F6

Question 1

How should I lease bonus be accounted for as a lessor?

Answer 1

Unearned Income, earned over the life of the lease.

Question 2

Who is the lessor in a lease transaction?

Answer 2

The entity leasing the equipment out. (owner)

Question 3

How should leasehold improvements be depreciated?

Answer 3

Over the lesser of:

1. ) Life of lease
2. ) Life of improvement

Question 4

Under GAAP, on the lessee side, what is the criteria for finance leases?

Answer 4

(One must be met)

1.) Ownership
2.) Written option for bargain purchase
3.) Ninety % of leased property FV (Pv of lease payments)
4.) Seventy-five % or more of the asset life
Asset is specialized

Easy to remember = Lessee must OWNS it.

Question 5

Under GAAP, on the lessor side, what is the criteria for fiance leases?

Answer 5

(Must meet all 3)

1. ) Lessee owns leased property
2. ) Uncertainties don’t exist for un-reimbursable costs
3. ) Collectbility of payments is reasonably predictable

Question 6

Who records depreciation on a finance lease?

Answer 6

The lessee, since they are carrying the asset on their books.

Question 7

According to GAAP, how should the lessor treat the lease (operating or finance) if the lessee treats it as a finance lease?

Answer 7

It is possible the lessee treats as finance lease while lessor treats as operating lease under U.S GAAP.

See criteria for each to determine.

Question 8

According to IFRS, how should the lessor treat the lease (operating or finance) is the lessee treats it as a finance lease?

Answer 8

Copy cat rule. If lessee treats as a capital lease, so does lessor.

Question 9

When should a nonrefundable lease bonus paid by a lessee on signing be recognized by a lessor?

Answer 9

Over the life of the lease.

Question 10

Can operating lease payments change in amount of the life of the lease?

Answer 10

No. Operating lease expense (rent) must be recorded equally over the life of the lease.

Question 11

How should finance leases be depreciated by the lessee?

Answer 11

Depends:

If meet the: ASSET LIFE
1.) Ownership
(or)
2.) Written bargain purchase option

If meet the: LEASE LIFE

1. ) Ninety % of FV (PV of lease pmts)
2. ) Seventy-five % of useful life

**ASSET LIFE will supersede all if O or W satisfied.

Question 12

What amount of interest should be recorded on an operating lease by a lessee?

Answer 12

No interest on an operating lease.

Question 13

What is the difference between a Sales-Type lease vs. Direct Financing lease?

Answer 13

Sales Type = Profit on sale

Direct Financing = No profit, only interest income

Question 14

How would you go about calculating “rent expense” for a finance lease?

Answer 14

No rent expense on a capital lease.

Only booking depreciation on the asset recorded, and interest on the liability recorded.

Question 15

You have to allocate each payment made for a finance lease, what are you allocating to?

Answer 15

Allocate to interest expense &; liability principal reduction.

Principal reduction is the plug figure after you calculate amount allocated to interest.

Question 16

At the inception of a finance lease, what amount should the lessee record as the asset & liability? (GAAP)

Answer 16

LESSER OF:

1. ) FV of asset @ inception
2. ) Cost (pv of minimum lease pmts*)

*3 PV’s to calculate:

a. ) Required pmts (PV of annuity)
b. ) Bargain Purchase Option (PV of $1)
c. ) Guaranteed Residual Value (PV of $1)

**exclude executory costs & optional buyouts

**IFRS includes initial direct costs to be capitalized

Question 17

What interest rate is used to calculate the PV of the minimum lease pmts?

Answer 17

LESSER of:

1. ) Rate implicit in the lease
2. ) Lessee’s incremental borrowing rate (available in the market)

Question 18

How is the effective interest method used to calculate interest expense on a capital lease?

Answer 18

CV @ beg. of period (liab) X Lower Rate = Interest Expense

Question 19

How do you know how much to allocate as a principal reduction to the liability in a finance lease pmt?

Answer 19

Payment - Interest Expense = Principal reduction (plug)

Question 20

How would you determine what amount to record a capital lease @ with a bargain purchase option?

Answer 20

Take the PV of all the lease pmts, and add it to the PV of the bargain purchase option.

Compare that to the FV of the asset @ inception, which is lower?

Use that amount.

Question 21

The liability and asset that come with a capital lease on the lessee side are initially recorded at the same amount, but then the account balances change over time to no longer be the same. Why is that?

Answer 21

Because:

The asset is being depreciated over the asset life or lease life, depending on which criteria satisfied it as a capital lease (OWNS)

The liability is being amortized based on the pmts made. First the pmt needs to allocate to interest exp, and the left over amount will be a reduction of the liability principal.

EACH IS RECORDED INDEPENDENTLY, BUT INITIALLY RECORDED AT THE SAME AMOUNT.

DR: Leased Asset $
CR: Lease Obligation $

Question 22

What is a sale-leaseback?

Answer 22

The owner sells the property and simultaneously leases it back from the purchaser.

Question 23

What is the first step in attacking sale-leaseback question on the side of the lessee?

Answer 23

Figure out the mathmatical G/L.

SP - CV =G/L

Next issue becomes can you recognize that, or do you have to defer it.

Question 24

In a sale-leaseback transaction, what is the treatment of a gain when the PV of rent payments is greater than or equal 90% of the FV of the property?

Answer 24

Defer all gain and amortize with the leased asset.

Question 25

In a sale-leaseback transaction, what is the treatment of a gain when the PV of rent payments is less than 90% but greater than 10% of the FV of the property?

Answer 25

Operating Lease= Defer gain up to PV of minimum leaseback payments

Capital Lease= Capitalize asset, recognize excess gain immediately.

Question 26

In a sale-leaseback transaction, what is the treatment of a gain when the PV of rent payments is 10% or less of the FV of the property?

Answer 26

Recognize gain immediately.

Question 27

What is the significant rule to be mindful of when dealing with the treatment of sale-leaseback transactions? What does it mean?

Answer 27

The “between 10 & 90%” rule.

Provides rules on treatment of a gain if an entity sells something, then leases it right back.

The rules depend on how long they are leasing the leased property for, after they just sold it.

Question 28

What is an artificial loss in regards to a sales-leaseback transaction, and how is it treated?

Answer 28

When the sales price is below the fair value (should equal if it was arms length)

Loss is deferred because it’s not “real”, and amortized over the lease period.

Question 29

What derivatives require no initial investment?

Answer 29

Forwards, futures, & SWAPS.

Options require an initial investment.

Question 30

What is the difference between a forward & a future?

Answer 30

Future = Public (Exchange traded)

Forward = Private (OTC)

Question 31

What is credit risk in regards to derivatives?

Answer 31

The risk of the other party on the contract not performing according to the terms of the contract.

Question 32

What is market risk in regards to derivatives?

Answer 32

Risk that the entity will incur a loss on the contract.

Question 33

What is a put option?

Answer 33

Gives an entity the ability, but not the obligation, to sell at a strike price.

Question 34

What is a call option?

Answer 34

Gives an entity the ability, but not the obligation, to buy at a strike price.

Question 35

How do you calculate G/L on an option?

Answer 35

Strike - Price sold = G/L per share

G/L per share X # of shares = Total Proceeds

Total proceeds - Premium paid = Total G/L.

Question 36

What does it mean to hedge?

Answer 36

To offset risk.

I sell wheat, the price keeps going up on me which is raising my COGS.

I buy a forwards contract (long) on the price of wheat to offset my building COGS with a gain on the contract.

Question 37

When you buy an option, how is it presented in the FS?

Answer 37

As an asset, no contingent liability.

Ability, but not obligation to buy/sell.

Question 38

What is the largest amount of loss you can have when entering into an option contract?

Answer 38

The cost of the premium.

No other cash outflows, no other losses can be incurred.

Question 39

Where is the G/L on a fair value hedge reported? And what is it?

Answer 39

On the income statement.

Own a stock, worried about price dropping, get a put option to cover risk.

Question 40

Where is the G/L on a cash flow hedge reported?

Answer 40

Effective = OCI

Ineffective = Income Statement

Question 41

How are derivatives valued on the balance sheet?

Answer 41

@ Fair Value

Question 42

What is the JE to record the purchase of a forward contract?

Answer 42

No JE recorded until G/L determined since there is no cash inflow/outflow initially.

Question 43

For your understanding, what is an example of a notional amount?

Answer 43

of shares.

Question 44

Which G/L gets plugged to OCI?

1. ) Foreign Currency Translation G/L
2. ) Foreign Currency Remeasurement G/L

Answer 44

Foreign Currency Translation G/L.

Question 45

Which G/L gets plugged to the income stmt?

1. ) Foreign Currency Translation G/L
2. ) Foreign Currency Remeasurement G/L

Answer 45

Foreign Currency Remeasurement G/L.

Question 46

What characterstics makes a currency functional and not need to be remeasured before being translated?

Answer 46

1. ) Does their own banking
2. ) Not hyper-inflationary
3. ) Use that country’s currency (in which they do business in)

Question 47

Which method (remeasurement or translation) is the balance sheet converted before the income statement?

Answer 47

Remeasurement method.

Question 48

Which method (remeasurement or translation) is the income statement converted before the balance sheet?

Answer 48

Translation method.

Question 49

What is the JE to record a translation gain?

Answer 49

DR: Cummulative Translation Adjust
CR: OCI

Question 50

Which type of differences (perm or temp) between tax and GAAP cause deferred tax assets/liabs?

Answer 50

Temporary - represents a timing difference.

Question 51

When you are asked what your “current” income tax expense is, what is it asking you for?

Answer 51

Not including deferred items, how much tax attributable to CY.

If 30% tax rate and $650k in taxable income = $195,000 current income tax expense.

Don’t take permanent differences into consideration.

Question 52

What is the JE to record current tax expense, along with the recognition of a deferred tax liability?

Answer 52

DR: Income Tax Exp
ense $ (plug)CR: Income Tax Payable $ (current portion)
CR: Def. Tax Liab $ (later portion)

Question 53

What is the JE to record current tax expense, along with the recognition of a deferred tax asset?

Answer 53

DR: Income Tax Expense $ (plug)
DR: Def. Tax Asset $ (later)
CR: Income Tax Payable $ (now)

Question 54

What happens when you have multiple temporary differences in one year, that create both deferred tax assets & liabilities?

Answer 54

Use “net” amount to book CY income tax expense.

Question 55

How do you determine income tax expense for the CY?

Answer 55

Current Tax (inc. tax pay)
(+/-) Def. Tax Asset/Liab
= Total Tax Expense for CY

Question 56

What is an uncertain tax position, and what is the treatment?

Answer 56

An uncertain tax position is a risk position taken on reporting income/deductions to the IRS that might result in an unfavorable reversal by the IRS

Ex: You try to deduct something or allocate income to somewhere with a lower rate, IRS catches on and doesn’t allow it.

Treatment = Reserve account (in case). Acts as an increase to income tax expense as follows:

DR: Income Tax Expense
CR: Income Tax Payable (now)
CR: Deferred Tax Liability (later)
CR: Uncertain Tax Positions (liability)

Question 57

How are changing tax rates in the future treated?

Answer 57

Reverse temporary differences for the tax rate enacted during the reversal (in future years). Treat as a change in estimate (prospective approach)

Question 58

On an operating lease, if you make a leasehold improvement to a property as a lessee, what is the accounting treatment?

Answer 58

Capitalize and amortize over the lesser of the lease life or the asset life.