FAR Liabilities Flashcards
Explain the difference between the net method and gross method of recording accounts payable.
Gross method-
- The gross method records a purchase without regard to the discount. When invoices are paid withing the discount period, a purchase discount is credited.
Net Method
- Under the net method, purchases and accounts payable are recorded net of the discount. If payment is made within the discount period, no adjustment is necessary. If payment is made after the discount period, a purchase discount lost account is debited.
What types of costs are associated with exit and disposal activities?
-involuntary employee termination benefits
- Costs to terminate a contract that is not a capital lease
- Costs to consolidate facilities
- Costs to relocate employees
Define an asset retirement obligation (ARO)
A legal obligation associated with the retirement of a tangible long-lived asset that results from the acquisition, construction, development, and/or normal operation of a long-lived asset.
How is an ARO initially measured?
At Fair Value (present value of the future obligation) as an asset (asset retirement cost) and a liability (asset retirement obligation).
How is an ARO accounted for in periods after initial measurement?
The ARO liability is adjusted for acceretion expense and the ARO asset is depreciated.
What is the accounting treatment of gain contingencies?
Gain contingencies are not reflected on the balance sheet but are disclosed as to their nature and amount if likelihood is probable and to do so would not be misleading.
Identify the three ranges of likelihood that a future event will confirm a contingent liability
Probable
Reasonably possible
remote
When are contingent liabilities accrued?
-when the loss is both probable and can be reasonably estimated, then record and disclose.
- Financial statement disclosure only for reasonably possible contingent losses.
- Remote contingent losses are not disclosed, unless they are “guarantee-type” contingent losses, which must be disclosed.
Premiums, warranties, and service contracts are examples of estimated liabilities. When are the liabilities for these types of expenses recorded and why?
Estimated liabilities for premiums, warranties, and service contracts are recorded in the same period as the revenue associated with the various transactions in order to accomplish matching of costs and revenue.
What is the equation to calculate the present value of $1?
PV= FV/(1+r)^n
PV=Present value
FV=Future Value
r=interest rate
n= number of years
What is the difference between an ordinary annuity and an annuity due?
Timing of payments-
Ordinary annuity= payments at the end of each period
Annuity due= payments are at beginning of each period.
How are notes payable recorded in the financial statements?
Notes payable must be recorded at present value at the date of issuance.
If a note is non-interest bearing or the interest rate is unreasonable (usually below market value), the value of the note must be determined by imputing the market rate of the note and by using the effective interest method.
What is the effective interest rate method?
The effective interest method is a method under which each payment on a note (or other loan) would be divided between an interest component and a principal component as though the note had a constant effective stated rate (or adequate rate) of interest.
How are premiums or discounts resulting from recording notes payable and receivable at present value presented in the financial statements?
The premium or discount that arises from the use of present values on cash and noncash transactions is inseparable from related asset or liability. Therefore, such premium or discount valuation accounts are added to (or deducted from) their related asset or liability on the balance sheet.
Why do creditors use debt covenants in lending agreements, and how could this impact the issuer?
Debt covenants are stipulated in lending agreements to protect the creditors interests by limiting or prohibiting certain actions of the debtors that may be harmful to the creditors interest (issuing more debt)
Debt covenants are disadvantageous to the issuer (the debtor), as they may restrict certain management activities (selling assets).
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 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.
How id the bond selling price computed?
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 fate the bonds are issued.
What is the preferred method of accounting for bond issuance costs under US GAAP?
Deducted from the carrying amount of the liability and amortized using the effective interest method.
Name 2 methods of amortizing bond premium (discount)
Straight line method
- Premium (discount)/number of periods outstanding
Interest (effective rate) method (US GAAP)
- Premium (discount) amortized= (Carrying value * effective rate)- (face value* Stated rate)
Interest expense= (Face value* stated rate) +discount amortized - premium amortized= carrying value * effective rate
***NOTE= the straight-line method is permitted under US GAAP if not materially different from the effective interest method.
What are the major disclosures for long-term debt?
- maturity dates
- interest rates
- call and conversion privileges
- Assets pledged as security
- Borrowed-imposed restrictions
Name 4 types of restructurings involving debt
- Transfer of assets
- Transfer of equity interest
- Modification of terms
- A combination of the above 3
How is the gain (loss) measured in a troubled restructuring involving a transfer of assets?
Restate the assets transferred to Fair value and recognize a gain or a loss in ordinary income.
Recognize a gain for the difference between the fair value of the assets transferred and the carrying amount of the debt forgiven.
How is the gain (loss) measured in a troubled debt restructuring involving the modification of terms?
It is the difference between the carrying amount of the obligation prior to restructuring and undiscounted total future cash flows required after restructuring, if undiscounted future cash flows are less than the carrying amount.
When is a loan considered impaired?
When it is probable that all amounts due under the original contract will not be received when due.
How is the loss incurred as a result of a modification of terms of an impaired loan reported by the creditor?
The amount of the loss is the present value of the loans expected future cash flows discounted at the loans effective interest rate minus the carrying value of the loan before the modifications of terms.
Debit Bad debt expense
credit Allowance for credit losses
When is a liability considered extinguished?
If either one of the following conditions are 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.
