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Financial Accounting 2 Reviewer Part 1
Financial Accounting 2 Reviewer Part 1
Essential Characteristics
the liability is a present obligation
the liability arises from a past event
the settlement of the liability requires an outflow of resources embodying
economic benefits
Subsequent measurement
at amortized cost
at fair value through P/L
Current liabilities
it is expected to be settled in the entitys normal operating cycle
it is held primarily for the purpose of trading
it is due to be settled within twelve months after the balance sheet date
the entity does not have an unconditional right to defer settlement of the
liability for at least twelve months after the the blance sheet date
Noncurrent liabilities
Liabilities not classified as current. These include the following: noncurrent
portion of long term debt, capital lease liability, noncurrent deferred tax liability,
long term obligations to company officers, long term deferred revenue
Refinancing activity
Current: between end of reporting period & date of authorization for issue of
financial statement
Noncurrent: on/before end of reporting period or the entity has discretion to
refinance
Breach of covenant
PAS 1, par. 74, states that such liability is classified as current even if the lender
has agreed after the reporting period and before the statements are authorized for
issue, not to demand payment as a consequence of the breach
Liability is classified as noncurrent if the lender has agreed on or before the end of
the reporting period to provide a grace period ending at least twelve months after
that date.
PREMIUM AND WARRANTY LIABILITY
Premiums are articles of value such as toys, dishes, silverware and other goods and
in some cases cash payments given to customers as result of past sales or sales
promotion
Computation of EWL
To be redeemed XX
Redeemed (XX)
Balance XX
Sale of Warranty- sold separately from the product sold or may offer the product
sold but with an additional cost. Amount is recognized as deferred revenue.
Accrued Liabilities and Deferred Revenue
Refundable Deposits
Refundable deposits consist of cash or property received from customers but which
are refundable after compliance with certain conditions.
PAS 37 par. 14
Provision is an existing liability of uncertain timing or amount. The liability does
exist on balance sheet date but the amount or the date of obligation is due and in
some cases the payee cannot be determined. It is the equivalent of estimated
liability or a loss contingency that is accrued because it is both probable and
measurable.
Measurement of Provision
The amount recognized as a provision should be the best estimate of the
expenditure required to settle the present obligation at the balance sheet date. The
estimates of outcome are determined by the judgment of the management. Where
there is a continuous range of possible outcomes, the midpoint of the range is used
The expected outflows- the range of outflows and their effects shall be taken into
account by estimating the expected present value of the outflows
Decommissioning Liability
The outflows include the amount that the entity would rationally pay a contractor
if theres an active market- the amount is the price that the entity estimates a
contractor would charge
if theres no active market for the service- the amount if would charge
another party at the future date to undertake the service
Restructuring
PAS 37 par. 10 defines restructuring as a program that is planned and controlled
by management and materially changes either the scope of an enity or the manner
in which that business is conducted.
Provision for restructuring
when the entity has a detailed formal plan for the restructuring
the entity has raised valid expectation in the minds of those affected
Amount of restricting provision
A restructuring program shall include only direct expenditures arising from
restructuring. The expenditures are necessarily entailed by the restructuring and
not associated with the ongoing activities of the enity
Contingencies
Contingent liability- is a possible obligation that arises from past event and whose
existence will be confirmed only by the occurrence or nonoccurrence of one or
more uncertain future events not wholly within the control of the entity.
Contingent asset- is a possible asset that arises from past event and whose
existence will be confirmed only by the occurrence or nonoccurrence of one or
more uncertain future events not wholly within the control of the entity.
Degrees of probability Contingent Liability Contingent Asset
according to PAS 37
Virtually certain 95% Provide Recognize
Probable, above 50% Provide Disclose to note
Possible 5% to 50% With disclosure No disclosure
Remote, below 5% No disclosure No disclosure
BONDS PAYABLE
Bond is a contract of debt whereby one party called the borrower or issuer borrows
funds from another party called the investor or bondholder
Bond indenture- document which shows in detail the terms o the bond and the
rights and duties of the borrower and other parties to the contract
Types of bonds
term bonds- bonds with single maturity date
serial bonds- bonds with series of maturity date
mortgage bond- bonds secured by mortgage or real properties
collateral bonds- bonds secured by investments in stocks and bonds
debenture bonds- bonds without collateral security
registered bonds- requires the registration of the name of the bondholder on
the books of the corporation
coupon bonds- the name of the bondholder is not registered
convertible bond- bonds that can be exchanged for equity shares of the entity
callable bonds- bonds that can be called in for payment anytime
guaranteed bond- bonds issued whereby another party guarantees to pay if
the borrower fails to do so
junk bonds- high risk high yield bonds
commodity-backed binds- bonds redeemable in commodities such as oil
Premium on bonds payable- sales price is more than the face value of the bonds
Discount on bonds payable- the sales price is less than the face value of the bonds
Bond issue costs- incremental costs that are directly attributable to the issue of the
bonds payable.
Bond retirement
On maturity date
Bonds payable XX
Interest expense XX
Cash XX
Prior maturity
1. update amortization
2. compute for the balance of amortization
3. compute for the accrued interest if any
4. compute for cash consideration- retirement price plus accrued interest
5. compute the CA of the bonds
6. compute for the gain or loss- CA less retirement price
7. Bonds payable XX
Interest expense XX
Loss on retirement XX
Discount on bonds XX
Cash XX
Nominal rate- the rate appearing on the face of the bonds. Also known as coupon
or stated rate.
Effective rate- the rate that exactly discounts estimated cash future payments
through the expected life of the bonds payable or when appropriate. Also known as
yield or market rate.
If the bonds are sold at face amount, the nominal rate and effective rate are the
same.
If the bonds are sold at a discount, the effective rate is higher than nominal rate.
If the bonds are sold at a premium, the effective rate is lower than nominal rate.
Convertible bonds
Convertible bonds are those which give the holders the right to convert their
bondholding into share capital or other securities of the issuing entity within a
specified period of time
Issue of a convertible bond
Classify the instrument or its component parts on initial recognition as a financial
liability, a financial asset or an equity instrument with the substance of the
contractual arrangement and the definitions of a financial liability, a financial asset
and equity instrument.
Allocation of issue price
The bonds assigned an amount equal to the market value of the bonds without the
conversion privilege. The residual amount of the issue price shall then be
allocated to the conversion privilege or equity component. In the absence of
market value without conversion privilege, the amount allocated to the bonds is
equal to the present value of the bonds payable
Debt restructuring is a situation in which the creditor for economic or legal reasons
related the debtors financial difficulties grants a concession to the debtor that it
would not otherwise consider. That the concession either from an agreement
between the creditor and the debtor or is imposed by the law or cout.
Types of restructuring
Asset swap- is the transfer of any asset such as real estate, inventory or investment
by the debtor to the creditor in full settlement of an obligation.
PFRS 9 par. 3.3.1 and 3.3.3, asset swap is treated as a derecognition of a financial
liability or extinguishment of an obligation.
The difference between the carrying amount of the financial liability over the
carrying amount of the asset given is recognized in profit or loss
USA GAAP, asset swap is recorded as if two transactions have taken place, the
sale of the asset and the extinguishment if the liability. Accordingly, two gains or
losses are recognized. The difference between the fair value and the carrying
amount of the asset is the gain or loss from exchange while the difference between
the carrying amount of the liability over the fair value of the asset is gain or loss
from restructuring.
Dacion en pago- arises when a mortgaged property is offered by the debtor in full
settlement of the debt. The transaction is accounted for as an asset swap.
Equity swap- the issuance of share capital by the debtor to the creditor in full or
partial payment of an obligation.
IFRIC 19 The equity instruments issued to extinguish a financial liability shall be
measured at the following amounts in the order of priority
1. Fair value of equity instruments issued
2. Fair value of the liability extinguished
3. Carrying amount of the liability extinguished
Such gain or loss on extinguishment shall be disclosed as a separate line item in the
income statement.
Modification of terms
Interest concession- may involve a reduction of the interest rate. Forgiveness of
unpaid interest or a moratorium on interest payment
Maturity value concession- may involve an extension of the maturity date or
reduction of the amount to be paid at maturity
Accounting for substantial modification
PFRS 9 par. 3.3.2 provides that a substantial modification of terms of an existing
financial liability shall be accounted for as an extinguishment of the old financial
liability
Under Application Guidance B3.3.6 of PFRS 9 there is substantial modification
of terms if the gain or loss is at least 10% of the carrying amount of the liability.
The difference between the present value of the new liability over the carrying
amount of the liability is treated as gain or loss on extinguishment. The present
value of the new liability shall be determined using the original effective interest
method.
Accounting for no substantial modification
Application guidance B3.3.6, if the gain or loss is less than 10% of the old
liability, theres no substantial modification of terms.
The gain or loss is not recognized because the modification is not an
extinguishment of the old liability. The old liability is simply continued but with
modified interest charges.
OPERATING LEASE
PAS 17 par. 4 defines a lease as an agreement whereby the lessor conveys to the
lessee for a payment or series of payments the right to use an asset for an agreed
period of time
A contract of lease may lead to a finance lease if any of the following is met
1. The lease transfers ownership to the lessee by the end of the lease term.
2. The lessee has the option to purchase the asset at a bargain
3. The length is for the major part of the economic life of the asset even if the
title is not transferred. Major implies over 75%.
4. At the inception of the lease, the present value of the minimum lease
payments amounts at least substantially all of the fair value of the leased
asset. Substantial implies 90% of the fair value of the asset.
5. The assets are of a specialized nature such that only the lessee can use them.
Indicators of situations that individually or in combination could also lead to a
lease being classified as finance lease
1. If the lessee can cancel the lease, the losses of the lessor in connection of the
cancellation shall be incurred by the lessee.
2. Gains or losses from the change in FV of the residual accrue to the lessee.
3. The lessee has the ability to continue the lease for a secondary term at a rent
that is substantially lower than the market rent.
The cost of a leased asset acquired on a finance lease should be the present value
of future minimum payments. Minimum payments include rental payments
required over the lease term plus any amount to be paid for the residual value,
either through bargain purchase or a guarantee of the residual value. Any
executor costs such as maintenance, and taxes do not form part of the minimum
lease payments. There is a bargain purchase option if the price is less than the fair
value of the asset upon the option exercise date, since the option price is is
estimated to be the same fair value on option exercise date, therefore, the lease
contract has no bargain purchase option.
Initial direct costs are often incurred by the lessors and include amounts such as
commissions, legal fees and internal costs that are incremental and directly
attributable to negotiating and arranging a lease. For finance leases other than those
involving manufacturer of dealer lessors, initial direct costs are included in the
initial measurement of the fianc lease receivable and reduce the amount of income
recognized over the lease term, the interest rate implicit in the lease is defined in
such a way that the initial direct cost are included automatically in the finance
receivable, there is no need to add them separately. Cost incurred by manufacturer
or dealer lessors in connection with negotiating and arranging a lease is excluded
from the definition of initial direct costs. As a result they are excluded from the net
investment in the lease and are recognized as an expense when the selling prfit is
recognized, which for a finance lease is normally at the inception of the term.
Sales type lease involves the recognition of a manufacturer or dealer profit on the
transfer of the asset to the lessee in addition to the recognition of interest income.
Accounting consideration
Gross investment- equal to the gross rentals for the entire lease term plus the
absolute amount of the residual value whether guaranteed or
unguaranteed. This is the amount debited to lease receivable.
Net investment in the lease- equal to the present value of the gross rental
plus the present value of the residual value, whether guaranteed or
unguaranteed.
Unearned interest income- total financing revenue of the lessor which is the
difference between the gross investment and net investment.
Sales- amount equal to the net investment or FV of asset whichever is lower.
Cost of goods sold- equal to the cost of the asset plus any initial direct cost.
Gross profit- sales minus cost of goods sold
Initial direct cost- amount is expensed immediately as a component of cost
of goods sold.
Actual sale of the leased asset- the difference between the carrying amount of the
lease receivable is recognized in profit or loss. The carrying amount of the lease
receivable is equal to the balance of the lease receivable minus the unearned
interest income.
SALE AND LEASBACK
Sale and leaseback is an arrangement whereby one party sells a property to another
party and then immediately leases the property back from to its new owner. The
sell becomes the lesse and the purchaser becomes the lessor. The lease rent and the
sale price are usually interdependent as they are negotiated as a package. The
accounting treatment of a sale and leaseback transaction depends upon the typed of
the lease involved.