constitutes a highly inflationary economy.
Remeasurement, based on the temporal method of conversion, converts foreign currency amounts to reporting currency amounts using different exchange rates for different accounts based on which of the following distinctions?
Monetary and non-monetary.
Which one of the following sets shows the correct reporting of an adjustment (gain or loss) that results from translation and one that results from remeasurement of financial statements from a foreign currency to a reporting currency?
An adjustment resulting from translation of financial statements would be reported in other comprehensive income, and an adjustment resulting from remeasurement would be reported in net income.
A company has a long-lived asset with a carrying value of $120,000, expected future cash flows of $130,000, present value of expected future cash flows of $100,000, and a market value of $105,000. What amount of impairment loss should be reported?
The recoverable cost (expected future cash flows) of $130,000 exceeds the $120,000 book value. Therefore, the asset is not impaired, and no loss is recorded. Although both the market value and present value of the future cash flows are less than book value, as long as the nominal sum of future cash flows ($130,000) exceeds book value, no impairment is recorded. The firm is expected to recover its book value.
Bard Co., a calendar-year corporation, reported income before income tax expense of $10,000 and income tax expense of $1,500 in its interim income statement for the first quarter of the year. Bard had income before income tax expense of $20,000 for the second quarter and an estimated effective annual rate of 25%. What amount should Bard report as income tax expense in its interim income statement for the second quarter?
$6,000
Interim income tax expense equals the difference between (1) the total income tax through the end of the interim period at the estimated annual tax rate, and (2) the income tax expense recognized in previous interim periods of the same year. For the second quarter, income tax expense therefore is computed as ($10,000 + $20,000)(.25) - $1,500 = $6,000.
On March 15, 2004, Krol Co. paid property taxes of $90,000 on its office building for the calendar year 2004.
On April 1, 2004, Krol paid $150,000 for unanticipated repairs to its office equipment. The repairs will benefit operations for the remainder of 2004.
What is the total amount of these expenses that Krol should include in its quarterly income statement for the three months ended June 30, 2004?
$72,500
One-fourth of the property taxes should be recognized for the second quarter income statement: $22,500 = $90,000/4. Although the entire annual amount was paid in the first quarter, only 1/4 of the total annual amount should be recognized in each quarter. This allocation is based on benefits received (the benefits that flow from payment of property taxes). It is reasonable to assume that each quarter benefits the same amount.
The repair cost benefits three quarters on an equal basis because it was paid at the beginning of the second quarter. Therefore, 1/3 of the cost, or $50,000, should be reported in the income statement for the second quarter.
Thus, the total expense to be recognized in the second quarter is $72,500 ($22,500 + $50,000).
Green Co. incurred leasehold improvement costs for its leased property. The estimated useful life of the improvements was 15 years. The remaining term of the nonrenewable lease was 20 years. These costs should be
Capitalized and depreciated over 15 years.
A leasehold improvement has a useful life equal to the useful life of the property or the remaining lease term, whichever is shorter. Leasehold improvements remain with the leased property - the lessee therefore cannot continue to use the improvement beyond the term of the lease.
In this case, the useful life of the improvement (15 years) is less than the remaining lease term (20 years). The remaining useful life represents the period of benefit to the firm. The leasehold improvement is capitalized and amortized to expense based on the pattern of its benefits to the firm.
Oak Co. leased equipment for its entire 9-year useful life, agreeing to pay $50,000 at the start of the lease term on December 31, 2004 and $50,000 annually on each December 31 for the next 8 years. The present value on December 31, 2004 of the nine lease payments over the lease term, using the rate implicit in the lease, which Oak knows to be 10%, was $316,500. The December 31, 2004 present value of the lease payments using Oak’s incremental borrowing rate of 12% was $298,500. Oak made a timely second lease payment. What amount should Oak report as capital lease liability in its December 31, 2005 balance sheet?
The lessee uses 10% because it is the lower of the two rates and is known to the lessee. The lease liability balance immediately after the first payment (at inception) is $266,500 ($316,500 - $50,000). The first payment includes no interest because it is made immediately. The entry for the 12/31/05 payment is:
Lease liability 23,350
Interest expense .10($266,500) 26,650
Cash 50,000
The ending lease liability balance is $266,500 - $23,350 = $243,150.
On December 31, 2005, Neal, Inc. leased machinery with a fair value of $105,000 from Frey Rentals Co. The agreement is a 6-year noncancelable lease requiring annual payments of $20,000 beginning December 31, 2005.
The lease is appropriately accounted for by Neal as a capital lease.
Neal’s incremental borrowing rate is 11%. Neal knows the interest rate implicit in the lease payments is 10%.
- The present value of an annuity due of $1 for 6 years at 10% is 4.7908.
- The present value of an annuity due of $1 for 6 years at 11% is 4.6959.
In its December 31, 2005 balance sheet, Neal should report a lease liability of
The $75,816 lease liability at December 31, 2005 is the initial liability at inception less the first payment, which is completely a principal payment. The first payment occurs at inception and therefore could have no interest component. The initial liability at inception is the present value of an annuity due of six periods.
Ending 2005 lease liability = liability at inception - $20,000 first payment
= $20,000(4.7908) - $20,000
= $75,816
The lessee must use the lower of its incremental borrowing rate (11%) and the rate implicit in the lease (10%), hence the use of the 4.7908 present value factor.
Glade Co. leases computer equipment to customers under direct-financing leases.
The equipment has no residual value at the end of the lease, and the leases do not contain bargain purchase options. Glade wishes to earn 8% interest on a 5-year lease of equipment with a fair value of $323,400. The present value of an annuity due of $1 at 8% for 5 years is 4.312.
What is the total amount of interest revenue that Glade will earn over the life of the lease?
Total interest over the term equals the difference between total lease payments and the fair value of the property at inception. The lease payment is $75,000 ($323,400/4.312). Thus, total interest is 5($75,000) - $323,400 = $51,600.
Winn Co. manufactures equipment that is sold or leased. On December 31, 2005, Winn leased equipment to Bart for a 5-year period ending December 31, 2010, at which date ownership of the leased asset transferred to Bart.
Equal payments under the lease were $22,000 (including $2,000 executory costs) and were due on December 31 of each year.
The first payment was made on December 31, 2005. Collectability of the remaining lease payments was reasonably assured, and Winn had no material cost uncertainties. The normal sales price of the equipment was $77,000, and cost was $60,000.
For the year ending December 31, 2005, what amount of income should Winn realize from the lease transaction?
This is a capital lease to the lessor because ownership is transferred to the lessee. There is no interest revenue in 2005 because the lease inception and the balance sheet date are the same. The first payment, thus, includes no interest.
The lease is a sales-type lease to the lessor because the normal selling price of $77,000 exceeds the cost of $60,000. The difference of $17,000 is the dealer profit to be recognized in 2005. There is no other income to be recognized in 2005.
Robbins, Inc. leased a machine from Ready Leasing Co. The lease qualifies as a capital lease and requires 10 annual payments of $10,000 beginning immediately.
The lease specifies an interest rate of 12% and a purchase option of $10,000 at the end of the tenth year, even though the machine’s estimated value on that date is $20,000. Robbins’ incremental borrowing rate is 14%.
The present value of an annuity due of $1 at:
12% for 10 years is 6.328
14% for 10 years is 5.946
The present value of $1 at:
12% for 10 years is .322
14% for 10 years is .270
What amount should Robbins record as lease liability at the beginning of the lease term?
The $66,500 beginning balance of the lease liability is the present value of the minimum lease payments, which includes the bargain purchase option.
The lower of the two rates should be used to capitalize the lease. $66,500 = $10,000(6.328) + $10,000(.322).
The bargain purchase option uses a single value present value factor.
