Non-current liabilities

Question 1

What is a bond?

Answer 1

It is a contract between a borrower and a lender that obligates the borrower to make payments to the lender over the bond term. There are 2 types of payments involved: periodic interest payments and principal repayments.

Question 2

What is the par value or face value of the bond?

Answer 2

It is the amount that the borrower must pay back to investors at maturity.

Question 3

What is the coupon rate of the bond?

Answer 3

It is multiplied by the bond’s par value to determine the periodic coupon payment.

Question 4

What are market interest rates?

Answer 4

• There are used to value bonds.
• These rates incorporate various types of risks inherent in the bond and must not be confused with coupon rates.
• Market interest rates change from day to day.

Question 5

What is the value of a company’s debt obligations at any point in time?

Answer 5

It is the present value of all remaining payments discounted at current market interest rates.

Question 6

How is the liability’s book value recognized on the issuer’s BS?

Answer 6

It is recognized with the PV of its obligations discounted at market interest rates at issuance.
The market rates at issuance determine how much the company receives in bond proceeds from the issuance of bonds.

Question 7

What is a bond issued at a discount?

Answer 7

• It is when the market interest rate is greater than the coupon rate.
• The coupon rate offer is less than the compensation required by market participants.

Question 8

What is a bond issued at a premium?

Answer 8

• It is when the market interest rate is lower than the coupon rate.
• The coupon rate on offer exceeds the compensation required by the market.

Question 9

What is interest expense?

Answer 9

It is calculated as the book value of the liability at the beginning of the period multiplied by the market interest rate at issuance. It is recognized on the IS.

Question 10

What are the 2 methods of accounting for noncurrent liabilities?

Answer 10

• The effective interest method: It is 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.
• The straight-line method: It evenly amortized the premium or discount over the life of the bond.

Question 11

What are zero-coupon bonds?

Answer 11

• They accrue interest over their terms.
• There are no coupon payments that are made.
• The lump sum payment at maturity includes repayment of principal and interest.

Question 12

Why are zero-coupon bonds steeply discounted instruments?

Answer 12

Because coupon rates fall significantly short of the compensation required by the market for investing in them.

Question 13

How are classified the related cost of a bond (printing, legal fees, and other charges) under IFRS and US GAAP?

Answer 13

• IFRS: they are included in the measurement of the liability.
• US GAAP: Companies usually capitalize these costs and write them off over the bond’s term.

Question 14

How are classified the bond’s interest payments under IFRS and US GAAP?

Answer 14

• US GAAP: it requires bond payments to be classified under CFO.
• IFRS: it allows more flexibility in classifying interest payments as CFO or CFF is permitted.

Question 15

How can a company report financial liabilities at fair value under US GAAP and IFRS?

Answer 15

• IFRS: financial liabilities at fair value through profit or loss.
• US GAAP: liabilities under the fair value option.

Question 16

What are the consequences of reporting a liability at fair value?

Answer 16

• It will report decreases in the liability’s fair value as income and increase in the liability’s fair value as losses.
• Companies must report the portion of the change in value attributable to changes in their credit risk in OCI.
• Only the portion of the change in value not attributable to changes in their credit risk will be recognized in profit or loss.

Question 17

What happens if the company chooses not to report fair values?

Answer 17

They need to provide fair value disclosures in the financial statement unless the carrying amount approximates fair value or fair value cannot be reliably measured.

Question 18

What happens when the company leaves the bonds outstanding until maturity?

Answer 18

It pays investors the par value of bonds at maturity.

Question 19

What happens when the company decides to retire the bonds prior to maturity?

Answer 19

The book value of the liability is reduced to zero and a gain or loss on extinguishment is recorded. The gain or loss is computed by subtracting the amount paid to retire the bonds from their book value.

Question 20

What is the accounting treatment for issuance costs under IFRS and US GAAP?-

Answer 20

• US GAAP: since issuance costs are capitalized, any unamortized issuance costs must also be subtracted from gains on extinguishment.
• 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.

Question 21

What is a lease?

Answer 21

It is a contract between the owner of the asset (the lessor) and another party that wants to use the asset (the lessee).

Question 22

What are the conditions for a contract to be classified as a lease?

Answer 22

• It must identify a specific underlying asset.
• It must give the asset customer the right to obtain largely all of the economic benefits from the asset over the contract term.
• It must give the customer, not the supplier, the ability to direct how and for what objective the underlying is used.

Question 23

What are the advantages of leasing an asset?

Answer 23

• Leases require little or no upfront payments.
• Leases typically carry an effective interest rate that is lower than an otherwise identical unsecured loan or bond. This is because the underlying asset serves as collateral for the lease.
• There are lower risks of asset ownership (ex: obsolescence).

Question 24

What are the 2 types of lease?

Answer 24

• Financial lease: a lease that resembles a purchase.
• Operating lease: all other leases.

Question 25

What are the 5 criteria for a lease to be a finance lease?

Answer 25

• The lease transfers ownership of the underlying asset to the lessee.
• The lessee has the option to purchase the underlying asset and is reasonably certain it will do so.
• The lease term is for a major part of the asset’s useful life.
• The PV of the sum of the lease payments equals or exceeds substantially all of the fair value of the asset.
• The underlying asset has no alternative use to the lessor.

Question 26

What is the accounting treatment for finance and operating leases under IFRS?

Answer 26

The treatment of finance and operating lease is the same:
- The lessee reports a right-of-use (ROU) asset and a lease liability on its BS
- The discount rate used in the lease liability computation is either the rate implicit in the lease or an estimated secured borrowing rate.

Question 27

How do you calculate the lease liability under IFRS?

Answer 27

With the PV of fixed lease payments.

Question 28

What are the accounting entries on the BS during the lease term under IFRS?

Answer 28

• The value of the ROU asset falls every year as it is depreciated.
• Interest is charged on the liability as the appropriate discount rate times the beginning of-year value of the liability.
• The excess of the lease payment over the year’s interest expense reduces the liability.

Question 29

What are the accounting entries on the IS during the lease term under IFRS?

Answer 29

• Depreciation expense is charged against the asset.
• Interest expense is charged against the liability.

Question 30

What are the accounting entries on the CF statement during the lease term under IFRS?

Answer 30

The portion of the lease payment equal to the interest expense is subtracted from CFO or CFF, while the remainder that serves to reduce the liability is subtracted from CFF.

Question 31

How does the lease accounting work in US GAAP?

Answer 31

• Accounting treatments for finance leases and operating leases are different.
• The finance lease accounting model is identical to the lessee accounting model for IFRS.
• The operating lease accounting model is different.
• With an operating lease, accounting at inception is also the same as under IFRS.

Question 32

What is the main between IFRS and US GAAP?

Answer 32

The key difference under US GAAP is how ROU asset is amortized over the lease term. Asset amortization expense is calculated as the lease payment minus interest expense:
- It implies that the total expense shown on the IS will equal the lease payment.
- Every year, the lease liability and the ROU asset will equal each other.
- Amortization expense will equal the excess of the lease payment over interest expense.

Question 33

What are the accounting entries on the BS during the lease term under US GAAP?

Answer 33

The lesson reports the lease liability (net of principal repayments) and an ROU asset (net of accumulated amortization).

Question 34

What are the accounting entries on the IS during the lease term under US GAAP?

Answer 34

Interest expense on the lease liability and the amortization expense related to the ROU asset is reported as a single line titled “lease expense” as an operating expense. The total equals the annual lease payment.

Question 35

What are the accounting entries on the CF statement during the lease term under US GAAP?

Answer 35

The entire lease payment is reported CFO.

Question 36

What are the differences between finance and operating leases for lessees under US GAAP?

Answer 36

• The ROU asset is lower under a finance lease in each period because amortization expense is higher.
• Total expenses are higher for finance leases initially but lower for financial leases in the latter years.
• Operating expenses are higher under an operating lease due to the single line item classification of both interest and amortization expenses.
• Total CF is the same, but the classification is different: CFO is higher under a finance lease and CFF is higher under an operating lease.

Question 37

What is the accounting treatment for finance leases at inception under US GAAP?

Answer 37

• The lessor recognized a lease receivable asset equal to the PV of future lease payments and removed the leased asset from its BS.
• The difference between the 2 is immediately recognized as a gain or loss.

Question 38

What is the accounting treatment for finance leases during the lease term under US GAAP?

Answer 38

• The lease receivable asset is reduced by cash each lease payment using the effective interest method.
• Each lease payment is composed of interest income and repayment of principal.

Question 39

What are defined contribution plans?

Answer 39

They are pension plans in which the company attributes a certain amount of funds to the plan.

Question 40

What is the accounting treatment of defined-contribution plans?

Answer 40

• On the IS: the company recognizes the amount it is required to contribute to the plan as pension expense for the period.
• On the BS: the company records a decrease in cash and a liability in the case that the amount agreed upon is not deposited into the plan during a particular period.
• On the CF statement: the outflow is treated as a CFO.

Question 41

What is a defined benefit plan?

Answer 41

The company promises to make future payments to the employee during retirement.

Question 42

What is a pension obligation?

Answer 42

It is the PV of the total amount of benefits that the company expects to pay out to an employee during her retirement,

Question 43

What are the main assumptions to determine the pension obligation?

Answer 43

• The expected salary at the date of retirement.
• Number of years the employee is expected to live after retirement.

Question 44

What are the 3 general components of the change in net pension asset or liability each period under IFRS? Describe each component.

Answer 44

• Employee service cost: The service cost during a period for an employee refers to the PV of the increase in pension benefit earned by the employee as a result of providing one more year of service to the company.
• Net interest expense or income: change in the value of the net defined benefit pension asset liability.
• Remeasurements: these include actuarial gains and losses and the actual return on plan assets less any return included in net interest expense or income.

Question 45

What are the 5 general components of the change in net pension asset or liability each period under US GAAP? Describe each component.

Answer 45

• Employee service costs for the period: these are recognized in profit and loss in the period incurred.
• Interest expense accrued on the beginning pension obligation: interest costs are added to pension expense because the company does not pay out service costs earned by the employee over the year until retirement.
• Expected return on plan assets: this reduces the amount of pension expense recognized in P/L for the period.
• Past service costs: they are recognized in OCI during the period they are incurred and are subsequently amortized into pension expense over the future service period of employees covered by the plan.
• Actuarial gains and losses: they are also recognized in OCI when they occur and amortized into pension expense over time.

Question 46

How is pension expense reported?

Answer 46

• For DL, pension expense is added to inventory and expensed through COGS.
• For indirect labor, pension expense is included in SG&A.

Question 47

How is pension cost reported under IFRS?

Answer 47

• Service cost and net interest expense would be reported in P/L.
• Remeasurements would be reported in OCI.