ACC302 Exam 1

What cash flows are discounted when pricing a bond?

1. Interest payments

2. Principal payments

What rate is used to discount bond cash flows?

The market (effective) rate at issuance

When is a loss contingency accrued?

When the loss is probable and reasonably estimable

Difference between interest-bearing and non interest bearing notes?

Interest bearing: Interest stated specifically (accounts payable)
Non interest bearing: Issued at a discount (trade notes payable)

What are advance collections?

Cash received before goods/services are provided, then recorded as liabilities

(Ex; customer deposits, gift cards, subscriptions, advance ticket sales)

How are gift cards recorded initially?

As a deferred revenue (a liability)

Collection for third parties JE

Debit cash

Credit sales revenue

Credit sales tax payable

When can short term obligations be classified as non-current?

If the company:

1. Intends to refinance long term

2. Demonstrates ability to refinance

When are bonds issued at par?

When stated rate = market rate

When are bonds issued at premium?

When stated rate > market rate

When are bonds issued at a discount?

When stated rate < market rate

JE for bonds issued at par

Debit Cash

Credit Bonds payable

JE for bonds issued at discount

Debit cash

Debit discount on bonds payable

Credit bonds payable

JE for bonds issued at premium

Debit cash

Debit bonds payable

Credit premium on bonds payable

What does each interest payment include under the effective method?

• Cash interest paid

• Interest expense (effective rate x carrying value)

• Amortization of premium/discount

What happens to a carrying value when amortizing a discount?

It increases towards face value

What happens to carrying value when amortizing a premium?

It decreases towards face value

What is early extinguishment of debt?

Retiring bonds before maturity

Early extinguishment of debt JE

Debit bonds payable

Debit loss on early extinguishment

Credit discount on bonds payable

Credit cash

What happens to interest expense over time for discount bonds?

It increases each period

What happens to interest expense over time for premium bonds?

It decreases each period

What is the conceptual “substance over form” of a lease?

While the legal form of a lease is a rental agreement, the accounting substance often treats it as a purchase of an asset financed by debt

• The lessee records a right-of-use asset and a lease payable

What are the 5 Classification Criteria for a finance/sales type lease?

1. Does the agreement specify that ownership of the asset transfers to the lessee?

2. Does the agreement contain a bargain purchase option?

3. Does the lease term constitute the major part (>/= 75%) of the expected economic life of the asset?

4. Is the PV of the lease payments >= substantially all (>/= 90%) of the fair value of the asset?

5. Is the 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?

What are the initial JE for a finance lease?

Lessee:

Debit Right of use asset

Credit lease payable

Lessor:

Debit lease receivable

Credit equipment

How is the lease on Jan.1 recorded?

Lessee:

Debit lease payable

Credit cash

Lessor:

Debit cash

Credit lease receivable

How is the year end entry recorded for a finance lease?

Lessee:

Debit interest expense

Debit lease payable

Credit Cash

Lessor:

Debit cash

Credit lease receivable

Credit interest revenue

When does a “selling profit” occur for a lessor?

When the fair value of the leased asset (the PV of lease payments) is greater than the lessor’s cost/carrying value

What is the lessor’s entry at the start of a lease with selling profit?

Debit lease receivable

Credit COGS

Debit sales revenue

Credit Equipment

When is gift card revenue recognized?

• When redeemed

• When breakage occurs

Why might companies prefer non-current classification?

Why might companies prefer non-current classification?

It improves working capital and the current ratio

What are collections for third parties?

Amounts collected that must be remitted to others

(Ex; sales taxes, payroll withholdings, employee benefit deductions)

How can subsequent events affect contingencies?

They may clarify whether a loss existed at the balance sheet date

How are gain contingencies reported?

• Not accrued (conservatism)

• Disclosed if material

How is selling price of a bond determined?

Present value of future cash flows:

• PV of periodic interest payments

• PV of principal at maturity

• Discounted at the market (effective) rate

What is a liability?

A present obligation to transfer economic benefit arising from past transactions

Accrued liabilities

Expenses incurred but not yet paid

(Ex; salaries payable, interest payable, income taxes payable)

Examples of current liabilities

Accounts payable, notes payable, income taxes payables, dividends payable, accrued liabilities)

How are current liabilities usually recorded?

At maturity amount (not present value) because they’re short term

What are current liabilities?

Obligations payable within one year or the operating cycle, using current assets or creating other current liabilities

What is a gain contingency?

An uncertain situation that may result in a gain

When must callable debt be classified as current?

If the creditor can demand payment within the year

Why are litigation losses rarely accrued early?

Outcomes are highly uncertain

How are warranty costs accounted for?

Estimated and recorded as an expense in the period of sale

What is a loss contingency?

An uncertain situation that could result in a loss depending on a future event