FAR Chapter# 5

Question 1

FAR 5-1 - PRESENT VALUES and ANNUITIES | What is the difference between an ordinary annuity and an annuity due?

Answer 1

TIMING OF PAYMENTS

• Ordinary annuity - Payments are at end of each period
• Annuity due - Payments are at beginning of each period

Question 2

FAR 5-2 - ACCOUNTING FOR LEASES | Identify and define two types of leases from the lessee’s perspective under IFRS and U.S. GAAP.

Answer 2

Capital (U.S. GAAP) | Finance (IFRS)
Transfers substantially all of the benefits and risks inherent in ownership of the property to the lessee. In substance, an installment purchase. The lessee accounts for the lease as an acquistion of an asset and a related liability.

Operating (IFRS and U.S. GAAP)
All other leases are simple rental agreements in which the lessee debits rent expense and credits cash/ rent payable.

Question 3

FAR 5-3 - ACCOUNTING FOR LEASES | Identify and define types of leases from the lessor’s perspective under IFRS and U.S. GAAP.

Answer 3

Capital Lease -
Sales-type: Gives rise to manufactures or dealers profit or loss. Fair value differes from cost or carrying value.
Direct-financing: Fair value is the same as cost or carrying value at the beginning of the 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.

Question 4

FAR 5-4 - ACCOUNTING FOR LEASES | In an operating lease, give the treatment of a lease bonus, from both the lessor’s and lessee’s perspective.

Answer 4

Lessor: Lease bonus is deffered 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.

Question 5

FAR 5-5 - ACCOUNTING FOR LEASES | Name the criteria for determining if a lease is a capital lease for lessee under U.S. GAAP. OWNS

Answer 5

To be classified as a capital lease under U.S. GAAP, the transaction must meet one or more of the following critera:

• Ownership transferred
• Written bargain purchase option
• Nintey percent, present value of 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 qualifiying criteria as long as asset is not in last 25% of original estimated life.

Question 6

FAR 5-6 - ACCOUNTING FOR LEASES | Name the criteria for determining if a lease is a finance lease for the lessee and lessor under IFRS.

Answer 6

The lessee and lessor classify a lease as a finance leas if the lessor transfers substantially all the risks and rewards of ownership to the lessee.

Question 7

FAR 5-7 - ACCOUNTING FOR LEASES | How does the lessee record the capital lease?

Answer 7

At lower of FV or present value of minimum lease payments, using the lower of lesee’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 cost or an optional purchase.

Under IFRS, initial direct costs are recognized as part of the finance lease asset.

Question 8

FAR 5-8 - ACCOUNTING FOR LEASES | Name the criteria for determining if a lease is a capital lease for the lessor under the U.S. GAAP. LUC

Answer 8

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 payemnts is reasonably predictable.

Question 9

FAR 5-9 - ACCOUNTING FOR LEASES | What is the difference between sales-type and direct-financing leases (lessor finance leases)?

Answer 9

Sales-type lease: Gives rise to manufactures or dealers profit or loss. Fair value differes from cost or carry value.

Direct-financiing lease: Fair value is the same as cost or carrying value at the beginning of the lease term.

I profit from my sales lease, not from my finance lease.

Question 10

FAR 5-10 - ACCOUNTING FOR LEASES | What period of benefit is used to depreciate the leased asset by the lessee?

Answer 10

Estimated economic life of asset if lessee takes ownership or there is a bargain purchase option.

Otherwise, lease term.

Question 11

FAR 5-11 - ACCOUNTING FOR LEASES | Identify the three classifications used with respect to the seller-lessee’s rights retained in a sale-leaseback under U.S. GAAP.

Answer 11

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 the fair value of the property
• Gain recognized to extent gain exceeds present value of lease payments

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, loses (NBV>FV) are recognized immediately.

Question 12

FAR 5-12 - ACCOUNTING FOR LEASES | Outline the accounting by the seller-lessee in a sale-leaseback transaction under IFRS.

Answer 12

If sale-leaseback results in a finance lease, defer profit and amortize over the lease term.

If sale-leaseback results in an operating lease, profit or loss is recognized based on the relationship between the leased asset’s carrying amount, fair value, and selling price.

Question 13

FAR 5-13 - ACCOUNTING FOR LEASES | What are the lessee’s major footnote disclosures for capital leases under U.S. GAAP?

Answer 13

1. Gross amount of assets capitalized by major property categories.
2. Future minimum lease payments in the aggregate and for each of the next five years.
3. Amount of imputed interest to reduce net minimum lease payments to present value.

Question 14

FAR 5-14 - LONG-TERM LIABILITIES and BONDS PAYABLE | When is a bond issued at a discount? A premium?

Answer 14

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.

Question 15

FAR 5-15 - LONG-TERM LIABILITIES and BONDS PAYABLE | How is the bond selling price computed?

Answer 15

The price is the sum of the present value of the future principal payment plus the present value of the periodic interest payments discounted using the market/effective rate on the date the bonds are issued.

Question 16

FAR 5-16 - LONG-TERM LIABILITIES and BONDS PAYABLE | Name two methods of amortizing bond premium (discount).

Answer 16

Straight Line Method: Premium (discount) / # of periods outstanding

Interest (Effective Rate) Method (U.S. GAAP/ IFRS): Premium (Discount) amortized = (Carrying value x effective rate) - (face value x stated rate)

Interest expense = (Face value x stated rate) + discount amortized - premium amortized = Carrying value effective rate

Note: the straight line method is permitted under U.S. GAAP if not materially different from effective interest method. It is prohibited under IFRS.

Question 17

FAR 5-17 - LONG-TERM LIABILITIES and BONDS PAYABLE | What is the Preferred method of accounting for bond issue costs under U.S. GAAP and IFRS?

Answer 17

U.S. GAAP: Capitalize as a deferred charge (asset) and amortize 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.

Question 18

FAR 5-18 - LONG-TERM LIABILITIES and BONDS PAYABLE | How are convertible bonds accounted for when issued under IFRS and U.S. GAAP?

Answer 18

U.S. GAAP: Like nonconvertible bonds. No separate recognition of the conversion feature.

IFRS: Both a liability (bond at fair value) and equity (difference between proceeds and fair value) recognized.

Question 19

FAR 5-19 - LONG-TERM LIABILITIES and BONDS PAYABLE | Describe the two methods of accounting for the conversion of convertible bonds.

Answer 19

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.

Question 20

FAR 5-20 - LONG-TERM LIABILITIES and BONDS PAYABLE | Define stock warrants.

Answer 20

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.

Question 21

FAR 5-21 - LONG-TERM LIABILITIES and BONDS PAYABLE | Describe the two methods of accounting for bonds with detachable stock purchase warrants.

Answer 21

Warrants Only Method: Warrants are valued at fair value in stockholders’ equity. Residual of bond proceeds is assigned to the bonds.

Market Value Method: Bond proceeds are allocated to the bonds and warrants according to their relative fair values.

Question 22

FAR 5-22 - LONG-TERM LIABILITIES and BONDS PAYABLE | When is a liability considered extinguished?

Answer 22

If either one of the following condtions 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.

Question 23

FAR 5-23 - LONG-TERM LIABILITIES and BONDS PAYABLE | Define in-substance defeasance.

Answer 23

An arrangement in which a company places puchased 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.

Question 24

FAR 5-24 - LONG-TERM LIABILITIES and BONDS PAYABLE | How is the gain or loss on early extinguishment of debt treated?

Answer 24

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 (U.S. GAAP only) and premium or (discount) and the reaquisition price of the debt.

Question 25

FAR 5-25 - LONG-TERM LIABILITIES and BONDS PAYABLE | What are the major disclosures for long-term debt?

Answer 25

1. Maturity dates
2. Interest rates
3. Call and conversion privileges
4. Assets pledged as security
5. Future sinking fund payments
6. Maturities for each of the next five years

Question 26

FAR 5-26 - LONG-TERM LIABILITIES and BONDS PAYABLE | List some examples of current liabilities.

Answer 26

1. Trade accounts and notes payable
2. Current portion of long term debt
3. Cash dividends payable
4. Accrued liabilities
5. Payroll liabilities
6. Taxes payable
7. Customer advances (deferred / unearned revenue)