Test 4 Flashcards
What is a Lease?
a contractual agreement between a lessor and a lessee
gives the lessee the RIGHT to use specific property owned by the lessor for a SPECIFIED PERIOD OF TIME
What are some advantages of leasing for the lessor?
-can provide profitable interest margins
-can provide high residual value to the lessor
-can provide tax benefits/advantages
-can stimulate sales of a lessor’s product
What are some advantages of leasing for the lessee?
-100% financing at fixed rates
-protection against obsolescence
-flexibility
-less costly financing
Are all long-term leases (>12 months) recorded on the balance sheet?
YES - all of them
What are the two classifications of leases?
Finance: must fulfil one of the five classification tests or else it is an operating lease
Operating
If a lessee CAPITALIZES a lease, how must they record this?
Lessee records a right-of-use asset and a lease liability generally equal to the PRESENT VALUE of the minimum lease payments
FASB has identified five criteria for a finance lease.
If ONE OR MORE of these criteria are met, what type of lease is this classified as?
Finance lease
Besides meeting at least one of the five tests, what else must occur for the classification of a finance lease?
it must also be NON-CANCELABLE
What are the five tests to determine if a lease is classified as a finance lease?
- Transfer of Ownership test
- Purchase Option test
- Lease Term test
- Present Value test
- Alternative Use test
FASB has identified five criteria for a finance lease.
If NONE of these criteria are met, what type of lease is this classified as?
Operating lease
What interest rate does the Lessee use to compute the minimum lease payments, if known?
implicit interest rate
If the Lessee does NOT know the Lessor’s implicit interest rate, what rate do they use?
incremental borrowing rate (which is their own)
What are the initial journal entries for the lessee at the inception date (say 1/1)?
Dr. Right-of-use Asset
Cr. Lease Liability
What is the journal entry for the lessee at the time the first payment of the annuity lease is made, at inception?
Dr. Lease Liability
Cr. Cash
What is the journal entry for the lessee at the year-end (12/31/xx) for annuity due (only)?
Dr. Interest Expense
Cr. Lease Liability
Dr. Amortization Expense
Cr. Lease Liability
In which section would the CURRENT PORTION (<12 months) of disclosure for lease receivable/liability be found in the financial statement?
current receivable/liability section (lease and interest)
In which section would the REMAINDER of disclosure for lease receivable/liability be found in the financial statement?
long-term asset/liability section (>12 months, noncurrent)
What are examples of a change from ONE accepted ACCOUNTING PRINCIPLE to ANOTHER?
i.e. GAAP -> GAAP
LIFO to FIFO; Average Cost to FIFO
Completed Contract Method to Percentage of Completion Method
When changing from one accepted accounting principle to another, how are changes reported?
RETROSPECTIVELY
-must adjust financial statements for each prior period presented
-adjusts beginning retained earnings balance
What are some examples of a change in ACCOUNTING ESTIMATES?
- Uncollectible receivables
- Inventory obsolescence
- Useful life and salvage value of assets
- Periods benefited by deferred costs
- Liabilities for warranty costs and income taxes
- Recoverable mineral reserves
- Change in depreciation methods
When reporting changes in accounting estimates, how are they reported?
PROSPECTIVELY
-changes in CURRENT year and future periods
What are some examples of ACCOUNTING ERRORS?
- Change from an accounting principle that is NOT generally accepted to an accounting policy that is acceptable (e.g., cash basis to accrual basis)
- Mathematical mistakes
- Changes in estimates that occur because a company did not prepare the estimates in good faith
- Failure to accrue or defer certain expenses ore revenues
- Misuse of facts
- incorrect classification of a cost as an expense instead of an asset (vice versa)
How are accounting errors reported?
reported as a PRIOR PERIOD ADJUSTMENT
restate PRIOR YEAR (retrospective) by ADJUSTING beginning Retained Earnings balance
What is the primary purpose of the Statement of Cash Flows?
to provide information about a company’s CASH RECEIPTS and CASH PAYMENTS during a period
What questions does a Statement of Cash Flows look to answer?
- Where did the cash come from?
- What was the cash used for?
- What was the change to the cash balance?
What is the secondary purpose of the Statement of Cash Flows?
provide cash-basis information about the company’s operating, investing, and financing activities
The information provided on a Statement of Cash Flows looks to help assess:
-ability to generate future cash flows
-ability to pay dividends and meet obligations
-reasons for difference between net income and net cash flow from operating activities
-cash and noncash investing and financing transactions
Broadly, what does the Operating section of the Statement of Cash Flows show a change in?
Current Assets and Current Liabilities
Broadly, what does the Investing section of the Statement of Cash Flows show a change in?
Long Term Assets
Broadly, what does the Financing section of the Statement of Cash Flows show a change in?
Long Term Liabilities and Stockholders Equity
In which section of the Statement of Cash Flows is the Direct Method, when applicable, present?
ONLY in the Operating section
What are the three sections of the Statement of Cash Flows?
- Operating
- Investing
- Financing
Per FASB, what are Cash Equivalents?
short-term, highly liquid investments that are:
-readily convertible to known amounts of cash
-so near their maturity that they present an insignificant risk of changes in interest rates (i.e. 3 months or less)
What are the THREE SOURCES of information for the Statement of Cash Flows?
- Comparative Balance Sheets
- Current Income Statement Data
- Selected Transaction Data
In the indirect method, what are the steps of sharing the Operating Section?
- Net Income
- Add Non-cash expenses (depr., amort., bad debt exp.)
- Add any losses reported on the I/S
- Deduct any gains reported in I/S
- Analyze non-monetary current assets (inventory)
- Analyze current liabilities (A/P)
What is a keyword for what the Direct Method is in the Operating Section
GROSS for Cash Receipts from Customers, Cash Payments to Suppliers, and Cash Payments for Operating Expenses
What does the Full Disclosure Principle call for in financial reporting?
financial reporting of ANY financial facts SIGNIFICANT enough to INFLUENCE the judgement of an informed reader
One of the Notes to Financial Statements is a “Summary of Significant Accounting Policies” (Footnote 1).
What are some examples that would be shown here?
-Allowance for Doubtful Accounts
-Inventory valuation
-PP&E
-Revenue Recognition
-Intangible Assets
What are the two types of Subsequent events?
TYPE 1: events that provide additional evidence about conditions that existed AT THE BALANCE SHEET DATE, which requires an adjustment to the financial statements if material
TYPE 2: events that provide additional evidence about conditions that existed SUBSEQUENT TO THE BALANCE SHEET DATE (i.e., following), which requires a disclosure if material
What are examples of Type 1 and Type 2 Subsequent Events?
Type 1: loss on a lawsuit after year-end that was uncertain at year-end; material loss on a year-end receivable due to customer bankruptcy
Type 2: loss of plant or inventories from a fire after year-end; merger with another company; issuance of a significant number of ordinary shares
