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ACCT 343 > Midterm #1 > Flashcards

Midterm #1 Flashcards

1
Q

What is a Lease?

A

A contractual agreement between a lessor (owns the asset) and a lessee (now going to take control of the asset for a set period of time) that gives the lessee the right to use specific property, owned by the lessor, for a specific period of time.

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2
Q

Most Commonly leased asset include:

A

real estate–> apartment
vehicles–> car rental and car lease
equipment–>heavy machinery, laptop from library, cell phone.

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3
Q

Why Lease Assets (vs. Buy)

A

Lower Financing Costs:
-less upfront cash required
-lower payments
Avoid risk of obsolescence/declining value
Flexibility:
-disposing of a leased asset is easy and cheap; not
so true for an owned asset.

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4
Q

Why Lease Asset (vs. Sell)

A

“Leasing an asset you own is a good source of income”
Interest Revenue:
-Can continue to generate income from an asset,
even through not using it.
Keep residual value
Tax benefits
-depreciation deduction

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5
Q

For accounting purposes, we classify leases as follows:

A

Lessee:
Finance-ownership shifts
Operating-rental
Lessor:
Sales-Type Lease:
w/ selling profit
w/out selling profit
Operating Lease

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6
Q

Classification Criteria, What are the five questions that establish whether the lease transfers the risks and rewards of ownership to the lessee:

A
  1. Does the contract provide for a transfer of ownership at the end of the lease?
  2. Does the contract contain a bargain purchase option?
  3. Does the lease term account for the “Major Part” of the remaining useful life of the asset?
    4.Is the present value of the total lease payments >_ “substantially all” of the FMV of the asset value?
  4. IS the nature of the asset highly specialized so as to offer no alternative uses of the lessor?
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7
Q

For the classification of the lease, how many yes’s are required for a finance/sales type lease.

A

1 yes=finance/sales type
5 no=operating

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8
Q

What is the fundamental question about any lease:

A

Does the lease agreement transfer substantially all of the risks and rewards of ownership to the lessee?

if yes, then the lease is accounted for as a finance/sales-type lease (account like a sale).

if no, then the lease if an operating lease (account like a rental).

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9
Q

What if there’s selling profit on the sales-type lease (lessor)?

A

The profit gets recognized at the beginning of the lease through the initial entry to set up the lease on the lessor’s books.
PROFIT ONLY AFFECTS JE #1
All other entries are unchanged
lessee is unaffected

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10
Q

Other lease accounting issues (lessee and lessor): Discount Rate

A

discount rate- an important variable in accounting for finance and operating leases for lessees and sales-type leases for lessors is the implicit (or discount) rate.

Interest rate used in PV calculation

For the lessor… the desired rate of return, lessor sets the rate

for the lessee…depends on knowing the lessor rate
if known- then use lessor rate
if unknown- use incremental borrowing rate

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11
Q

What is lease uncertainty?

A

Uncertainty can arise with respect to various aspects of a lease, often due to the structure of the contract itself.

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12
Q

Where do leases show up on the statement of cash flows:

A

Lessor-always received are always operating cash flows.

Lessee- it depends.
operating lease–> payments made are operating
cash flows.
finance lease–>payments made are both
operating (interest) and financing
(principle) cash flows.

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13
Q

What’s a pension plan?

A

an arrangement through which an employer provides benefits (payments) to retired employees for services provided while working.

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14
Q

Types of Pension Plans: Contributory

A

both employer and employee make contributions

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15
Q

Types of Pension Plans: Noncontributory

A

only employer makes contributions

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16
Q

Types of Pension Plans: Qualified

A

tax designated–> once you contribute money, its allowed to grow tax free until withdrawn.

withdrawn=taxed

ex. 401k —> contributory and Qualified

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17
Q

Defined-Contribution Plan:

A

employer contribution determined by plan (fixed)

benefits based on plan value

risk borne by employees

about 3/4 of pension are DC

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18
Q

Defined-Benefit Plan:

A

Benefit determined by plan

employer contribution varies (determined by actuaries)

risk borne by employer

about 1/4 of pension are DB

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19
Q

What is the pension obligation/liability:

A

present value of cumulative expected future benefit payments

netted against the fair value of the assets set aside for the pension

net funded status=the difference between these two

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20
Q

what is pension expense:

A

current year change in the net pension obligation, mostly

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21
Q

Measuring Pension Expense: Service Cost

A

Increase in PBO resulting from current year work

this is told–> no calculation–>actuaries provide this

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22
Q

Measuring Pension Expense: Interest on the PBO

A

interest cost on the PBO

Beg. PBO x Interest Rate (given)= interest cost

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23
Q

Measuring Pension Expense: Return on Plan Assets

A

Actual Return=
(Plan Assets End balance-Plan asset beg. balance) - (contributions-benefits paid)

We include the expected return in pension expense.
Beg. FMV Plan assets x Expected ROR

24
Q

Residual Value

A

the residual value of leased property is the estimated FMV of the asset at the end of the lease term.

Recall that the lessor will typically get the asset back at the end of the lease.

25
Q

a leased asset’s residual value reduces the lease payment amount because…

A

the lessor determines the payments based on the value of the lease contract.

may be guaranteed by the lessee or not
can affect lease classification.

26
Q

Residual Value generally does not affect accounting for who?

A

The Lessee

The lease payments are just smaller because of the residual value, but the accounting mechanics are the same.

27
Q

However, if the lessee guarantees the residual value:

A

PV of the guaranteed residual value is included in the present value of lease payments for purpose of the “present value of lease payments test” to determine the lease classification

The guaranteed Residual value is not included in the lease liability or ROU asset unless the lessee expects to have to pay cash at the end of the lease die to the guarantee.

28
Q

Bargain Purchase Options

A

Recall that if the lease contract contains a purchase option that is “reasonably certain” to be exercised, also called BPO, the lease is automatically treated as a finance/sales-type lease.

29
Q

How does the BPO affect the accounting for the lease?

A

The exercise price of the BPO is treated as an additional cash payment for both the lessor and lessee.
Affects calculation of lease liability and ROU asset (Lessee)
and lease receivable (lessor).
The Lease term is considered to end at the earliest point where the BPO can be exercised.

30
Q

What is the BPO affect on ROU asset

A

since the lessee is predicted to own the asset after the lease term, the ROU asset recognized by the lessee should be amortized over the economic life of the asset, rather than over the lease term.

31
Q

BPO: if exercise is reasonably certain

A
  • limits lease term
    PV of exercise price added to ROU asset and Lease Liability
    PV of exercise price added to lease recievable
32
Q

Qualitative lease disclosures:

A

a general description of the lease arrangement is required, including info about variable lease payments, options, non lease payments, and residual values.

a reason for excluding variable lease payments from the measurement of the lessee’s liability and the lessor’s receivable is that they could result in unreliable measurements in the financial statements.

33
Q

What is an actuary?

A

a professional trained in a particular branch of statistics and mathematics to assess the various uncertainties and to estimate the company’s obligation to employees in connection with its pension plan.

34
Q

Accounting for a defined contribution plan:

A

simple

when the employer makes a contribution to the plan:
pension expense x
cash x

that is, the pension account is managed by a third party company that “belongs” to the employee.

35
Q

Accounting for a defined benefit plan:

A

complex

the employer makes contributions to the plan now to fund some committed and unknown future retirement benefit.
unknowns include:
future salaries of the employee
how long the employee will work before retiring
employees age at retirement
how long employees will live after retirement

so the accounting seeks to measure and report a pension obligation that grows over time with employee work and shrinks with benefits paid, along with its funded status.

36
Q

Measuring Pension Expense: Prior Service Cost

A

happens when there is a change to the contract, due to an amendment, that changes the amount of payments
retroactive change.
Changes in PBO in relation to prior year work.

37
Q

Measuring Pension Expense: Gains and Losses

A

RE:PBO-change in PBO because change in actuary’s assumptions. Plan doesn’t change. PBO Increase (decrease)=Loss (gain)

RE: Return on Plan Assets
Actual return-expected return=gain/loss
actual return is higher=gain

38
Q

does a company recognize retroactive benefits resulting from a plan amendment (PSC) as pension expense in the year of the amendment.

A

No, they do not recognize retroactive benefits.

Instead, the company amortizes those PSC amounts over the remaining service lives of the employees affected by the amendment. Generally, straight-line is used.

39
Q

In our class Prior service costs increase expense. T/F

A

T

40
Q

in the year of the plan amendment, the amortized portion of PSC is part of ____ (ie. _____) and the unamortized portion is part of ____(i.e. _____)

A

pension expense, debited

OCI, debited

In subsequent years, the amortized portion of PSC for each year is credited to OCI and added to pension expense (ie moved from AOCI to pension expense).

41
Q

Gains and Losses: Unexpected swings in pension expense can result from.

A

Sudden and large changes in the fair value of plan assets.

Changes in actuarial assumptions that affect the amount of the PBO.

These unexpected changes in the FMV of plan assets and/or the PBO potentially create volatility in earnings

GAAP provides for certain “smoothing” techniques to mitigate this volatility.

42
Q

Gains/Losses: smoothing related to unexpected gains and losses on plan assets:

A

The expected return (not the actual return) is included as a component of pension expense.

The Unexpected return (ie gains or less) is included in OCI.

Unexpected gains and losses accumulated in AOCI over time.

43
Q

Gains/Losses: smoothing related to unexpected gains and losses on the pension liability (PBO):

A

Liability G/L are included in OCI (G/L will not touch pension expense).

Liability gains/losses accumulate in AOCI.

The overarching philosophy is that gains and losses stemming from unexpected changes in the values of the PBO and plan assets will generally cancel each other out over time. Hover around zero.

44
Q

Corridor Amortization

A

The accumulated net g/l from AOCI must be moved from AOCI to pension expense (ie amortized) if it gets “too large”.

“Too large” means more than 10% of the beginning balance of the PBO or the FMV of plan assets, whichever is larger. nothing if less than or equal to 10%.

Any net g/l balance in AOCI above the 10% threshold must be amortized, generally over the remaining service life of the active employee group.

Amortized amounts are no longer in AOCI balance.

45
Q

Reporting of Pension Plans: One the face of the financial statements:
Net funded status
Pension expense on the income statement
PSC adjustments and g/l in OCI

A

Net funded status of the plan(asset or liability) on the balance sheet- the only number shown on the BS:
if asset- always noncurrent
if liability- classification depends (generally
noncurrent)
Pension expense on the income statement- but the service cost component is broken out and shown as part of compensation expense.

PSC adjustments and gains and losses in OCI

46
Q

Residual Value affects accounting for he lessor in a few ways:

A
  • Present value of the residual value (guaranteed or not) is subtracted from the present value of the total amount to be recovered from the asset to calculate the lease payment amount.
    PMT=FMV/PV Factor
    is there is residual value(guaranteed or not)=(FMV-PV(Residual))/PV Factor

-present value of any lessee-guaranteed residual value is included in the present value of lease payments for purpose of the “present value of lease payments test” to determine the lease classification.

-If a sales-type lease, the PV of the residual value (guaranteed or not) is added to the present value of lease payments to calculate the lease receivable.

  • if profit on the sales-type lease, the present value of the residual value (guaranteed or not) is subtracted from both the sales revenue and COGS amounts in the lease setup entry
47
Q

Reporting of Pension Plans: in the notes to the financial statements

A

major components of pension expense

changes in PBO and FMV of plan assets and effect on net income and OCI

rates used in measuring the benefit amounts (ie. interest, expected return).

breakdown of pension plan assets by category(ex. equity securities, debt securities ,other assets.

Expected future benefits payments (5years) and contributions (1 year)

accumulated pension-related oci amounts that will affect net income in future periods.

amount of net actuarial gains and losses and PSC to be amortized from AOCI to next income over nest year.

48
Q

Lease Uncertainty: Lease Term

A

non-cancelable period for which a lease has the right to use an underlying asset, modified by any renewal or termination options that are “reasonably certain” to be exercised, or not exercised.

options whose exercise is under the control of the lessor automatically included.

Reassessed only when a significant occurrence indicates a change in the economic incentive.

49
Q

Lease Uncertainty: Variable Lease payments
Included only if payments are:

A

In-substance fixed payments or

based on an index or rate, with changes due to the index or rate considered only if and when the lessee remeasures the lease liability for another reason.

50
Q

Lease Uncertainty: Unguaranteed Residual Value

A

Present Value (Called Residual Asset):
- influences the size of lease payments.
- added to lease receivable
- subtracted from sales revenue and COGS in sales-type lease

51
Q

Lease Uncertainty: Lease Guaranteed residual value

A

Present Value:
- considered when determining lease classification (criterion 4)
- included in lease receivable
- included in sales revenue.

52
Q

Lease Uncertainty: Excess of guaranteed residual value over expected residual value

A

Present Value:
- influences the size of lease payments
- added to ROU asset and lease liability

53
Q

Lease Uncertainty: Purchase Options
If exercise is “reasonably certain”:

A
  • limits lease term
    -PV of exercise price added to ROU asset and lease liability
    -PV of exercise price added to lease receivable
54
Q

Lease Uncertainty: Termination Penalties
If exercise is “reasonably certain”:

A

-limits lease term
- PV of penalty amount added to ROU asset and Lease liability
- PV of penalty amount added to lease receivable

55
Q

Lease Uncertainty: Modification of Lease:

A

If a modification grants the lessee an additional ROU, the original lease is terminated and a new lease is created.

otherwise, it means adjusting, adding, or deleting accounts to conform with the new terms and perhaps reclassify it from one type of lease to another.

ACCT 343 (4 decks)

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