FAR Lecture 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 the beginning of each period
Identify and define two types of leases from the lessee’s perspective under IFRS and U.S. GAAP.
Capital (U.S. GAAP) / 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 U.S. GAAP)
All other leasses are simple rental agreements in which the lessee debits rent expense and credits cash/rent payable.
Identify and define types of leases from the lessor’s perspective under IFRS and U.S. GAAP.
Capital (Finance) Leases
Sales-type: Gives 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 of 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 receivables 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 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 for determining if a lease is a capital lease for the lessee under U.S. GAAP.
[OWNS]
To be classified as a capital lease under U.S. GAAP, the transaction must meet one or more of the following criteria:
- Ownership transferred
- Written bargain purchase option
- (Ninety) Percent of 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
The last two items are qualifying criteria as long as the asset is not in the last 25% of the original estimated late.
Name the criteria for determining if a lease is a finances 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?
At 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 the lessee.
Note: Minimum lease payments include payments, bargain puchase option, and guaranteed residual value. They do not include executory costs or an optional 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 U.S. GAAP.
[LUC]
To be classified as a capital lease, the transaction must meet all three of the following criteria:
- Lessee “owns” the lease property
- Uncertainties do not exist regarding any nonreimburseable 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 or loss. Fair value differs from cost or carrying value.
Direct-financing
Fair value is the same as the cost or carrying value at the beginning of lease term.
What period of benefit does the lessee use to depreciate the leased asset under a capital lease?
The estimated economic life of the asset 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 U.S. GAAP.
Substantially all rights retained
- PV of rent payments is equal to or greater than 90% of the fair value of the property.
- Gain is 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 is 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 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 an 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 U.S. 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 then the market/effective rate of interest.
A bond is issued as 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) / Number 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 x Effective Rate
Note: The straight-line method is permitted under U.S. 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 U.S. GAAP and IFRS?
U.S. GAAP
Capitalized as a deferred charge (asset) and amortized to expense over the period the bond is outstanding using the 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 U.S. GAAP?
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.
Describe the two methods of accounting for the 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 at a fixed price within a specific time period.
Describe the two method of accounting for bonds with detachable stock warrants.
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.
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 occurance, 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 reacquisition price of the debt.
What are the major disclosures for long-term debt?
- Maturity dates
- Interest rates
- Call and conversion privileges
- Assets pledged as security
- Future sinking fund payments
- Maturities for each of the next five years.
