FAR 6 - Leases + other

Question 1

Lease definition

Answer 1

A contract that:

1) depends on an identifiable asset
2) conveys the right to control the use of the asset over the lease term to the lessee. The lessee will have the right to obtain all economic benefits from using the asset

Question 2

Separate lease components

Answer 2

Step 1: Identify each right to use an underlying asset within the contract

Step 2: For a contract that includes both lease and nonlease components, the lessee has two options:

1) Lease components are separate from nonlease components
2) Each separate lease component is combined with related nonlease components
* Find relative stand-alone %s and allocated based on total consideration amount (see ex page F6-6)

Question 3

OWNES

Answer 3

• Ownership transfers to the lessee at the end of the lease term
• Written purchase option which lessee is reasonably certain to exercise
• Net present value equal or exceeds 90% or more of the fair value of the underlying asset
• Economic life - term of lease is 75% or more of economic life of asset
• Specialized asset such that it will not have an expected, alternative use to lessor

Question 4

PC (leases)

Answer 4

• Present value of the sum of the lease payments and any third party guaranteed residual value is equal to or substantially exceeds the underlying asset’s fair value
• Collection of the lease payments is probable

Question 5

Lease Classification (lessee)

Answer 5

If any of OWNES is met:
Finance Lease (capitalize)

If none are met or lease is short term (12 months or less):
Operating Lease (capitalize)

Question 6

Lease Classification (lessor)

Answer 6

If OWNES is met:
Sales-type lease

If no OWNES, but both of PC is met:
Direct Financing lease

If no OWNES and one or none of PC:
Operating Lease

Question 7

Lease term beginning

Answer 7

Begins on the commencement date, the date the lessor makes the asset available for use. From the date the lease contract was signed to commencement date is a footnote, not JE

Question 8

Lease payments

Answer 8

REPORT

• Required contractual fixed payments
• Exercise option REASONABLY assured
• Purchase price at the end of the lease
• Only indexed or rate variable payments
• Residual guarantees likely to be owed
• Termination penalties reasonably assured

Lessee lease payments have the option to include:
NGO
-Nonlease components
-Guarantees of lessor debt by lessee or third parties
-Other variable lease payments

Question 9

Initial direct costs

Answer 9

Capitalize, these are included in the valuation of ROU asset

Question 10

Sales Leaseback

Answer 10

To qualify as a sale a contract must exists and control has transferred from the seller to the buyer.

If sale criteria met:
Take equipment off the books and recognize a gain on the sale of equipment

If sale criteria not met:
Treated as a financing transaction. Book as a financing liability, recognize interest expense and continue to book depreciation

Question 11

Operating Leases - lessee

Answer 11

ROU asset and lease liability are initially booked. Effective interest method is used. There is 1 expense on the income statement as interest is part of this lease expense which is calculated on a straight line basis (Total payments/Total periods)

1) Capitalize lease:
Dr ROU asset
Cr Lease liability

2) Subsequent Entries:
Dr Lease expense (straight line)
Dr Lease liability (principal reduction)
Cr Cash
Cr Accumulated amortization - ROU asset

Question 12

Finance Lease - lessee

Answer 12

ROU asset and lease liability are initially booked. Effective interest method. There are 2 expense in the form of lease expense and interest expense that are booked.

1) Capitalize lease:
Dr ROU asset
Cr Lease liability

2) Subsequent Entries:
Dr Interest expense
Dr Lease liability
Cr Cash

Dr Amortization expense
Cr Accumulated amortization - ROU asset

Question 13

Operating lease - lessee (calculations)

Answer 13

1) Initial Lease liability = PV of payments
2) Lease expense = straight line annual payments
3) Interest expense = CV x rate
4) Reduction in ROU = Lease expense - Reduction in ROU

Capitalize lease:
Dr ROU asset (1)
Cr Lease liability (1)

Subsequent Entries:
Dr   Lease expense (2)
Dr   Lease liability (4)
Cr        Cash (2)
Cr        Accumulated amortization - ROU asset (4)

Question 14

Finance Lease - lessee (calculations)

Answer 14

1) Initial Lease liability = PV of payments
2) Interest expense = CV x rate
3) Amortization expense = PV/# of periods
4) Total lease expense = 2 + 3 (greater than cash paid)
5) Lease expense = straight line annual payments
6) Reduction in ROU = Lease expense - Reduction in ROU

Capitalize lease:
Dr ROU asset (1)
Cr Lease liability (1)

Subsequent Entries:
Dr Interest expense (2)
Dr Lease liability (6)
Cr Cash (5)

Dr Amortization expense (3)
Cr Accumulated amortization - ROU asset (3)

Question 15

Sales-Type Lease - lessor

Answer 15

All risks and rewards to lessee.

1) Derecognize asset (at CV)
2) Recognize gain
3) direct costs are EXPENSED

Dr   Lease expense (direct costs)
Dr   Residual asset (value of leftover asset)
Dr   Lease receivable (PV of payments)
Cr        Cash (amount of direct costs)
Cr        Gain
Cr        Truck (asset removal at NBV)

Question 16

Direct Financing Lease - lessor

Answer 16

Lessee does not gain control of the asset.

1) Derecognize asset (at FV)
2) Defer gain
3) Direct costs included in receivable and cash

Dr Residual asset (value of leftover asset)
Dr Lease receivable (includes direct costs)
Cr Truck (asset removal at FV)
Cr Cash (amount of direct costs)

Question 17

Operating Lease - lessor

Answer 17

Keep the asset on the balance sheet.

1) Asset stays on books - continue to depreciate
2) Defer gain
3) Direct costs deferred

Dr Cash
Cr Rental income
Dr Depreciation expense
Cr Accumulated depreciation

Question 18

ROU amortization

Answer 18

1) Useful life if: ownership or written option criteria are met
2) Shorter of the lease term and useful life if: net present value, economic life, or specialized asset criteria are met

Question 19

Underlying

Answer 19

A specified price, rate, or other variable that may or may not occur

Question 20

Call

Answer 20

Gives the holder the right to buy from the option writer at a specified price (holder hoping prices go up)

Question 21

Put

Answer 21

Gives the holder the right to sell to the option writer at specified price (holder hoping prices go down)

Question 22

Futures Contract

Answer 22

An agreement to exchange a commodity, currency or other asset. One party takes a LONG position (buy/profit if price goes up) one party takes a SHORT position (sell/profit if price goes down)
*Publicly traded, more liquid

Question 23

Forward Contract

Answer 23

Similar to futures except they are private

Question 24

Accounting for derivatives on Balance sheet

Answer 24

All derivatives are recognized as an asset or liability and are measured at FAIR VALUE

Question 25

Accounting for derivatives on IS (G/L)

Answer 25

Included in current earnings: - No hedge designation - Fair value hedge - Ineffective portion of cash flow hedge Included in OCI -Effective portion of cash flow hedge

Question 26

Reporting Currency

Answer 26

The currency of the entity ultimately reporting financial results of the foreign entity (USD)

Question 27

Functional Currency

Answer 27

The currency of the primary economic environment in which the entity operates, usually the local currency or the reporting currency

Question 28

Translation vs. Remeasurement

Answer 28

Translation - restatement of the FS denominated in the functional currency to the reporting currency Remeasurement - restatement of the FS from the foreign currency to the functional currency when the reporting is the functional

Question 29

Remeasurement Method (Temporal Method)

Answer 29

Dysfunctional 1) Convert BS to $ - Monetary items = current/year-end rate (spot rate) (fixed amounts such as AR) - Nonmonetary items = historical rate (assets and liabilities that fluctuate with inflation) 2) Covert IS to $ - Non-BS related items = weighted average rate - Balance sheet related items (depreciation, COGS) = Historical rate 3) Plug "currency gain/loss" to get NI required amount to adjust RE in order to make BS balance (G/L on IS)

Question 30

Translation Method (Current Rate Method)

Answer 30

Functional 1) Convert IS to $ - All IS items = Weighted average rate - Transfer NI to RE 2) Convert BS to $ - Assets/Liabilities = current/year-end rate (spot rate) - CS/APIC = Historical rate 3) Plug "translation adjustment" to OCI.

Question 31

Permanent Tax Differences

Answer 31

NO deferred taxes, ignore. Affects only income per books or taxable income, but not both. Main examples include: - Tax-exempt interest (municipal, state) - Life insurance premium

Question 32

Total tax expense can be depicted as

Answer 32

Current income tax payable (taxable income x tax rate) +/- change in deferred income tax asset(-) or liability(+) (temporary differences x future/enacted rate) = total tax expense *NEVER FS income x current tax rate

Question 33

Temporary tax differences

Answer 33

1) Revenues or gains that are included in taxable income after they have been included in financial accounting income, results in a deferred tax liability (contractors accounting) 2) Revenues or gains that are included in taxable income before they have been included in financial accounting income, results in a deferred tax asset (Prepaid rent - gift certificate) 3) Expenses or losses deducted from taxable income after they have been deducted from financial accounting income, results in a deferred tax asset (Bad debt expense - gift certificate) 4) Expenses or losses deducted from taxable income before they have been deducted from financial accounting income, results in a deferred tax liability (Depreciation/Amortization) *when there are multiple temporary difference, use net amount

Question 34

Temporary difference example

Answer 34

FS income = $225,000 Book depreciation > tax depreciation = $25,000 200,000 x .21 (tax rate) + 25,000 x .21 (same, but is enacted rate) = 42,000 + 5,250 (+ because tax liability) Income tax expense - current 42,000 Income tax expense - deferred 5,250 Deferred Tax liability 5,250 Income tax payable 42,000 *If deferred tax asset Income tax expense - current 42,000 Deferred tax asset 5,250 Income tax benefit - deferred 5,250 Income tax payable 42,000 **Valuation account set up for any limitations on recognizing deferred assets

Question 35

More likely than not test

Answer 35

Must win more than 50% of the time to recognize in the financial statements. Used with aggressive tax positions. If test fails: tax expense goes up If test passes: Recognize the largest amount that has greater than 50% likelihood of being realized

Question 36

Rate to use when temporary differences reverse itself

Answer 36

Tax rate in effect | NOT: Anticipated, proposed or unsigned rates