FAR 5 - Liabilities

Question 1

Exit or disposal activities

Answer 1

1) A liability must be recognized for these activities (severance pay, costs to terminate a contract, etc.).
2) Footnote until announced, then it gets recorded in the FS.
3) Future operating losses expected to be incurred due to these activities are recognized in the period(s) incurred.
4) Recognized at fair value (discounted cash flows) in continuing operations

Question 2

Asset Retirement Obligation (ARO)

Answer 2

The obligation (liability) associated with the retirement of a tangible long-lived asset. Recorded at fair value which is generally equal to the present value of the future obligation (discounted amount)

Question 3

Asset Retirement Cost (ARC)

Answer 3

The amount capitalized (asset) that increases the carrying amount of the long-lived asset when an ARO is recognized

Question 4

Adjustments to AROs and ARCs at year-end

Answer 4

ARO = accretion expense
ARC = depreciation expense

Cumulative accretion expense + cumulative depreciation expense = ARO over the life

Dr Accretion expense
Cr ARO
Dr Depreciation expense
Cr Accumulated depreciation

Question 5

Gain Contingencies

Answer 5

Not recognized, DO NOT record JE. Disclose in notes and state amount and nature. Ignore if likelihood is remote

Question 6

Loss Contingencies

Answer 6

1) Probable and amount can be reasonably estimated = Record JE
1a) Probable and amount cannot be reasonably estimated = Disclose range and nature
2) Reasonably possible = Record JE
3) Remote = Ignore

Question 7

Reasonably estimated range of loss contingency

Answer 7

Accrue for the best estimate of the loss. If range given and no amount is better than another, accrue for the minimum and disclose the possibility of an additional loss

Question 8

Premiums and Warranties

Answer 8

Loss contingencies that are probable and reasonably estimated.

Dr Premium/Warranty Exp
Cr Premium/Warranty Liability
*For warranty expense add up yearly estimated expenses and multiply by sales each year to get your total exp/liability estimate

Question 9

Annuities

Answer 9

Multiple cash flows of identical value.
Ordinary annuity - payments are made at the end of each period
Annuity due - payments occur at the beginning of each period

Question 10

OA vs. AD

Answer 10

PV AD for 3* periods = PV OA for 2* periods + 1

Question 11

Long-Term Liabilities

Answer 11

Record at PV

Question 12

Imputing interest

Answer 12

When no interest or an unreasonable rate of interest is given interest must still be recorded. Not required for short term notes

Question 13

Effective interest method

Answer 13

1) Find CV of liability (PV)
2) Multiply by appropriate interest rate (=interest expense)
3) Difference between cash payment and interest expense is your principal payment (reduce discount)
* The amount allocated to principal and interest charges changes as the carrying value decreases

Question 14

Bond interest exp vs. cash payment

Answer 14

Cash payment is constant at stated rate x face value.
If interest exp > cash paid = discount
If interst exp < cash paid = premium

Question 15

Bond Issuance Costs

Answer 15

Decreases initial carrying value. Acts like a discount (will be added to discount and amortized)
**Will lead to borrower and investor having different JEs as borrower uses effective rate while investor uses market rate to account for interest payments. Investor also ignores issuance costs when investment is initially booked

Question 16

Bond amortization period

Answer 16

Begins when bond is actually SOLD not when it is dated.

Question 17

Market rate vs. effective rate

Answer 17

Effective rate includes bond issue costs

Question 18

JEs as an investor in a bond

Answer 18

Issuance:
Dr Investment in bonds (whatever cash you get, could be more or less than face value)
Cr Cash

Interest payments:
Dr Cash
Dr/Cr Investment in bonds (premium/discount)
Cr Bond interest revenue (same as borrower’s interest expense)

NOTE: entries are not effected by bond issue costs

Question 19

Bonds issued between interest dates

Answer 19

Accrued interest is added to the price of the bond. The purchaser pays for this interest and reimbursed the full period’s interest at the next payment date.

Dr Cash
Dr Discount
Cr Bonds Pay
Cr Bond interest expense or payable

Question 20

Troubled Debt Restructuring

Answer 20

The creditor allows the debtor certain concessions to improve the likelihood of collection.

1) Receipt of assets/equity
2) Modification of Terms

Question 21

Transfer of Assets (debt restructuring) example

Answer 21

Hull is in debt to Apex under a $500,000, 12 percent, 3 year note. Hull owes $60,000 in accrued interest. Settled note for a piece of land with a FV of $450,000. Hull’s acquisition cost of the land is $360,000.

Hull:
Notes payable 500,000
Interest payable 60,000
Land 360,000
Gain on disposal of land 90,000 (450-360)
Gain on restructuring 110,000 (560-450)

Apex:
Land 450,000
Allowance for credit losses 110,000
Note receivable 500,000
Interest receivable 60,000

Question 22

Transfer of Equity (debt restructuring) example

Answer 22

Hull is in debt to Apex under a $500,000, 12 percent, 3 year note. Hull owes $60,000 in accrued interest. Settled for an equity interest in Hull with a FV of 450,000 (100,000 shares of CS, par value 2/share)

Hull:
Notes payable 500,000
Interest payable 60,000
CS 200,000
APIC 250,000
Gain on restructuring 110,000

Apex:
Investment in Hull 450,000
Allowance for credit loss 110,000
Note receivable 500,000
Interest receivable 60,000

Question 23

Modification of Terms (debt restructuring) example

Answer 23

Hull is in debt to Apex under a $500,000, 12 percent, 3 year note. Hull owes $60,000 in accrued interest. Interest was forgiven, interest rate was lowered to 3 percent and maturity date was extended 2 years.

Hull:
Notes payable 500,000
Interest payable 60,000
Note payable 530,000
Gain on restructuring 30,000
*530 = 500 x .15 YR4 + 500 x .15 YR5 (int) + 500 (face)

Apex:
Bad debt expense 136,050
Allowance for credit losses 136,050
Present value of restructured cash flows at HISTORICAL RATE = 423,950
**560,000-423,950 = 136,050
**Bumping up allowance since the debt has not been extinguished (written off - like AR process)

Question 24

Bond extinguishment before maturity (callable bonds)

Answer 24

Gain or loss is recorded:

1) Reacquisition price = Face x % paid (ex. called at 101)
2) Carrying value = Face - unamortized discount or + unamoritzed premium - unamortized issuance cost
3) G/L = Reacquisition price - CV or Step 1 - Step 2