FAR 5 - Liabilities Flashcards
Exit or disposal activities
1) A liability must be recognized for these activities (severance pay, costs to terminate a contract, etc.).
2) Footnote until announced, then it gets recorded in the FS.
3) Future operating losses expected to be incurred due to these activities are recognized in the period(s) incurred.
4) Recognized at fair value (discounted cash flows) in continuing operations
Asset Retirement Obligation (ARO)
The obligation (liability) associated with the retirement of a tangible long-lived asset. Recorded at fair value which is generally equal to the present value of the future obligation (discounted amount)
Asset Retirement Cost (ARC)
The amount capitalized (asset) that increases the carrying amount of the long-lived asset when an ARO is recognized
Adjustments to AROs and ARCs at year-end
ARO = accretion expense ARC = depreciation expense
Cumulative accretion expense + cumulative depreciation expense = ARO over the life
Dr Accretion expense
Cr ARO
Dr Depreciation expense
Cr Accumulated depreciation
Gain Contingencies
Not recognized, DO NOT record JE. Disclose in notes and state amount and nature. Ignore if likelihood is remote
Loss Contingencies
1) Probable and amount can be reasonably estimated = Record JE
1a) Probable and amount cannot be reasonably estimated = Disclose range and nature
2) Reasonably possible = Record JE
3) Remote = Ignore
Reasonably estimated range of loss contingency
Accrue for the best estimate of the loss. If range given and no amount is better than another, accrue for the minimum and disclose the possibility of an additional loss
Premiums and Warranties
Loss contingencies that are probable and reasonably estimated.
Dr Premium/Warranty Exp
Cr Premium/Warranty Liability
*For warranty expense add up yearly estimated expenses and multiply by sales each year to get your total exp/liability estimate
Annuities
Multiple cash flows of identical value.
Ordinary annuity - payments are made at the end of each period
Annuity due - payments occur at the beginning of each period
OA vs. AD
PV AD for 3* periods = PV OA for 2* periods + 1
Long-Term Liabilities
Record at PV
Imputing interest
When no interest or an unreasonable rate of interest is given interest must still be recorded. Not required for short term notes
Effective interest method
1) Find CV of liability (PV)
2) Multiply by appropriate interest rate (=interest expense)
3) Difference between cash payment and interest expense is your principal payment (reduce discount)
* The amount allocated to principal and interest charges changes as the carrying value decreases
Bond interest exp vs. cash payment
Cash payment is constant at stated rate x face value.
If interest exp > cash paid = discount
If interst exp < cash paid = premium
Bond Issuance Costs
Decreases initial carrying value. Acts like a discount (will be added to discount and amortized)
**Will lead to borrower and investor having different JEs as borrower uses effective rate while investor uses market rate to account for interest payments. Investor also ignores issuance costs when investment is initially booked
Bond amortization period
Begins when bond is actually SOLD not when it is dated.
Market rate vs. effective rate
Effective rate includes bond issue costs
JEs as an investor in a bond
Issuance:
Dr Investment in bonds (whatever cash you get, could be more or less than face value)
Cr Cash
Interest payments:
Dr Cash
Dr/Cr Investment in bonds (premium/discount)
Cr Bond interest revenue (same as borrower’s interest expense)
NOTE: entries are not effected by bond issue costs
Bonds issued between interest dates
Accrued interest is added to the price of the bond. The purchaser pays for this interest and reimbursed the full period’s interest at the next payment date.
Dr Cash
Dr Discount
Cr Bonds Pay
Cr Bond interest expense or payable
Troubled Debt Restructuring
The creditor allows the debtor certain concessions to improve the likelihood of collection.
1) Receipt of assets/equity
2) Modification of Terms
Transfer of Assets (debt restructuring) example
Hull is in debt to Apex under a $500,000, 12 percent, 3 year note. Hull owes $60,000 in accrued interest. Settled note for a piece of land with a FV of $450,000. Hull’s acquisition cost of the land is $360,000.
Hull:
Notes payable 500,000
Interest payable 60,000
Land 360,000
Gain on disposal of land 90,000 (450-360)
Gain on restructuring 110,000 (560-450)
Apex:
Land 450,000
Allowance for credit losses 110,000
Note receivable 500,000
Interest receivable 60,000
Transfer of Equity (debt restructuring) example
Hull is in debt to Apex under a $500,000, 12 percent, 3 year note. Hull owes $60,000 in accrued interest. Settled for an equity interest in Hull with a FV of 450,000 (100,000 shares of CS, par value 2/share)
Hull:
Notes payable 500,000
Interest payable 60,000
CS 200,000
APIC 250,000
Gain on restructuring 110,000
Apex:
Investment in Hull 450,000
Allowance for credit loss 110,000
Note receivable 500,000
Interest receivable 60,000
Modification of Terms (debt restructuring) example
Hull is in debt to Apex under a $500,000, 12 percent, 3 year note. Hull owes $60,000 in accrued interest. Interest was forgiven, interest rate was lowered to 3 percent and maturity date was extended 2 years.
Hull:
Notes payable 500,000
Interest payable 60,000
Note payable 530,000
Gain on restructuring 30,000
*530 = 500 x .15 YR4 + 500 x .15 YR5 (int) + 500 (face)
Apex:
Bad debt expense 136,050
Allowance for credit losses 136,050
Present value of restructured cash flows at HISTORICAL RATE = 423,950
**560,000-423,950 = 136,050
**Bumping up allowance since the debt has not been extinguished (written off - like AR process)
Bond extinguishment before maturity (callable bonds)
Gain or loss is recorded:
1) Reacquisition price = Face x % paid (ex. called at 101)
2) Carrying value = Face - unamortized discount or + unamoritzed premium - unamortized issuance cost
3) G/L = Reacquisition price - CV or Step 1 - Step 2
