Liabilities

Question 1

What are the different types of shipping terms, when does the title transfer over, and when do you record the entry?

Answer 1

FOB Shipping Point:

• Title transfers over to the buyer once the goods are with the common carrier. A payable can be recorded once sent to the common carrier - no need to wait for buyer to receive the gooods

FOB Destination:

• Title does not transfer over to the buyer until they receive the goods from the common carrier. A Payable can only be recorded when received by the buyer

Question 2

How to record Liabilities after the year-end date, but before issuance of financial statements?

Answer 2

Any activity that takes place and is known prior to the issuance of the financial statements should be reflected in the statements. For example:

• $750,000 Note Payable due in 6 months, as at Dec 31st - this would be included in the YE statements as a Current Liability
• Company uses excess cash to pay off $250,000 of the existing Note Payable on Jan 2
• Company decides to refinance, float bonds for $1,500,000, and use the proceeds to pay for the Notes Payable - completes this transaction Feb 2
• Company issues Financial Statements Mar 3

How much of the Note Payable should be included in the Current Liabilities section of the Financial Statements?

Since $250,000 is paid off, but the remaining $500,000 is refinanced for a longer term, the $250,000 is a short term liability and is the amount that should be included

Question 3

How is deferred compensation liability accounted for?

Answer 3

If the required period of service is greater than a year, then the amount of deferred compensation is accrued for during the years of service required to get the total amount of the deferred compensation.

For example:

Executive will receive $100,000 per year in each of years 6, 7 and 8 if they are employed at the end of year 5.

In such a case, the company will accrue the total amount to be paid ($300,000) over the preceding 5 years that is the required years of service:

$300,000 / 5 = $60,000

Question 4

What activities are associated with exit and disposal activities?

Answer 4

• Involuntary employee termination benefits
• Contract terminations that are not lease contracts
• Other costs associated with exit and disposal including employee relocation and costs to consolidate facilities

Question 5

What is the formula for accretion expense related to ARO?

Answer 5

accretion expense is the increase in the ARO due to the passage of time. Calculation:

Beginning ARO x interest rate used for passage of time

Interest rate used is typically the credit adjusted risk-free rate, NOT

Question 6

How are contingent gains and losses treated in financial statements?

Answer 6

• GAINS - if the range of values in the gain are all equally likely, then gains are reported as a disclosure in the financial statements, for the range of possibilities expected - e.g. if the range is $75K to $150K, the gain is disclosed in the notes, with the mention of the specific range as above. UNLESS the realization of the gain is remote - then NO DISCLOSURE NECESSARY.
• LOSSES - if the loss is REASONABLY PROBABLE, AND range of losses / payouts are equally likely, then the lowest amount in the range of possibilities is accrued as a liability. If the realization of the loss is remote, then NO DISCLOSURE NECESSARY

In the above cases, if only reasonably possible, but not probable, then just a footnote disclosure is necessary.

Question 7

What is the formula to calculate the unearned revenue related to a premium (coupons, box tops, labels etc.)

Answer 7

of coupons (or any other form of sales incentive) issued or sold x redemption rate

Question 8

How are warranty liabilities recorded?

Answer 8

• Record the liability based on the probable cost (usually some form of % of sales that will be claimed, or anticipated cost per unit x units sold)
• To record the liability based on probable cose, recognize a warranty expense, credit a warranty liability
• When the actual cost is incurred, debit the liability (reduce it) and credit inventory, or whatever other side needs to be, on assets to come down

Question 9

How do leases impact the statement of cash flows?

Answer 9

Operating Leases:

• Any kind of lease payments (operating lease, short-term lease payments, variable lease payments) are considered an outflow of CFO
• Any amounts spent toward preparing an asset for intended use are considered CFI

Financing Leases:

• Any variable lease payments, or lease payments not included in the original lease terms impact CFO
• Interest payments impact CFO
• Principal payments on the lease impact CFF

Question 10

Once classified as a finance lease, what is the term over which the lesee should amortize the asset?

Answer 10

The lessee should amortize the asset over the economic life of the asset

BUT

should recognize the lease liability over the lease term

Question 11

How are capital and finance leases different when it comes to amortization expense?

Answer 11

• Operating (Capital) Lease - Amortization is calculated on based on the lease term
• Finance Lease -
  Amortization is calculated based on the useful life of the asset

Question 12

What rate is used when calculating the PV of the minimum lease payments - is it the implicit rate on the lease, or the incremental borrowing rate of the borrower?

Answer 12

You use the implicit rate on the lease

Question 13

What are the items that determine the the value of the lease to be recorded on the balance sheet at inception?

Answer 13

• PV of the minimum lease payments - either using the PV factor for annuity (lease payment at period end) or PV factor for annuity due (lease payment at period beginning)
• Any costs associated with the setup of the lease (other than the lease payments), such as Consulting Fees, Legal fees, other setup costs etc. would be added to the PV of the min lease payments, and then THAT amount would be amortized out in the case of a finance lease
• ## PV of any residual cost of the asset at the end of the lease

Question 14

How is the interest expense on a finance lease liability calculated?

Answer 14

• Take the principal balance outstanding and multiply it by the implicit interest rate

For example, you are told, the outstanding balance on a finance lease liability is $75,000, net of a current portion of $1,364, with an implicit interest rate of 10%, and annual payments of $9,000.

Need to add in the the current portion back to the finance lease liability, then the interest on this amount -

Interest = 76,364 x 10% = $7,636.40 - so principal will be $9,000 - $7,636 = $1,364

Remaining balance - $75,000

Next payment -

Interest = 75,000 x 10% = $7,500 - so principal will be $9,000 - $7,500 = $1,500

Remaining balance - $73,500

Question 15

What is the formula for the PV factor of an ordinary annuity?

Answer 15

(1-((1+r)^-n)) whole divided by r

Question 16

What is the formula for a PV factor for an annuity due?

Answer 16

(PV factor for ordinary annuity) x (1+r)

Question 17

How do you determine sick pay vs. vacation pay liability?

Answer 17

Vacation Pay is accrued as a liability if it either vests or is accumulated.

Sick pay is only accrued as a liability if it vests.