FAR 5 Flashcards
What is the difference between an ordinary annuity and an annuity due?
Timing of payments
- Ordinary annuity - Payments are at END of each period
- Annuity due- Payments are at BEGINNING of each period
Identify and define two types of leases from lessee’s perspective under IFRS and US GAAP?
Capital (US GAAP) I Finance (IFRS)
Transfers substantially all of the benefits and risks inherent in ownership of property to the lessee. In substance, an installment purchase. The lessee accounts for the lease as an acquisition of an asset and a related liability
Operating (IFRS and US GAAP)
All other leases are simple rental agreements in which the lessee debits rent expense and credts cash/rent payable.
Identify and define types of leases from the lessor’s perspective under IFRS and US GAAP.
Capital(Finance) Leases
Sales - type: Give rise to manufacturer’s or dealer’s profit or loss. Fair value differs from cost or carrying value.
Direct-financing: Fair value is the same as cost or carrying value at the beginning of lease term.
IFRS: does not use the terms “sales type” and “direct financing”
Operating
All other leases are simple rental agreements in which the lessor debits cash/rent receivable and credits rental income
In an operating lease, give the treatment of a lease bonus, from both the lessor’s and lessee’s perspective.
Lessor
Lease bonus is deferred and amortized as income over the life of the lease
Lessee
Lease bonus is capitalized and amortized as an expense over the life of the lease
Name the criteria fro determining if a lease is a capital lease for the lessee under US GAAP (OWNS)
To be classified as a capital lease under US GAAP, the transaction must meet one or more of the following criteria:
-Ownership transferred
-Written bargain purchase option
-(Ninety) present value of minimum lease payments is equal to or greater than 90% of FMV of asset
-(Seventy-five) lease term equals or exceeds 75% of estimated useful life
Last two items are qualifying criteria as long as asset is not in last 25% of original estimated life
Name the criteria for determining if a lease is a finance lease for the lessee and the lessor under IFRS
The lessee and lessor classify a lease as a finance lease if the lessor transfers substantially all the risks and rewards of ownership to the lessee.
How does the lessee record the capital lease?
A lower of FV or present value of minimum lease payments, using the lower of lessee’s incremental borrowing rate or the rate implicit in the lease, if known by lessee
Note: Minimum lease payments include payments, bargain purchase option, and guaranteed residual value. They do not include executory costs or an option purchase.
Under IFRS, initial direct costs are recognized as part of the finance lease asset.
Name the criteria for determining if a lease is a capital lease for the lessor under US GAAP? (LUC)
To be classified as a capital lease, the transaction must meet all three of the following criteria:
- Lessee “owns” the leased property
- Uncertainties do not exist regarding any nonreimbursable costs to be incurred by the lessor
- Collectibility of the lease payments is reasonably predictable
What is the difference between sales-type and direct-financing leases (lessor finance leases)?
Sales-type
Gives rise to manufacturer’s or dealer’s profit loss. Fair value differs from cost or carrying value.
Direct-financing
Fair value is the same as cost or carrying value at the beginning of lease terms.
I profit from my sales (-type) lease, NOT from my (direct-) financing lease.
What period of benefit does the lessee use to depreciate the leased asset under a capital lease?
The estimated economic life of the asset is used if the lessee takes ownership or there is a bargain purchase option.
Otherwise, the lease term is used.
Identify the three classifications used with respect to the seller-lessee’s rights retained in a sale-leaseback under US GAAP.
Substantially all rights retained
- PV of rent payments is equal to or greater than 90% of the fair value of the property
- Gain deferred and amortized
Rights retained are less than substantially all but greater than minor:
- PV of rent payments is less than 90%, but greater than 10% of fair value of the property.
- Gain deferred up to the present value of lease payments (operating lease) or capitalized asset (capital lease). The excess is recognized immediately.
Minor portion of rights retained:
- PV of rent payments is 10% or less of the fair value of the property
- Entire gain is recognized
In all cases, losses (NBV>FV) are recognized immediately.
Outline the accounting by the seller-lessee in a sale-leaseback transaction under IFRS.
If sale-leaseback results in a FINANCE LEASE, defer profit and amortize over the lease term.
If sale-leaseback results in OPERATING LEASE, profit or loss is recognized based on the relationship between the leased asset’s carrying amount, fair value, and selling price.
What are the lessee’s major footnote disclosures for capital leases under US GAAP?
- Gross amount of assets capitalized by major property categories.
- Future minimum lease payments in the aggregate and for each of the next five years.
- Amount of imputed interest to reduce net minimum lease payments to present value.
When is a bond issued at a discount? A premium?
A bond is issued at a discount when the coupon/stated interest rate is less than the market/effective rate of interest.
A bond is issued at a premium when the bond interest rate is greater than the market rate of interest.
How is the bond selling price computed?
The price is the sum of the present value of the future principal payments plus the present value of the periodic interest payments discounted using the market/effective rate on the date the bonds are issued.
Name two methods of amortizing bond premium (discount).
Straight-Line Method
Premium (Discount) / # of periods outstanding
Interest (Effective Rate) Method (US GAAP/IFRS):
Premium (Discount) amortized = (Carrying value x Effective rate) - (Face value x Stated rate)
Interest expense = (Face value x Stated rate) + Discount amortization - Premium amortized = Carrying value x Effective rate
Note: The straight-line method is permitted under US GAAP if not materially different from the effective interest method. It is prohibited under IFRS.
What is the preferred method of accounting for bond issue costs under US GAAP and IFRS?
US GAAP:
Capitalized as a deferred charge (asset) and amortized to expense over the period the bond is outstanding using straight-line method
IFRS:
Deducted from the carrying amount of the liability and amortized using the effective interest method
How are convertible bonds accounted for when issued under IFRS and US GAAP?
US GAAP:
Like nonconvertible bonds. No separate recognized of the conversion feature.
IFRS:
Both a liability (bond at fair value) and equity (difference between proceeds and fair value ) recognized.
Describe the two methods of accounting for conversion of convertible bonds.
Book Value Method (GAAP):
No gain/loss is recognized.
Market Value Method (not GAAP):
Gain/loss is recognized for the difference between market value of stock and book value of bond
Define stock warrants.
Option contracts that are issued with, and are usually detachable from, bonds and notes. Gives the bondholder the right to buy stock at a fixed price within a specific time period.
Describe the two methods of accounting for bonds with detachable stock purchase warrants.
Warrants Only Method:
Warrants are valued at fair value in stockholder’s equity. Residual of bond proceeds is assigned o the bonds.
Market Value Method:
Bond proceeds are allocated to the bonds and warrants according to their relative fair values.
When is a liability considered extinguished?
If either one of the following conditions is met:
- If the debtor pays the creditor and is relieved of its obligations for the liability.
- IF the debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor
Define in-substance defeasance.
An arrangement in which a company places purchased securities into an irrevocable trust and pledges them for the future principal and interest payments on its long-term debt.
The company remains the primary obligor; therefore, the liability is not considered extinguished.
How is the gain or loss on early extinguishment of debt treated?
Ordinary gain or loss on the income statement, shown as a separate line item, if material, in income from continuing operations, unless it meets the criteria of unusual in nature and infrequent in occurrence, in which case it is treated as an extraordinary item and reported net of taxes, below income from continuing operations.
The gain or loss is the difference between net carrying value (including unamortized bond issue costs asset (US GAAP only) and premium or discount) and the reacquisition price of the debt.
