Intermediate 2 Ch 19,20,21,22

Defined Contribution Plan

the employer agrees to contribute to a pension trust a certain sum each period based on formula

• employee selected the investment and risk

• benefit based on plan value

Defined Benefit Plan

outlines the benefits that employees will receive when they retire

• selected the investment and risk is employer

• benefit determined by the plan ahead of time

Measures of Liability

pension obligation

pension expense

Projected Benefit Obligation

Obligation based on both vested and non vested benefit at future salaries

Companies recognize overfunded status of defined benefit pension plan if

Projected Benefit Obligations < Fair Value of Plan Assets = Pension Asset

Companies recognize underfunded status of defined benefit pension plan if

Projected Benefit Obligations > Fair Value of Plan Assets- Pension Liability

Components of a Pension Expense

• interest on liability

• actual return on plant assets

• service cost for the yr

• amortization of prior service cost

• gain or losses

Service cost in pension expense

• the actual present value of benefits attributed by the pension benefit formula to employee service during the period

• increase to pension expense

interest on the liability in pension expense

interest expense accrued each yr on pension liability based on interest rate

increase to pension expense

actual return on plan assets in pension expense

actual return= (plant asset ending balance- plant asset beginning balance)- contributions + benefits paid

decrease to pension expense

amortization of prior service cost in pension expense

increase on pension expense

gain or loss in pension expense

increase or decrease on pension expense

Actual Return

(PA end- PA beg)-contribution + benefits paid

Pension Expense

service cost + interest cost-actual return

Finding the fund status on a pension plan

• look at both PBO and Fair Value PA values

• compare both

• if PBO is > FVPA- then it us underfunded and a pension liability (cr)

• if PBO< FVPA, then it is overfunded and a Pension Asset on BS (Dr)

Find interest cost

Beg PBO * settlement rate (given)

Lease

a contractual agreement between a lessor and lessee that gives the lease the right to use specific property, owned by the lessor, for a specified period of time

lessee

User of property

Lessor

Owner of property

two types of leases for lessee

finance lease

operating lease

finance lease

• uses lease classification tests

• recognizes interest expense on the ease liability over the life of the lease using effective interest method

• recognizes amortization expense on the right of use asset generally on a straight line basis

• classified by the lessee and sales type lease by the lessor

• has to be non-cancelable and meets at least one of the requirements

operating lease

a lease that is not a finance lease

• only recognize a single lease expense

“right to use”

asset

“lease commitment to make payment”

liability

the 5 lease classification tests under finance lease

1. transfer of ownership test

2. purchase option test

3. lease term test

4. present value test

5. alternative use test

Transfer of ownership test criteria

ownership of the asset transfers to the lessee by the end of the lease term

Purchase option test criteria

the lease grants the lessee a purchase option

lease term test criteria

the lease term is for a major part of the remaining economic life of the underlying asset: 75% test

Present Value Test Criteria

the present value of the total lease payments equal or exceeds “substantially all” of the fair value of the underlying asset : 90 % test

types of lease payments under present value test

• fixed payments

• variable payments that are based on the index or rate

• guaranteed residual value

• payments related to purchase or termination options that the lessee is reasonably certain to exercise

present value test: discount rate

• lessee should compute the PV of the lease payments using the implicit interest rate

• in the event that it is impracticable to determine the implicit rate, the lessee uses its incremental borrowing rate

Alternative use test

the underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term

residual value

is the expected value of the leased asset at the end of the lease term

• can be guaranteed or unguaranteed

For the classification purpose (90% test) - include the guaranteed residual and ignore any unguaranteed residual

Guaranteeed residual value

the lessee has an obligation to not only return the leased asset at the end of the lease term but also to guarantee that the residual value will be a certain amount

when finding present value

• take beg payments x %rate (this rate is found on table provided

  • use n= yrs

  • use i = the implicit interest rate/rate of return

• find pv of residual value

  • Residual value x % rate(found on table) - use same n and i value

• Add these two values together

At the beginning of the lease the amount is recorded as

lease liability which is the present value of lease payments

if it is probable that the expected residual value>=the guaranteed residual value,

the lessee should not include the guaranteed residual value in the computation of the lease liability (only the pv is the lease liability)

if it is probable that the expected residual value, the guaranteed residual value

include PV(guaranteed residual- expected residual) in the computation of the lease liability)

Journal entry to record the lease (LESSEE)

right of use asset

• lease liability (PV x (% given))+ (guaranteed residual value if qualified)

Journal entry to record the first lease payment

lease liability (use the payment at the beg of each yr)

• cash

interest expense for lessee

outstanding balance of lease liability * effective interest rate

• lease payments except the first, include interest on the outstanding balance as well as a residual portion that reduces outstanding balance

lessees amortization of the right of use asset

• straight line method (initial value of right of use)/ amortization period

• Amortization period ca be lease term or useful life of asset

recording interest expense and amortization expense

• create a amortization table

• Columns include: annual lease payments(annuity due), interest on lease liability, reduction on lease liability (sub the two), lease liability(cv)

• lease liability should be 0 by end

journal entry to record interest expense (LESSEE)

interest expense

• lease liability (prev lease liab x effective interest rate )

Journal entry to record amortization expense (LESSEE)

Amortization expense (lease liability/(n value(# use life yrs))

• right of use asset

LESSOR lease receivable calculation

PV(payments) + PV(guaranteed / unguaranteed RV)

journal entry to record the lease (LESSOR)

lease receivable (PV payments+ PV(RV)

COGS (cost of underlying assets)

• sales revenue

• inventory

Journal entry to record receipt of the first lease payment (LESSOR)

cash

• lease receivable (annuity due)

journal entry to record interest revenue (LESSOR)

Lease Receivable

• interest revenue (cv lease receivable * effective interest rate)

Operating Lease

• Assume rights and fundamentals belong to the lessor

• The lessee merely uses the asset temporarily

• more like a rental agreement

For recording

• lessee records the same amount of lease expense on a straight-line basis, including interest expense and amortization expense

• Lessor's economic benefits are from lease revenue

• asset is on lessor's book- record depreciation expense

Computation of lease payment (LESSOR) - how much they earn at beg of each month

take FV - PV of residual

• to find present value of residual (residual value x %(on table))

This equals amount recovered by lesser through payments

Next divide

(FV - PV of residual )/ % on table

Record journal entry for operating lease - record the lease LESSEE

right of use assets

• lease liability (FV- (PV of residual x %)

Record journal entry for first payment- operating lease - LESSEE

lease liability

• cash (lease liability amount/ % on table)

Operating lease- amortization schedule

• interest on lease liability is 0 for first 2 parts- entrys

• annual lease payments stays the same

• interest on lease liability= prev lease liability * effective rate

• lease liabilty can be found with prev lease liability- reduction of lease liabilty

operating lease- lease expense schedule

• have 1 beg date and 1 12/31 date as next row

• beg starts with 0 exceot for the begining cv

• cv goes to 0

journal entry to record lease expense- operating lease LESSEE

lease expense (annuity due each month)

• right of use asset (lease expense- lease liability)

• lease liability (intrest on lease liability)

record the lease receipt- operating lease LESSOR

cash

• unearned lease revenue (annuity due monthly)

journal entry to record the recognition of revenue - operating lease LESSOR

unearned lease revenue

• lease revenue

journal entry to record the depreciation expense on leased equipment- operating lease LESSOR

depreciation expense

• accumulated depreciation (fv x double declining rate)

find double declining rate

• find the straight line dep rate 1/# of useful lives

• that rate found times 2

for calculation of lease liability - if unguarenteed- LESSEE

just use pv (all lease payments)

for calculation of lease liability- if guaranteed- LESSEE

Pv (all lease payments) + PV of (residual payments)

PV(residual payments)= residual payments x single sum factor(on table)

residual payments= guaranteed - expected

when calculating LESSEE

calculate lease liability

3 types of accounting changes

accunting princiapl, accounting estimate, change in reporting entity

accounting principal change

a change from one generally accepted accounting principle to another one

• change from LIFO to average cost for inventory allocation

• adoption of a new generally accepted accounting standard

Accounting estimates change

a change that occurs as the result of new information or additional experience

• change in estimate of the useful lives of depreciable asset

• updating estimates

change in reporting entity

a change from reporting as one type of entity to another type of entity

• change from individual to consolidated reporting

• change the subsidiaries for a company

what is not an accounting change

errors

report changes retropectively means

previous financial statements must be recast as if new accounting principles have been used always

report changes currently means

apply new principle to current year financial

report changes prospectively

no changes to prior yr financial statements and no reporting cumulative effect of the change as an adjustment to the opening balance of retained earnings

• applied to current and future yr only

• no reporting of cummulative effect

what does FASB require when change in accounting principle

• use the retrospective approach

• adjust carrying amount of affected assets and liabilites as begining of current yr

• recast financials for each period

• prepare disclosure

Journal entry to record a change in accounting principle (beg of yr)

Inventory

• Retained Earnings (NI before change- NI after change)

Disclosure details for accounting principle change

• must show all yrs prior using new accounting principle

• prior yr amounts must be updated

examples of change in accounting estimates

• uncollectible recievables

• useful live and salvage value assets

• periods benifited by defered cost

• inventory obselence

• depreciation methods

how are changes in accounting estimates reported and how does FASB view changes

prospectively

FASB veiws it as normal recurring corrections and adjustments and prohits rectrospective treatment

How to find deprecation charge for change in accounting estimates

1. use straight line meth

(purchase price)/# useful life yrs

2. find accumulated depreciation

number from 1. x (recorded deprecation yrs)

3. find the book value

purchase price- accumulated deprecation

4. Find the dep expense

Book value / remaining service life (total life- life used)

change in accounting estimates journal entry

deprecation expense

• accumulated depreciation- buildings

Accounting errors

• all material errors must be corrected

• record correction of errors from prior periods as an adjustment to beg balance of retained earning

• corrections are called prior period adjustments

Journal entry to correct deprecation understatement, income tax overstatement, and net income overstatement

retained earnings (NI overstatement)

deferred tax liability (income tax overstatement)

• accumulated depreciation (depreciation expense understatement)

change in reporting entity

• employ the retrospective approach

• restate financials of prior

• disclose yr of change

changes due to error

• correct all prior period statements presented

• restate beg balance of RE for the first period presented

for income statement errors

• current yr- reclassify item to proper position

• prior yr - restate the income statement of prior

for balance sheet errros

• same as income statmeent

statement of cashflows purpose

provide information about a company’s cash receipts and cash payments during a period

statement of cash flows usefulness

• provides information to access

entity’s ability to generate future cash flows

entity’s ability to pay dividends and meet obligations

reasons for difference between NI and net cash provided by operating activates

cash investing and financing transactions during the period

operating activity - classifcations, informations

• income statement items

• involve the cash effects of transactions that enter into the determination of net income

Inflows

• from sale of goods or service

• from interest revenue or notes receviable

• from dividens of qutity investments

• receive dividends

Outflows

• to suppliers for inventory

• to employes for wages

• to governemnt for taxes

Investing activities- classifcations, extra

• change in investments and long term assets

• include making and collecting loans and aquiring and disposing investments and prorperty

inflow

• from sale of property plant, equipment

• from sale of investments in debt or quirty

• from collection of principal on loan

outflow

• purchase property, plant equipment

• purchase investments in debt equity(stock)

financing activity- classification and extra

• change in long term liabilities and stockholder equity

• include obtaining resources and borrowing money from creditors

inflow

• from sale of common and prefered stock

• from issuance of debt

• issue cs

outflow

• stockholder as dividends

• to lenders to pay off long term debt

• to stockholders to repurchase common stock (treasury stock)

• redemption of bonds

indirect method

begin with net income (accrual based) and make adjustments necessary

specfic adjustments to remember for cash flow statements

IS- loss on disposal of plant assets - ADD

IS- gain on disposal of plant assets- SUB

BS- decrease in bond discount- ADD

BS- decrease in bond premium- Deduct