Reading 24: Non-current Liabilities
Lesp Industries issues five-year bonds dated 1 January 2015 with a face value of $2,000, 000 and 3% coupon rate paid annually on 31 December. The market interest rate on bonds of comparable risk and term is 4%. The sales proceeds of the bonds are $1,910,964. Under the effective interest rate method, the interest expense in 2017 is closest to: A. $77,096. B. $77,780. C. $77,807.
B.
Two companies with equal credit risk simultaneously issue debt with identical characteristics. One company reports under IFRS, and the other company reports under US GAAP using the straight-line method. The characteristics of the debt issue are presented below. Issue date:01-JanTerm: 5 years Coupon date: 31-Dec (annual coupon) Par Value: $5,000,000 Price at issuance (% of par): 103 Coupon rate: 4.0% Effective interest rate: 3.34% Currency: USD After three years, the difference in the carrying values (IFRS - GAAP) of the debt issues is closest to: A. $2,010. B. $3,194. C. $3,085.
B.
Under IFRS, it is most appropriate to include which of the following pension costs of a defined-benefit plan in other comprehensive income? A. Net interest expense accrued on the beginning net pension liability B. Actuarial gains or losses C. Employees service cost
B. B is correct. Under IFRS, only actuarial gains or losses can be recognized in other comprehensive income. A is incorrect. Net interest expense accrued on the beginning net pension liability is recognized in profit and loss. C is incorrect. Employees service cost is recognized in profit and loss.
A company issues €10,000,000 face value of 10-year bonds dated 1 January 2015 when the market interest rate on bonds of comparable risk and terms is 6%. The bonds pay 7% interest annually on 31 December. Based on the effective interest rate method, the interest expense on 31 December 2015 is closest to: A. €644,161. B. €700,000. C. €751,521.
A.
A company that prepares its financial statements in accordance with IFRS issues £5,000,000 face value 10-year bonds on 1 January 2013 when market interest rates for such bonds are 5.50%. The bonds carry a coupon of 6.50% with interest paid annually on 31 December. The carrying value of the bonds as of 31 December 2014 will be closest to: A. £5,316,000. B. £4,695,000. C. £5,301,000.
A.
An automobile manufacturer provides a defined-benefit pension plan to all of its employees. The company will most likely include pension costs attributable to its assembly line workers in which of the following categories on its income statement? A. Cost of goods sold B. Salaries and wages C. Administrative expenses
A.
Consolidated Enterprises issues €10 million face value, five-year bonds with a coupon rate of 6.5 percent. At the time of issuance, the market interest rate is 6.0 percent. Using the effective interest rate method of amortisation, the carrying value after one year will be closest to: A. €10.17 million. B. €10.21 million. C. €10.28 million.
A.
Midland Brands issues three-year bonds dated 1 January 2015 with a face value of $5,000,000. The market interest rate on bonds of comparable risk and term is 3%. If the bonds pay 2.5% annually on 31 December, bonds payable when issued are most likely reported as closest to: A. $4,929,285. B. $5,000,000. C. $5,071,401.
A.
On 1 January, a corporation issues ten-year notes with a face value of €10,000,000 and with annual interest payments made each 31 December. The coupon rate is 2.0 percent, and the effective interest rate is 3.0 percent. Using the effective interest rate method, the amortized discount at the end of year 1 is closest to: A. €74,409. B. €274,409. C. €82,035.
A.
The following information is available from a company's current financial data, prepared according to US GAAP: $ thousands Defined-Contribution Plan: Contributions to defined contribution plan: 1,000 Defined-Benefit Plan: Contributions to defined benefit plan: 1,500 Employees' service cost for the period: 1,400 Interest expense accrued on the beginning pension obligation: 200 Expected return on plan assets: 400 Actuarial gains for the period: 100 The pension expense (in $ thousands) reported in the current year is closest to: A. 2,200. B. 2,500. C. 2,400.
A.
The following information is associated with a company that offers its employees a defined benefit plan: Fair value of fund's assets: $1,500,000,000 Estimated pension obligations: $2,600,000,000 Present value of estimated pension obligations: $1,200,000,000 Based on this information, the company's balance sheet will present a net pension: A. asset of $300,000,000. B. asset of $1,400,000,000. C. liability of $1,100,000,000.
A. A company that offers a defined benefit plan makes payments into a pension fund and the retirees are paid from the fund. The payments that a company makes into the fund are invested until they are needed to pay retirees. If the fair value of the fund's assets is higher than the present value of the estimated pension obligation, the plan has a surplus and the company's balance sheet will reflect a net pension asset. Because the fair value of the fund's assets is $1,500,000,000 and the present value of estimated pension obligations is $1,200,000,000, the company will present a net pension asset of $300,000,000 on its balance sheet.
Under US GAAP, a lessor's reported revenues at lease inception will be highest if the lease is classified as: A. a sales-type lease. B. an operating lease. C. a direct financing lease.
A. A is correct. A sales-type lease treats the lease as a sale of the asset, and revenue is recorded at the time of sale equal to the value of the leased asset. Under a direct financing lease, only interest income is reported as earned. Under an operating lease, revenue from lease receipts is reported when collected.
Previously, a manufacturer of high-quality industrial electrical generators only sold its units to customers, but it has just introduced a leasing program. The generators have expected useful lives of about 25 years, and the company anticipates that the leases will have a term of 20 years or more. If the company reports under International Financial Reporting Standards, which of the following statements about the first year of the new leasing program is most accurate? The company will recognize: A. revenue equal to the value of the leased asset. B. depreciation of the leased asset as an expense. C. cost of goods sold equal to the market value of the asset.
A. A is correct. Because the company is a manufacturer, under IFRS the lessor would classify the lease as a finance lease and recognize revenue equal to the value of the leased asset and cost of goods sold equal to the carrying value of the asset, not its market value. The asset would be derecognized from the balance sheet and replaced with a lease receivable therefore there is no asset to depreciate. B is incorrect. Because the company is a manufacturer, under IFRS the lessor would classify the lease as a finance lease. The asset would be derecognized from the balance sheet and replaced with a lease receivable, therefore there is no asset to depreciate. C is incorrect. Because the company is a manufacturer, under IFRS the lessor would classify the lease as a finance lease and recognize revenue equal to the value of the leased asset and cost of goods sold equal to the carrying value of the asset, not its market value.
Information about the coupon rates on the various long-term fixed-rate debt issues of a company can most likely be found in the: A. notes to the financial statements. B. non-current liabilities section of the balance sheet. C. Management Discussion and Analysis (MD&A).
A. A is correct. Information about the coupon rates on the various long-term fixed-rate debt issues can usually be found in the notes to the financial statements. The MD&A is more likely to discuss interest rate trends and/or current financing costs but not specific information on individual debt issues. B is incorrect. Only the carrying amount can be found in the non-current liabilities section of the balance sheet. C is incorrect. Financing strategies and market trends can be found in the MD&A.
Innovative Inventions, Inc. needs to raise €10 million. If the company chooses to issue zero-coupon bonds, its debt-to-equity ratio will most likely: A. rise as the maturity date approaches. B. decline as the maturity date approaches. C. remain constant throughout the life of the bond.
A. A is correct. The value of the liability for zero-coupon bonds increases as the discount is amortised over time. Furthermore, the amortised interest will reduce earnings at an increasing rate over time as the value of the liability increases. Higher relative debt and lower relative equity (through retained earnings) will cause the debt-to-equity ratio to increase as the zero-coupon bonds approach maturity.
Fairmont Golf issued fixed rate debt when interest rates were 6 percent. Rates have since risen to 7 percent. Using only the carrying amount (based on historical cost) reported on the balance sheet to analyze the company's financial position would most likely cause an analyst to: A. overestimate Fairmont's economic liabilities. B. underestimate Fairmont's economic liabilities. C. underestimate Fairmont's interest coverage ratio.
A. A is correct. When interest rates rise, bonds decline in value. Thus, the carrying amount of the bonds being carried on the balance sheet is higher than the market value. The company could repurchase the bonds for less than the carrying amount, so the economic liabilities are overestimated. Because the bonds are issued at a fixed rate, there is no effect on interest coverage.
A company issued $2,000,000 of bonds with a 20-year maturity at 96. Seven years later, the company called the bonds at 103 when the unamortized discount was $39,000. In the year the bonds were called, the company would most likely report a loss of: A. $99,000. B. $138,000. C. $60,000.
A. At year 7: Carrying value + $39,000 = $2,000,000 ---> carrying value = $1,961,000 Loss from redemption = $1,961,000 - $2,000,000x1.03 = -$99,000
On 1 January 2014, the market rate of interest on a company's bonds is 5%, and it issues a bond with the following characteristics: Face value: €50 million Coupon rate, paid annually: 4% Time to maturity: 10 years (31 December 2023) Issue price: (per €100)€92.28 If the company uses International Financial Reporting Standards (IFRS), its interest expense (in millions) in 2014 is closest to: A. €2.307. B. €2.386. C. €1.846.
A. IFRS requires the effective interest method for the amortization of bond discounts/premiums. The bond is issued for 0.9228 × €50 million = €46.140. Interest expense = Liability value × Market rate at issuance = 0.05 × €46.140 = €2.307
At the time of issue, for a corporate bond that sells at par, the liability on the issuer's balance sheet would be: A. equal to face value. B. greater than face value. C. less than face value.
A. On the issuer's balance sheet at the time of issue, bonds payable normally are measured and reported at the sale proceeds, which is the face value of the bonds minus any discount, or plus any premium. When a bond is issued at its face value, there is no discount or premium, so the liability would be equal to face value. B is incorrect because bonds payable being more than the face value of the bond would indicate that the bonds sold at a premium (not par). C is incorrect because bonds payable being less than the face value of the bonds would indicate that the bonds sold at a discount (not par).
Duomo Corporation, which adheres to US GAAP, enters into a three-year operating lease of an asset valued at €178,400. The annual lease payments are €30,400. If the company uses the straight-line method of cost allocation, the annual amortization expense that it will record on its income statement is closest to: A. €0 B. €17,840 C. €30,400
A. Under US GAAP, lessees account for operating leases by recognizing a single lease expense based on a straight-line allocation of the cost over the term of the lease. There is no separate amortization component of the lease expense for an operating lease.
Stanwick Farms leases equipment that is used in its daily operations. If the company's interest coverage ratio is 24.1, its fixed charge coverage ratio is most likely: A. less than 24.1. B. equal to 24.1. C. greater than 24.1.
A. While the interest coverage ratio is simply EBIT divided by interest payments, the fixed charge coverage ratio is calculated as follows: (EBIT+Lease payments)/(Interest payments+Lease payment) Mathematically, adding the amount of the company's lease payments to both the numerator and the denominator will produce a fixed charge coverage ratio that is less than 24.1.
Amortization of bond at discount/premium using effective interest rate method: - Calculate bond price using calculator (calculate PV with N = bond life, I/Y = effective rate, PMT = coupon payment, FV = face value) - Calculate annual interest expense = effective rate x carrying value - Calculate amortization = interest expense - coupon payment for bond at [...], = coupon payment - interest expense for bond at [...] - Calculate ending carrying value for each year = carrying value + interest expense - coupon payment. (= carrying value [...] amortization for bond at premium, = carrying value [...] amortization for bond at discount).
Amortization of bond at discount/premium using effective interest rate method: - Calculate bond price using calculator (calculate PV with N = bond life, I/Y = effective rate, PMT = coupon payment, FV = face value) - Calculate annual interest expense = effective rate x carrying value - Calculate amortization = interest expense - coupon payment for bond at discount, = coupon payment - interest expense for bond at premium - Calculate ending carrying value for each year = carrying value + interest expense - coupon payment. (= carrying value - amortization for bond at premium, = carrying value + amortization for bond at discount).
Amortization of bond at discount/premium using straight-line method: - For bond at discount (Price < Face value): Amortization = (Face value - Price)/Bond life - For bond at premium (Price > Face value): Amortization = (Price - Face value)/Bond life
Amortization of bond at discount/premium using straight-line method: - For bond at discount (Price < Face value): Amortization = (Face value - Price)/Bond life - For bond at premium (Price > Face value): Amortization = (Price - Face value)/Bond life
Under US GAAP, a lessee's accounting for a long-term finance lease after inception will include: A. recognizing a single lease expense. B. recording depreciation expense on the right-of-use asset. C. increasing the balance of the lease liability by a portion of the lease payment.
B. B is correct. A lessee's accounting for a long-term finance lease under US GAAP and after lease inception includes recording depreciation expense on the right-of-use asset, recognizing interest expense on the lease liability, and reducing the balance of the lease liability for the portion of the lease payments that represents repayment of the lease liability. A lessee's accounting for an operating lease under US GAAP and after lease inception will recognize a single lease expense, which is a straight-line allocation of the cost of the lease over its term.
A company redeems $1,000,000 face value bonds with a carrying value of $990,000. If the call price is 104 the company will: A. reduce bonds payable by $1,000,000. B. recognize a loss on the extinguishment of debt of $50,000. C. recognize a gain on the extinguishment of debt of $10,000.
B. B is correct. If a company decides to redeem a bond before maturity, bonds payable is reduced by the carrying amount of the debt. The difference between the cash required to redeem the bonds and the carrying amount of the bonds is a gain or loss on the extinguishment of debt. Because the call price is 104 and the face value is $1,000,000, the redemption cost is 104% of $1,000,000 or $1,040,000. The company's loss on redemption would be $50,000 ($990,000 carrying amount of debt minus $1,040,000 cash paid to redeem the callable bonds).
Which of the following statements regarding the extinguishment of debt is correct? A. After an offsetting adjustment of net income, cash paid to extinguish debt is classified as cash used for operating activities. B. Net income is adjusted to remove any gain or loss on the extinguishment of debt from operating cash flows. C. A gain or loss on the extinguishment of debt is disclosed on the income statement in a separate line item, even if the amount is immaterial.
B. B is correct. In a statement of cash flows prepared using the indirect method, net income is adjusted to remove any gain or loss on the extinguishment of debt from operating cash flows. A is incorrect because net income is adjusted to remove any extinguishment effect from operating cash flows, and the cash paid to extinguish debt is classified as cash used for financing (not operating) cash flows. C is incorrect because a gain or loss on the extinguishment of debt is disclosed on the income statement in a separate line item only if the amount is material.
Where might an analyst look for details covering the full extent of a company's capital resources? A. Balance sheet B. Management discussion and analysis (MD&A) C. Notes to the financial statements
B. B is correct. In addition to the disclosures in the notes to the financial statements, the management discussion and analysis (MD&A) section commonly provides other information about a company's capital resources, including debt financing and off-balance-sheet financing and schedules summarizing a company's contractual obligations and other commitments in total and over the next five years. A is incorrect because while the balance sheet can include a section summarizing non-current (long-term) liabilities, this usually includes just a single line item listing the total amount of a company's long-term debt due after one year with no information about a company's capital resources, including debt financing and off-balance-sheet financing. C is incorrect because, while the notes to the financial statements provide details about a company's debt financing, it is the MD&A section that commonly provides information about its off-balance-sheet financing.
Relative to purchasing an asset, leases generally: A. have more restrictive provisions than other forms of borrowing. B. provide less costly financing in the form of lower fixed interest rates. C. require a larger down payment.
B. B is correct. Leases can provide less costly financing and are often offered at lower fixed interest rates than those offered for asset purchases. C is incorrect because leasing typically requires little, if any down payment. A is incorrect because the financial advantages of leases usually lead to lessors having several advantages over other lenders. Consequently, lessors are usually able to offer more attractive lease terms to lessees, such as less-restrictive provisions, than other forms of borrowing.
For a bond issued at a premium, using the effective interest rate method, the: A. carrying amount increases each year. B. amortization of the premium increases each year. C. premium is evenly amortized over the life of the bond.
B. B is correct. The amortization of the premium equals the interest payment minus the interest expense. The interest payment is constant and the interest expense decreases as the carrying amount decreases. As a result, the amortization of the premium increases each year.
Penben Corporation has a defined benefit pension plan. At 31 December, its pension obligation is €10 million and pension assets are €9 million. Under either IFRS or US GAAP, the reporting on the balance sheet would be closest to which of the following? A. €10 million is shown as a liability, and €9 million appears as an asset. B. €1 million is shown as a net pension obligation. Pension assets and obligations are not required to be shown on the C. balance sheet but only disclosed in footnotes.
B. B is correct. The company will report a net pension obligation of €1 million equal to the pension obligation (€10 million) less the plan assets (€9 million).
At the time of issue of 4.50% coupon bonds, the effective interest rate was 5.00%. The bonds were most likely issued at: A. par. B. a discount. C. a premium.
B. B is correct. The effective interest rate is greater than the coupon rate and the bonds will be issued at a discount.
Which of the following statements best describes the usual balance sheet presentation of long-term debt? A. Long-term debt due after one year is presented as multiple line items. B. Non-current, long-term debt is presented as a single line item. C. All long-term debt is excluded from classification as a current liability.
B. B is correct. The non-current (long-term) liabilities section of the balance sheet usually includes a single line item of the total amount of a company's long-term debt due after one year. A is incorrect because the non-current (long-term) liabilities section of the balance sheet usually includes a single line item of the total amount of a company's long-term debt due after one year. C is incorrect because the portion of long-term debt due in the next twelve months is shown as a current liability.
Under IFRS, the costs incurred in the issuance of bonds are most likely: A. expensed when incurred. B. included in the measurement of the bond liability. C. deferred as an asset and amortized on a straight-line basis.
B. B is correct. Under IFRS, debt issuance costs are included in the measurement of the bond liability. A is incorrect. Under both US GAAP and IFRS, they are not expensed.
Which of the following common debt covenants best describes an affirmative covenant? A. Restricting future borrowings B. Prohibiting financial ratios from falling below specified levels C. Limiting dividend payments
B. Common covenants include specifying minimum acceptable levels of financial ratios. Affirmative covenants restrict the borrower's activities by requiring certain actions, like maintaining certain ratios. A is incorrect because restricting future borrowings is a negative covenant in that it restricts the borrower from taking certain actions, like issuing new debt securities. C is incorrect because limiting dividend payments is a negative covenant in that it restricts the borrower from taking certain actions, like increasing dividends.
On 1 January 2010, Elegant Fragrances Company issues £1,000,000 face value, five-year bonds with annual interest payments of £55,000 to be paid each 31 December. The market interest rate is 6.0 percent. Using the effective interest rate method of amortisation, Elegant Fragrances is most likely to record: A. an interest expense of £55,000 on its 2010 income statement. B. a liability of £982,674 on the 31 December 2010 balance sheet. C. a £58,736 cash outflow from operating activity on the 2010 statement of cash flows.
B. The bonds will be issued at a discount because the market interest rate is higher than the stated rate. Discounting the future payments to their present value indicates that at the time of issue, the company will record £978,938 as both a liability and a cash inflow from financing activities. Interest expense in 2010 is £58,736 (£978,938 times 6.0 percent). During the year, the company will pay cash of £55,000 related to the interest payment, but interest expense on the income statement will also reflect £3,736 related to amortisation of the initial discount (£58,736 interest expense less the £55,000 interest payment). Thus, the value of the liability at 31 December 2010 will reflect the initial value (£978,938) plus the amortised discount (£3,736), for a total of £982,674. The cash outflow of £55,000 may be presented as either an operating or financing activity under IFRS.
A firm issues a bond with a coupon rate of 5.00% when the market interest rate is 5.50% on bonds of comparable risk and terms. One year later, the market interest rate increases to 6.00%. Based on this information, the effective interest rate is: A. 5.00%. B. 5.50%. C. 6.00%.
B. The market interest rate at the time of issuance is the effective interest rate that the company incurs on the debt. The effective interest rate is the discount rate that equates the present value of the coupon payments and face value to their selling price. Consequently, the effective interest rate is 5.50%.
Which of the following long-term debt information is presented both on the balance sheet and in the notes to the financial statements? A. Maturity dates B. Current maturities of long-term debt C. Effective interest rate
B. The portion of long-term debt due in the next twelve months is shown as a current liability on the balance sheet. The amount of scheduled debt repayments for the next five years, including an adjustment for long term debt currently coming due, is also shown in the notes to the financial statements. A is incorrect because maturity dates for debt are provided in the notes to the financial statements (but not on the balance sheet). C is incorrect because the notes to the financial statement generally include stated and effective interest rates, maturity dates, restrictions imposed by creditors (covenants), and collateral pledged (if any). This information is not found on the balance sheet.
A company that prepares its financial statements according to IFRS leased a piece of equipment on 1 January 2020. Information relevant to the transaction is as follows: Five annual lease payments of $25,000, with the first payment due 1 January 2020 Interest rate on similar company debt is currently 8% The fair value of the equipment is $115,000 Useful life of the equipment is seven years The company depreciates other equipment in the same asset class on a straight-line basis The total expense related to the lease on the company's 2020 income statement will be closest to: A. $25,000. B. $28,185. C. $22,024.
B. Under IFRS 16 all leases are classified as a finance lease and must be capitalized. Using a financial calculator for an annuity due at the beginning of the period: PV of lease payments: PMT = $25,000, i = 8%, N = 5, Mode = Begin, Compute PV. PV = $107,803 Therefore, the lease would be capitalized at $107,803. Note: Payment is due at the beginning of the year, so interest expense must be calculated as 8% of PV MINUS lease payment (0.08x(107,803-25,000).
Comte Industries issues $3,000,000 worth of three-year bonds dated 1 January 2015. The bonds pay interest of 5.5% annually on 31 December. The market interest rate on bonds of comparable risk and term is 5%. The sales proceeds of the bonds are $3,040,849. Under the straight-line method, the interest expense in the first year is closest to: A. $150,000. B. $151,384. C. $152,042.
B. Under the straight-line method, the bond premium is amortized equally over the life of the bond. The annual interest payment is $165,000 ($3,000,000 × 5.5%) and annual amortization of the premium under the straight-line method is $13,616 [($3,040,849 − $3,000,000)/3)]. The interest expense is the interest payment less the amortization of the premium ($165,000 − $13,616 = $151,384).
A company issues $1,000,000 face value of 10-year bonds on 1 January 2015 when the market interest rate on bonds of comparable risk and terms is 5%. The bonds pay 6% interest annually on 31 December. At the time of issue, the bonds payable reflected on the balance sheet is closest to: A. $926,399. B. $1,000,000. C. $1,077,217.
C.
Denson Corporation issued $5,000,000 of five-year bonds at a discount. After three years, the company calls the bonds at 101 when the bond's carrying value is $4,950,000. The company will realize a: A. loss of $50,000. B. gain of $50,000. C. loss of $100,000.
C.
When the market rate of interest falls after issuance, a company selecting the fair value option for reporting a liability with a fixed coupon rate will report: A. no change. B. a gain. C. a loss.
C. C is correct. A company selecting the fair value option for a liability with a fixed coupon rate will report a loss when market interest rates decrease. A is incorrect because a company selecting the fair value option for a liability with a fixed coupon rate will report losses when market interest rates decrease B is incorrect because a company selecting the fair value option for a liability with a fixed coupon rate will report losses (not gains) when market interest rates decrease.
The management of Bank EZ repurchases its own bonds in the open market. They pay €6.5 million for bonds with a face value of €10.0 million and a carrying value of €9.8 million. The bank will most likely report: A. other comprehensive income of €3.3 million. B. other comprehensive income of €3.5 million. C. a gain of €3.3 million on the income statement.
C. C is correct. A gain of €3.3 million (carrying amount less amount paid) will be reported on the income statement.
Which of the following is an example of an affirmative debt covenant? The borrower is: A. prohibited from entering into mergers. B. prevented from issuing excessive additional debt. C. required to perform regular maintenance on equipment pledged as collateral.
C. C is correct. Affirmative covenants require certain actions of the borrower. Requiring the company to perform regular maintenance on equipment pledged as collateral is an example of an affirmative covenant because it requires the company to do something. Negative covenants require that the borrower not take certain actions. Prohibiting the borrower from entering into mergers and preventing the borrower from issuing excessive additional debt are examples of negative covenants.
Beginning with fiscal year 2019, for leases with a term longer than one year, lessees report a right-to-use asset and a lease liability on the balance sheet: A. only for finance leases. B. only for operating leases. C. for both finance and operating leases.
C. C is correct. Beginning with fiscal year 2019, lessees report a right-of-use asset and a lease liability for all leases longer than one year. An exception under IFRS exists for leases when the underlying asset is of low value.
Debt covenants are least likely to place restrictions on the issuer's ability to: A. pay dividends. B. issue additional debt. C. issue additional equity.
C. C is correct. Covenants protect debtholders from excessive risk taking, typically by limiting the issuer's ability to use cash or by limiting the overall levels of debt relative to income and equity. Issuing additional equity would increase the company's ability to meet its obligations, so debtholders would not restrict that ability.
Under both IFRS and US GAAP, a lessor in an operating lease recognizes: A. selling profit at lease inception. B. a lease asset comprising the lease receivable and relevant residual value at lease inception. C. lease receipts as income and related costs, including depreciation, as expenses over the lease term.
C. C is correct. Lessor accounting for an operating lease under US GAAP is similar to that under IFRS: Over the lease term, the lessor recognizes lease receipts as income and recognizes related costs, including depreciation of the leased asset, as expenses. Under IFRS, at inception of a finance lease—not an operating lease—the lessor derecognizes the underlying leased asset and recognizes a lease asset comprising the lease receivable and relevant residual value. Further, an IFRS-reporting lessor will recognize selling profit at the beginning of all leases that are not classified as operating leases. In contrast, a US GAAP-reporting lessor will recognize selling profit only on sales-type leases at the beginning of the lease term.
Regarding a company's debt obligations, which of the following is most likely presented on the balance sheet? A. Effective interest rate B. Maturity dates for debt obligations C. The portion of long-term debt due in the next 12 months
C. C is correct. The non-current liabilities section of the balance sheet usually includes a single line item of the total amount of a company's long-term debt due after 1 year, and the current liabilities section shows the portion of a company's long-term debt due in the next 12 months. Notes to the financial statements generally present the stated and effective interest rates and maturity dates for a company's debt obligations
Which of the following is most likely a benefit of debt covenants for the borrower? A. Limitations on the company's ability to pay dividends B. Restrictions on how the borrowed money may be invested C. Reduction in the cost of borrowing
C. C is correct. The reduction in the cost of borrowing is a benefit of covenants to the borrower. A is incorrect. Limiting a company's ability to pay dividends is a benefit to the lender, not the borrower. B is incorrect. Restrictions on how the borrowed money may be invested is a benefit to the lender, not the borrower.
Which of the following statements relating to the financial reporting of defined contribution pension plans is correct? A. The only balance sheet impact from contributions to defined-contribution plans is on an asset account. B. Defined-contribution plans require companies to make several assumptions in order to estimate their pension obligations. C. Under a defined-contribution plan, company contributions to the plan are treated as an operating cash flow.
C. C is correct. Under a defined-contribution plan, company contribution to the plan are treated as an operating cash flow. A is incorrect because, if some portion of the agreed-upon contribution has not been paid by fiscal year end, a liability is recognized on the balance sheet. B is incorrect because defined benefit plans (not defined-contribution plans) require companies to make several assumptions in order to estimate their pension obligations.
For a lessor, the leased asset appears on the balance sheet and continues to be depreciated when the lease is classified as: A. a finance lease. B. a sales-type lease. C. an operating lease.
C. C is correct. When a lease is classified as an operating lease, the underlying asset remains on the lessor's balance sheet. The lessor will record a depreciation expense that reduces the asset's value over time.
On 1 January 2011, a company that prepares its financial statements according to International Financial Reporting Standards (IFRS) issued bonds with the following features: Face value: £20,000,000 Term: Five years Coupon rate: 6% paid annually on 31 December Market rate at issue: 4% The company carries all its bonds amortized at cost. In December 2013, the market rate on similar bonds had increased to 5%, and the company decided to buy back (retire) the bonds after the coupon payment on 31 December. As a result, the gain on retirement reported on the 2013 income statement income is closest to: A. £340,410. B. £371,882. C. £382,556.
C. The market value of debt at retirement can be determined by discounting the future cash flows at the current market rate (5%) by using a financial calculator: Face value (FV) = £20,000,000; i = 5%; PMT = £1,200,000; N = 2; Compute present value (PV) = £20,371,882. The book value after the third interest payment (two payments remaining) can be found by using either a financial calculator and the market rate at the time of issue (4%) or an amortization table (shown next). FV = £20,000,000; i = 4%; PMT = £1,200,000; N = 2; Compute PV = £20,754,438. The bond's initial value (required for amortization) can be found by using a financial calculator: FV = 20,000,000; i = 4%; PMT = 1,200,000; N = 5; Compute PV = 21,780,729.
A company issues $30,000,000 face value of five-year bonds dated 1 January 2015 when the market interest rate on bonds of comparable risk and terms is 5%. The bonds pay 4% interest annually on 31 December. Based on the effective interest rate method, the carrying amount of the bonds on 31 December 2015 is closest to: A. $28,466,099. B. $28,800,000. C. $28,936,215.
C. Using calculator PV bond = 28,701,157 Interest expense = 5%xPV = 1,435,057.85 Coupon payment = 0.04x30,000,000 = 1,200,000 Carrying amount = 28,701,157 + (1,435,057.85 - 1,200,000) = 28,936,215
Debt issuance (printing, legal fees, etc.) costs treatment under IFRS and GAAP:
Debt issuance (printing, legal fees, etc.) costs treatment under IFRS and GAAP: - IFRS: recorded as liability under bond payable - GAAP: recorded as asset under deferred charges amortized on straight-line basis over bond life. - Cash flow statement: included as an financing cash outflow under netted bond proceeds (both IFRS and GAAP).
Effects of bond issued at discount on financial statements: - Assets increase by proceeds of bond [...] face value, amortized [...] to face value - Equity increase by proceeds of bond [...] face value, amortized ... to face value - Interest expense [...] coupon payment = coupon payment [...] amortization - Increase [...] cash flow by proceeds - GAAP: [...] operating cash flow by interest expense - IFRS: [...] operating or financing cash flow by interest expense - CFO bond at premium [...] CFO bond at par - CFF bond at premium [...] CFF bond at par
Effects of bond issued at discount on financial statements: - Assets increase by proceeds of bond < face value, amortized upward to face value - Equity increase by proceeds of bond < face value, amortized upward to face value - Interest expense > coupon payment = coupon payment + amortization - Increase financing cash flow by proceeds - GAAP: Decrease operating cash flow by interest expense - IFRS: Decrease operating or financing cash flow by interest expense - CFO bond at premium > CFO bond at par - CFF bond at premium < CFF bond at par
Effects of bond issued at premium on financial statements: - Assets increase by proceeds of bond [...] face value, amortized [...] to face value - Equity increase by proceeds of bond [...] face value, amortized ... to face value - Interest expense [...] coupon payment = coupon payment [...] amortization - Increase [...] cash flow by proceeds - GAAP: [...] operating cash flow by interest expense - IFRS: [...] operating or financing cash flow by interest expense - CFO bond at premium [...] CFO bond at par - CFF bond at premium [...] CFF bond at par
Effects of bond issued at premium on financial statements: - Assets increase by proceeds of bond > face value, amortized downward to face value - Equity increase by proceeds of bond > face value, amortized downward to face value - Interest expense < coupon payment = coupon payment - amortization - Increase financing cash flow by proceeds - GAAP: Decrease operating cash flow by interest expense - IFRS: Decrease operating or financing cash flow by interest expense - CFO bond at premium < CFO bond at par - CFF bond at premium > CFF bond at par
