FAR CPA Lessons 155-168 Flashcards
What are the 5 steps of revenue recognition?
Step 1—Identify the contract with a customer.
Step 2—Identify the performance obligation(s) in the contract.
Step 3—Determine the transaction price.
Step 4—Allocate the transaction price to the performance obligation(s) in the contract.
Step 5—Recognize revenue when the entity satisfies the performance obligation(s).
Explain a contract
A contract is an agreement between two or more parties that creates enforceable rights and obligations
Criteria to be considered a contract
- The parties have approved the contract verbally, in writing, or by implication consistent with customary business practices.
- Each party’s rights to goods or services can be identified.
- Payment terms can be identified.
- The contract has commercial substance.
- Collectibility of substantially all of the consideration is probable
Indicators than a performance obligation has been satisfied:
- The entity has a present right to payment for the asset or service.
- Customer has legal title to the asset.
- Physical possession has transferred to the customer.
- Significant risks and rewards of ownership have transferred to the customer.
- The customer has accepted the asset.
Indicators that a performance obligation is being satisfied over time:
- The customer receives and consumes the benefits provided by the entity simultaneously as the entity performs its obligation
- The customer controls the asset that is being enhanced or created by the entity as the entity works on it.
- The entity creates an asset that does not have an alternative use to the entity and the entity has the right to payment for work completed to date.
Output method for revenue recognition
An entity recognizes revenue based on the value of the goods or services transferred to the customer to date relative to the remaining goods or services promised under the contract
Input method for revenue recognition
An entity measures revenue based on the proportion of input compared to the total expected inputs.
If the company has incurred $25,000 of the $100,000 total costs, then the company would recognize 25% of the revenue associated with the performance obligation.
Define Contract Asset
Prepaid Revenue - If the customer pays consideration before goods or services have been transferred to the customer, then the entity will record a contract liability to represent its obligation to satisfy the performance obligation for which the customer has paid.
Define Contract Asset
Unbilled Revenue - If the entity performs by transferring goods or services to the customer, before the customer pays consideration, then the entity may recognize a contract asset. A contract asset represents the entity’s right to consideration.
Unconditional Right to Contract Asset
Accoutns Receivable - An unconditional right to a contract asset occurs when an entity has earned the right to payment and is only waiting for the time to pass to receive payment.
Conditional Right to Contract Asset
Unbilled - A conditional right to a contract asset occurs when a company completes one performance obligation in the contract, but must complete another performance obligation before it is entitled to consideration from the customer.
Define Revenue according to ASC 606
Revenue is the inflows or other enhancements of assets of an entity or settlements of its liabilities from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.
Explain variable consideration
When a contract includes pricing terms that will be impacted or determined by a future event, then the contract’s transaction price is impacted by consideration that will vary based on the outcome
- Discounts
- Rebates
- Refunds
- Credits
- Incentives
- Performance bonuses
Expected Value Method
Uses the sum of probability-weighted outcomes to determine the transaction price.
Constraining Estimates of Variable Consideration
If there is significant uncertainty about the receipt of the variable consideration, then the company does not record revenue associated with the variable consideration.
Allocation of interest revenue
Contracts that allow the buyer to pay at a much later date (more than one year) typically include a significant financing component. Interest revenue is accrued over time and measured using an imputed interest rate.
Define imputed interest rate
either the rate that would be offered on a similar instrument to an entity with a similar credit rating or the rate that discounts the note to a value reflective of the current sales price of the goods or services.
When are performance obligations considered separate?
if the good or service is distinct from the other goods or services in the contract. To be distinct, the good or service must meet both of the following criteria:
- The customer can benefit from the good or service on its own or with other resources that are readily available.
- The good or service can be separately identified from other promises in the contract.
Are warranties considered separate performance obligations?
A warranty is accounted for as a separate performance obligation when the customer has the option to purchase the warranty as a distinct service separate from the product and the warranty provides a service in addition to the promises made under the assurance-type warranty.
Accounting for warranties for revenue recognition
If the warrant is a separate performance obligation the seller should allocate a portion of the transaction price to the warranty
When the customer pays an unearned revenue account is recorded and revenue is recognized over the life of the contract (Expenses associated with the services are recognized as incurred) The revenue should proportionately match the expense until the last year and all revenue should be recognized
Accounting for potential sales returns
Credit revenue in full and debit Allowance for sales returns and allowances (A contra accounts receivable account) for the estimated amount of returns expected
Consignor vs Consignee
Consignor - Owner of the goods
Consignee - The store the goods are sold in
Accounting for consignment goods
Nothing is recognized when goods are shipped to the consignee. When a retail customer purchases consigned goods on the consignee’s premises, only then does the consignor recognize a sale. Typically a fee is kept by the consignee. he amount of revenue recognized by the consignor is the total sales amount. The consignee’s fee is treated as an expense by the consignor (Commission expense).
Explain bill and hold arrangements
A contract with a bill-and-hold arrangement allows the seller to retain physical possession of the goods (i.e., hold the goods) until the buyer is ready to receive the goods at a future point in time.
In a bill and hold arrangement when can the seller recognize revenue?
The seller may recognize revenue before transferring the goods if the buyer has control of the goods and the following criteria are met:
- There is a substantive reason for the bill-and-hold arrangement (e.g., the customer requested the arrangement because its facility does not have available space to receive the goods).
- The seller separates the product from the other inventory and identifies it as belonging to the customer.
- The product is currently ready for transfer to the customer.
- The product cannot be used by or directed to another customer.
What is a principal-agent arrangement?
the agent provides access to the goods or services to the customer while the principal provides the actual goods or services.
When is an entity considered an agent in a principal-agent arrangement?
if its performance obligation is to arrange for the customer to be provided with the goods or services from another party (i.e., the principal)
When does an agent recognize revenue in a principal-agent arrangement?
The agent recognizes revenue based on a commission or fee to which it expects to be entitled in exchange for arranging the transaction.
A new separate contract results from the modification if:
- The modification is for new or additional promised goods or services that are distinct AND
- The consideration for the new or additional goods or services reflects standalone prices.
**This does not impact the accounting for the original contract.
Costs to fulfill contracts that are expenses as incurred
general and administrative costs or costs that result in an asset with an amortization period of less than one year. The company will expense those costs in the period incurred.
Costs to fulfill contracts that give rise to an asset
Costs that give rise to an asset to be amortized include incremental costs that the companies would not have incurred if not for the contract. These costs are considered direct and incremental.
When should an initial fee be recognized using an input or output method?
When the goods and services are provided over an extended time period
When should an initial fee be recognized using a cost recovery method?
When there are questions about collectibility and no estimate of uncollectibility can be made
When should an initial fee be recognized using an accrual basis?
The revenues and expenses related to continuing franchise fees should be accounted for under the accrual basis of accounting. The related costs are matched against this revenue in the same period the revenue is earned.
Accounting for gift cards
When a retailer sells a gift certificate or gift card, it records an unearned revenue account (a liability). When the customer uses the card for a purchase, the liability is reduced, and sales (and cost of goods sold) are recognized.
Accounting if gift certificates are forfeited
Revenue is recognized at expiration or
Some cards have no expiration dates. For these arrangements, after a certain amount of time and based on past experience, the retailer can assume that a certain percentage of cards will not be redeemed.
Accounting for container deposits
The amount received from the customer is a liability until the container is returned. However, this liability is much less an unearned revenue account because containers are not meant to be sold. However, some containers are never returned and the deposit is forfeited; a nonsales revenue is recognized at this point. An expense is recognized for the cost of containers not returned by customers.
Define deferred revenue
A liability recognized when cash is received before the service is provided or before the goods are shipped to customers.
Accounting for deferred revenue (Unearned revenue)
A liability is recognized upon receipt of cash. As the service or good is provided, the liability is extinguished because the revenue is earned.
What are the two methods of revenue recognition for construction contracts?
- Completed Contract Method
- Percentage of Completion
Explain the completed contract method
No gross profit or revenue is recognized until the contract is complete. This method is required if estimates of the degree of completion at interim points cannot be made.
Explain the percentage of completion method
Recognize gross profit in proportion to the degree of completion. The percentage of completion equals cost incurred to date divided by the total estimated project cost.
When is the percentage completion method required?
If estimates of the degree of completion at interim points can be made and reasonable estimates of total project cost (and therefore profitability) can be made, and when the buyer and seller can be expected to perform under the contract. The
Explain the construction in progress account
- Construction in progress is an inventory account and a current asset.
- Construction in progress is debited only when costs are incorporated into the project. Purchases of materials for the project are recorded in the materials account.
Explain the Billings account for construction in progress
Billings is contra to construction in progress. In the balance sheet, if the balance in construction in progress exceeds cumulative billings to date, the net difference is a current asset
-If cumulative billings exceed the construction in progress balance, the difference is disclosed in the current liability section.
Types of losses on long-term contracts
(1) single-period losses and
(2) overall losses.
Explain single-period losses
When the total gross profit through the end of a given year is less than the gross profit recognized in previous years, a loss has occurred in the given year although the contract still may be profitable.
The completed contract method is unaffected by single-period losses, only percentage of completion is effected.
Explain Overall Losses
GAAP requires, for both methods (percentage of completion and completed contract), that when an overall loss on a contract is anticipated, the loss must be recognized in full. An overall loss occurs when the total estimated costs of the project exceed the contract price.
Under IFRS what methods are available to recognize revenue for construction contracts?
- Percentage Completion Method
- Cost Recovery Method (zero-profit method)
Under IFRS when is the cost recovery method required?
(1) When total project cost cannot be estimated, and also for any other reason causing completion of the contract to be uncertain.
(2) a finding that the contract is not enforceable
(3) if completion is dependent on pending litigation
(4) if the contractor cannot complete the contract due to internal problems such as pending bankruptcy.
Types of pension plans
- Defined contribution plans
2. defined benefit plans
Explain defined contribution plans
The amount of the employer contribution is defined by contract. The benefits paid during retirement are dependent on the return on the pension fund assets and, therefore, are not defined.
-401k is an example
Accounting for defined contribution plans
The amount of annual pension expense recognized is the required contribution.
What is the difference between contributory and noncontributory plans?
In a contributory plan, the employer and the employees make contributions to the pension plan. In noncontributory plans, only the employer makes contributions to the pension plan.
Explain a defined benefit plan
The benefits paid during retirement are based on a formula and therefore are defined. the contribution to the pension fund is not defined. The employer bears the risk in this type of plan because the benefit is defined.
Accounting for defined benefit plans
Pension expense is recognized as benefits are earned and the pension obligation is recognized for unpaid benefits.
Why is a trustee used for defined benefit plans?
Many firms sponsoring defined benefit plans use a trustee to disburse retirement checks and perform other administrative tasks concerning the pension plan. Those contributions and the earnings on them comprise the pension plan assets available for payment of retirement benefits.
What is the formula for the defined benefit plan?
(Years of service/40)(Final or highest annual salary)(Age at retirement/65).
The annual benefit may not exceed final salary.
Explain pension expense
The cost to the firm of providing the pension benefits earned during the year. This amount is reported in the income statement and has five independently computed components.
- Service Cost
- Interest Cost
- Expected return on plan assets
- Amortization of prior service cost
- Amortization of net gain or loss
Explain PBO (projected benefit obligation)
The present value of unpaid pension benefits promised for work done through the balance sheet date, as measured by the benefit formula.
- Reported only in the footnotes
- Provided by an actuary
Explain Pension assets at market value
The current ending plan assets (with the trustee). This is the fund available for retirement benefits. (contributions made by the sponsoring firm to date + investment return to date (interest, dividends, stock appreciation, recognized gains and losses) − benefits paid to date.)
-Reported only in the footnotes
Explain pension liability
The difference between ending PBO and plan assets at the balance sheet date, reported in the balance sheet. Also called “funded status”
-Pension liability (PBO—assets) is the amount underfunded. If the plan is overfunded (assets exceed PBO), then pension asset is reported (assets—PBO).
Explain ABO (accumulated benefit obligation)
The present value of unpaid pension benefits through the balance sheet using current salaries. This calculation is the same as for PBO except that the latter uses future salaries.
Explain VBO (vested benefit obligation)
The present value of vested benefits.
In most situations, the following relationship holds: PBO > ABO > VBO.
Two important estimates in pension accounting
- Discount Rate - The rate used for all actuarial present-value pension calculations. It is the rate at which the pension obligation could be settled and is pegged at the market rate of interest.
- Expected rate of return - The rate used to compute expected return on plan assets, one of the components of pension expense.
Explain Service Costs for pension plans
The actuarial present value of pension benefits earned during the current period. This amount is the increase in pension expense due to service provided during the year.
Explain interest costs for pension plans
Equals growth in PBO for the period due to the passage of time = (discount rate) x (PBO at Jan. 1). This component is based on benefits earned through the end of the previous year
Explain the expected return on plan assets for pension plans
(expected rate of return)x(plan assets at January 1 at market value). This component reduces pension expense.
The return on plan assets is the amount of the pension fund that is not paid by the sponsoring firm.
Service costs effect on pension expense
always increase pension expense.
Interest costs effect on pension expense
always increase pension expense.
Expected return on plan assets effect on pension expense
always reduces pension expense.
Amortization of prior service costs effect on pension expense
almost always increases pension expense because benefits are usually increased by plan amendments.
Amortization of net gain or loss effect on pension expense
decreases pension expense for gains (PBO decreases and when actual return exceeds expected return), or increases pension expense for losses
disclosure requirements for defined benefit pension plans
- The amount of net periodic pension cost for the period.
- The fair value of plan assets.- An explanation of a significant change in plan assets if not apparent from other disclosures.
- The amount of any unamortized prior service cost or credit not recognized in the statement of financial position (balance sheet).
- Reconciliation of beginning and ending balance of the projected benefit obligation.
- The funded status of its pension plan with the amounts recognized in the balance sheet showing separately the noncurrent assets, current liabilities, and noncurrent liabilities recognized.
- expected long-term rate of return on plan assets.
What are vested benefits?
Benefits that are not contingent on the employee’s continuing in the service of the employer
A pension asset reported in the statement of financial position represents the
Amount by which the fair value of plan assets exceeds the projected benefit obligation for the company’s overfunded plans.
Explain the assumed discount rate for a defined benefit pension plan
The assumed discount rate should reflect the rates at which pension benefits could be effectively settled. This rate is sometimes referred to as the settlement rate. To determine the settlement rate, it is appropriate to look at rates implicit in current prices of annuity contracts that could be used to settle the obligation under the defined benefit plan.
These three components of pension expense occur each year
(1) service cost
(2) interest cost
(3) expected return on plan assets.
Who computers service cost?
Actuary - not the company/accountant
The Employee Retirement Income Security Act of 1974
requires that employee pension benefits vest within a certain period (five or seven years is typical). It also requires that firms provide minimum funding of pension plans. In addition, amounts funded by the employer are tax deductible, but only up to a maximum amount.
When are benefits considered vested?
Benefits are vested if they are not contingent on continued employment
Prior service cost (PSC)
This is an immediate increase in PBO from the retroactive application of an increase in benefits for services already rendered
Pension gains and losses
There are two sources of pension gains and losses: (1) changes in PBO due to estimate changes and experience changes, and (2) the difference between expected and actual return.
Straight line depreciation of pension expense prior service cost
amortize PSC over the average remaining service period of employees covered by the amendment
Service method of depreciation of pension expense prior service cost
amortize an equal amount of PSC per service year, more amortization is recognized when more employees are working
PBO formulas for year 1 and following years
PBO ending amount = SC to date + Interest cost to date − Benefits paid to date + PSC
PBO ending amount = PBO beginning balance + SC for year + Interest cost for year – Benefits paid in year + PSC if granted in year
Decrease in PBO from increase in expected or actual turnover, decrease in life expectancy etc.
Actual return > expected return
Increase in PBO from decrease in discount rate, decrease in turnover, etc
Actual Return < expected return
Two computations for Net Gain or Loss of pension expense each year
- Determin the amortization of the net gain or loss at the beginning of the current year to include in pension expense for the year
- Determine the net gain or loss at the end of the current year for amortization the following year
Two methods to determine the amortization for the net gain or loss for pension expense
(1) minimum (corridor) amortization and (2) SL amortization
When actual and expected return are the same for a period, the return on asset component of pension expense
reduces pension liability because assets are increased.
What are the six elements included in defined benefit pension plan net pension costs?
- service cost
- interest cost
- actual return on plan assets (Subtracted)
- amortization of unrecognized prior service cost
- deferral of unexpected gain or loss
- amortization of the unrecognized net obligation or unrecognized net asset existing at the date of initial application
The corridor approach
used to determine gain or loss amortization. Under this approach, only the unrecognized net gain or loss in excess of 10% of the greater of the projected benefit obligation (PBO) or the market-related asset value (M-RAV) is amortized.
=(Unrecognized Net Loss - (.10(Greater of PBO or Market-related asset value))/Average remaining service years
Under the corridor approach, how is the corridor amount calculated?
.10(Greater of PBO or Market-related asset value
Under the corridor approach, how is the amount in excess of corridor calculated?
Unrecognized Net Loss - (.10(Greater of PBO or Market-related asset value)
unexpected gains and losses from plan assets and unamortized portions of prior service costs from pension plan amendments effect what account?
Accumulated other comprehensive income (AOCI)
Accounting for prior service cost (PSC) for defined benefit plans under international accounting
The entire PSC amount, at present value, is recognized immediately in pension expense.
Under international standards, pension expense is reported using what accounts?
service cost (including past service cost), and net interest cost (interest cost netted against expected return).
Disclosures for Defined Contribution Plans (IFRS)
- Pension expense should be presented separately from defined benefit plan pension expense.
- Description of the plan
- Description of the nature and effect of significant changes during the period affecting comparability (e.g., a divestiture, business combination, or a change in the rate of contributions)
- Reconciliation of beginning and ending pension liability balance
Disclosures for Defined Benefit Plans (IFRS)
- Pension expense and its components
- Funded status (pension liability)
- Reconciliation of beginning and ending balances for PBO including SC, interest cost, gains and losses, amendments and other changes; and for plan assets including contributions, benefits, and other changes
- Accumulated benefit obligation (ABO) and vested benefit obligation (VBO)
- Any settlements or curtailments.
- Estimates and assumptions including benefits expected to be paid in each of the next five years, employer contributions expected to be paid in the next 12 months, discount rates, rate of compensation increase, and expected long-term rate of return on plan assets
- Amounts recognized in OCI and reclassification adjustments, and OCI amounts not yet recognized in pension expense
What method is used in IFRS to account for defined benefit pension plans
Projected-unit-credit method
Examples of Other Postemployment Benefits (OPEB)
- Healthcare or medical care benefits
- Dental care benefits
- Eye care benefits
- Life insurance benefits
- Benefits related to legal services
- Benefits related to tax services
- Benefits related to tuition assistance
- Benefits related to day care
- Benefits related to housing assistance
Expected Postretirement Benefit Obligation (EPBO)
the present value of benefits expected to be paid, by the firm, based on the level of coverage the employees are expected to attain (Based on year of service etc 50%, 75% etc) after deducting the contributions of the employee and any Medicare or other government-sponsored plan payments.
Accumulated Postretirement Benefit Obligation (APBO)
APBO is computed after EPBO as the fraction of EPBO earned by the employee as of the balance sheet date
(# of years worked/Total number of years needed to reach expected coverage) X EPBO
Postretirement benefit liability as reported in the balance sheet =
APBO − plan assets at market value
5 components of Postretirement Benefit Expense
- Service Cost
- Interest Cost
- Expected return on assets
- Amortization of prior service cost
- Amortization of net gain or loss at January 1
And SOMETIMES
6. Amortization of transition obligation
Explain Service Cost for Postretirement Benefit Expense
The increase in APBO attributable to service provided in the period. SC is recognized only during the attribution period—the period to full eligibility
Explain Interest cost for Postretirement Benefit Expense
The increase in APBO due to the passage of time = (discount rate) × (APBO at January 1).
Explain Expected return on assets for Postretirement Benefit Expense
expected rate of return) × (assets at January 1)
Explain Amortization of prior service cost for Postretirement Benefit Expense
Initial full recognition of PSC is recorded in PSC-OCI and postretirement benefit liability, as is the procedure for pensions.
Straight-line or Service method of depreciation is allowed
Explain amortization of net gain or loss at January 1 for Postretirement Benefit Expense
Changes in APBO and the difference between actual and expected return on plan assets are the two sources for gains and losses
Initial full recognition of postretirement benefit gains and losses is recorded in postretirement benefit gain/loss-OCI and postretirement benefit liability
Per capita claims
These costs are estimated based on historical norms adjusted for estimated healthcare cost-trend rates and are affected by the estimated age of employees at retirement, their health, and other factors. Only post-retirement healthcare plans require this type of estimate.
Stock option plans are considered noncompensatory if all apply:
- Essentially all employees can participate.
- Employee must decide within one month of the firm setting the price for the stock whether to enroll in the plan.
- Discount does not exceed the employer cost savings inherent in issuing directly to employees (≤ 5% market price meets this criterion).
- Purchase price must be based solely on the market price of the stock.
- Employees can cancel their enrollment before purchase date and obtain a full refund
Stock Option Plan
Provides an employee with the option to purchase shares of employer firm stock at a fixed price in the future, after a reasonable service period. The options expire beyond a certain point.
Exercise price (option price)
Higher fair value with lower option price (less must be paid to obtain the shares)
Expected average life of the option (service period + exercise period)
Higher fair value with longer option period (there is a greater chance the stock price will increase and the time value of money is greater)
Current stock price
Higher fair value with higher price (the fair value of the option is in part a function of current stock price)
Expected volatility of the stock
Higher fair value with greater volatility (there is a greater chance of price increase − decreases don’t hurt the holder)
Risk-free rate of interest
Higher fair value with higher interest rate (the option holder can invest the exercise price and earn interest during service period)
Dividend yield at the grant date
Higher fair value with lower dividend yield (higher stock price with lower dividends)
Deferred Tax Asset (DTA) GAAP
Whenever a current temporary difference between books and tax yields a future deductible difference causing future taxable income to be less than future pretax account income, a DTA is recorded for the tax effect of that difference.
the deferred tax asset for a stock award or stock option plan under U.S. standards is based on the cumulative compensation expense to date. That amount is used as the estimate of the future tax deduction and is the basis for increasing the deferred tax asset.
Deferred Tax Asset (DTA) IFRS
the deferred tax asset is increased only when the option has intrinsic value (market price > option price) during the service period. Under this approach, if there is no intrinsic value, there is no estimated tax deduction and no increase in deferred tax asset is recognized.
Graded Vesting
refers to groups of options within one award that vest at different dates.
Graded Vesting - GAAP vs IFRS
Under U.S. standards, the entire award may be accounted for as a single award using the fair value of the ”average” option in the award. Alternatively, each group may be accounted for separately (with separate fair values). may choose a simplified straight-line method. Either way, the minimum annual expense is the amount applicable to vested options.
For international standards, the straight-line method is not allowed nor is the minimum amount of expense required to be recognized.
Stock Warrants
issued to shareholders by a corporation as evidence of the ownership of rights to acquire its unissued or treasury stock
Black-Scholes model
binomial models that take into account the volatility of stock prices when measuring the fair value of options
Lattice value model
option-pricing models that take into account the volatility of stock prices when measuring the fair value of options
What amount is recognized as equity when a stock option is exercised?
the options is equal to the increase in cash - which is the amount per share that the employee has the option of purchase the stock at
Accounting for employee compensation expense as the result of a stock option plan
calculated as the fair value of the equity instrument at the date of grant times the number of option shares. The total compensation expense must be recognized over the requisite service period for which the option plan represents compensation.
**Use the Market price of similar stock option
The interest rate used to discount both the exercise price of the option and the future dividend stream
The risk-free interest rate
Formula to determine the contribution to an employee stock ownership plan - if the contribution is calculated as 10% of income after the deduction of the contribution
(10% x Income)/(1 + 10%)
stock award plans
Under stock award plans, stock is awarded for continuing employment but the employee cannot sell the stock (the main restriction) until the award is vested—and the employee may not receive the shares until vested. Employees acquire the normal rights of shareholders at grant.
stock award plans - total compensation expense
the number of shares awarded multiplied by the market price of the stock at grant date (the fair value at that date). This amount is recognized as expense over the period the employee provides the service for which the grant was awarded.
Restricted Stock Units (RSUs)
An RSU is the right to receive a specified number of shares. When vested, the shares are issued. Such awards are very similar to stock awards. The benefits are the same. The difference is that the shares are not issued until vested and thus the holders typically do not receive the normal rights of shareholders until the RSU vests.
Restricted Stock Units (RSUs) - Total compensation expense
determined at grant date using the share price on that date. That total expense is allocated over the vesting period.
Employee Stock Ownership Plans (ESOPs)
An employee stock ownership plan (ESOP) is a qualified stock bonus plan whereby the firm invests primarily in qualifying employer securities, including stock and other marketable obligations for the benefit of the employees. The shares are distributed to the employees as part of their compensation, and often are held by the firm until the employee retires.
Balance Sheet Effects of Employee Stock Ownership Plans (ESOPs)
- If funds are borrowed from a lender to acquire the shares the company should record a liability and debit shareholder’s equity
- Shareholders’ equity will increase symmetrically with the reduction of the liability as the ESOP makes payments on the debt.
- Assets held by an ESOP are not to be included in the employer’s financial statements, because such assets are owned by the employees, not the employer.
Income Statement effects of Employee Stock Ownership Plans (ESOPs)
The employer recognizes compensation expense for the amount the employer contributed, or committed to contributing to an ESOP in the year. This includes cash, and its stock measured at fair value.
Stock Appreciation Rights (SARs)
(1) employee receives the difference between the stock price at grant date, and the stock price at exercise date
(2) pays nothing
(3) the SAR specifies payment of the benefit in either cash or stock (employee may have a choice)
Stock Appreciation Rights (SARs) which allow the employer to issue stock
the SAR is accounted for as a stock option plan. The fair value of the SAR is estimated at grant date and the total fair value is allocated to compensation expense over the service period.
Stock Appreciation Rights (SARs) specifies that payment is in cash or allows the employee to choose cash payment
- The firm records a liability rather than paid-in-capital when compensation expense is recognized.
- For each year in the service period, the fair value of each right is reestimated in light of new information using an option pricing model.
- Compensation expense is recorded each year based on the fair value at the end of the period
- Estimated forfeitures are built into the calculation of total compensation expense
- At exercise date, the fair value of the SAR equals the difference between price at grant date and the price paid for the stock.
Unfunded projected benefit obligation
This is the projected benefit obligation, less pension plan assets at fair value. The amount reported at each balance sheet date
component of the changes in the net assets available for benefits of a defined benefit pension plan trust
- The net change in fair value of each significant class of investments.
- Contributions from the employer and participants.
- Benefits paid to participants.
aspects of accounting for pension gains and losses that contribute to the reduction in volatility of reported pension expense:
(1) use of corridor amortization as an acceptable method
(2) gains and losses cancel
(3) spreading the amount subject to amortization over the average remaining service period of plan participants
(4) the use of expected return for component 3 of pension expense
