Reading 28: Noncurrent (Long-Term) Liabilities Flashcards
Where do defined-contribution plans appear in financial statements?
On the income statement, the company recognizes the amount it is required to contribute into the plan as pension expense for the period.
On the balance sheet, the company records a decrease in cash. If the agreed-upon amount is not deposited into the plan during a particular period, the outstanding amount is recognized as a liability.
On the cash flow statement, the outflow is treated as an operating cash flow.
Describe net interest expense or income.
This is calculated as the net pension liability or asset at the beginning of a period multiplied by the discount rate used to estimate the pension obligation (present value of expected pension payments). Net interest expense or income is also recognized as pension expense in profit and loss.
Differentiate issuance costs between U.S. GAAP and IFRS.
Under U.S. GAAP, because issuance costs are capitalized, any unamortized issuance costs must also be subtracted from gains on extinguishment.
Under IFRS, issuance costs are included in the book value of the liability so there is no need to adjust the gain on extinguishment for these expenses.
Explain the effect of bonds issued at par on the statement of cash flows.
For bonds issued at a discount, the inflow recorded at issuance under CFF ($96,898) is lower than the outflow from CFF at maturity ($100,000). Coupon payments ($10,000) are deducted from CFO every year.
Explain the effect of bonds issued at par on the income statement.
Interest expense rises from year to year in line with the increasing book value of the liability.
Explain the effect of bonds issued at a premium on the balance sheet.
The book value of the liability decreases over the life of the bond. The entire premium ($3,240) is amortized over the 4 years. The value of the liability at the end of Year 4 equals the par value, which is the amount that must be paid to investors at maturity.
Explain employee service costs.
The service cost during a period for an employee refers to the present value of the increase in pension benefit earned by the employee as a result of providing one more year of service to the company. Service costs also include past service costs. They are recognized as pension expense in profit and loss.
List the 3 general components of a change in the net pension asset or liability each period (pension expense) under IFRS.
Employee service costs
Net interest expense or income
Remeasurements
Explain book value of debt when a company uses the effective interest method to amortize bond discounts and premiums.
The book value of debt is based on market interest rates at issuance. Over the life of the bonds, as market interest rates fluctuate, the actual value of the firm’s debt deviates from its reported book value.
List the 2 main types of pension plans and describe them.
Defined contribution plan is a pension plan in which the company is required to contribute a certain (agreed-upon or defined) amount of funds into the plan. However, the company makes no commitment regarding the future value of plan assets.
Defined benefit plan is a pension plan whereby the company promises to pay future benefits to the employee during retirement.
List the 5 components of a change in the net pension asset or liability each period (pension expense) under U.S. GAAP.
Employee service costs for the period
Interest expense accrued on the beginning pension obligation
Expected return on plan assets
Past service costs
Actuarial gains and losses
List the effects of bond issuance on the statement of cash flows.
At issuance, bond proceeds are reported as inflows from financing activities.
During the tenure of the bond, coupon payments (not interest expense) are deducted from cash flow from operating (CFO) activities.
At maturity, cash used to repay the principal amount (par value) is deducted from cash flow from financing (CFF) activities.
List the 2 methods of accounting for noncurrent liabilities and describe their accounting
Straight-line method evenly amortizes the premium or discount over the life of the bond (similar to straight-line depreciation). Effective interest method results in a constant rate of interest over the life of the bond. The market interest rate at issuance is applied to the carrying amount of the bonds to determine periodic interest expense. Further, the difference between interest expense and the actual coupon payment equals the amount of discount/premium amortized over the period.
