1 1 Accounting for Long-term Assets, Long-term Debt and Leases TABLE OF CONTENTS Introduction 2 Long-term Assets 2 Acquiring or creating 2 Tangible assets 2 Intangible assets 3 Depreciating, amortizing and depleting 3 Impairing and revaluing 5 Disposing 7 Long-term Debt 8 Issuing 8 Accruing interest 9 Reclassifying principal 10 Paying interest and principal 10 Leases 11 Classifying leases 12 Measuring initial value of a capital lease 12 Recording entries for leases 13 Proposed updates to leasing standards 15
2 2 Navigating Accounting INTRODUCTION This chapter examines accounting for long-term assets, long-term debt, and leases from the perspective of lessees (the company that leases property, plant or equipment from another company called the lessor). The reason we are combining these topics is most of the accounting and business issues associated with leases are applications of related issues for long-term assets and long-term debt. LONG-TERM ASSETS Accounting for tangible property, plant and equipment (PP&E) and intangible long-term assets centers on four events: Acquiring or creating Depreciating, amortizing or depleting Impairing and revaluing (revaluations are only allowed under IFRS) Disposing Acquiring or creating Accounting for the acquisition or creation of tangible and intangible long-term assets is similar in many respects, but there are enough differences that we will discuss them separately. Tangible assets We will focus our discussion of tangible assets on PP&E since other tangibles such as natural resources are only important in a few industries. Companies can acquire ownership of PP&E by purchasing it separately with cash or third-party debt financing, acquiring it as part of a business acquisition, or constructing it internally. They can also acquire the right to use PP&E through leasing. When these leases are classified as capital leases, which we will discuss later, they are included in PP&E. Strictly speaking, the leased property is tangible, but the lease itself the right to use the property is an intangible asset. The only significance of this difference is some companies describe the usage of capital leases as depreciation (of a tangible asset) while others describe it as amortization (of an intangible). We have already studied the entry for purchasing PP&E with cash: increase PP&E and decrease cash for the cost of the purchased asset. Delivery and installation costs are also included in the recognized cost. For purchasing PP&E financed with debt, the entry is similar except debt increases and possibly cash decreases if there s a down payment. For example, here is the entry if Berger Properties acquires a building for $90 million with 100% debt financing (along with land,which is recorded separately): Berger Properties acquires building with 100% debt financing PP&E (historical cost) $90 Long-term debt $90
3 3 When PP&E is acquired as part of a business acquisition, it is recorded at its fair value the hypothetical price it could be sold for to a third party. When PP&E is constructed internally, it is recorded at the aggregate cost to complete the construction. This includes capitalized interest: a portion of the interest associated with debt that is deemed attributable to the construction (through a formula that is beyond the scope of this chapter). Intangible assets When intangible assets are purchased from third parties separately with cash or debt financing or as part of a business acquisition, the accounting is the same as PP&E purchases. This is not true for leasing or creating intangible assets and the related guidance can be quite different for US GAAP and IFRS. Generally, US GAAP guidance for leases applies only to PP&E and, in particular, not to intangibles. This means that with one exception the future payments associated with leased intangibles (e.g., licensing arrangements) can t be capitalized: they are expensed as incurred during the term of the contract. The exception is software leased for internal use. The software can be capitalized if it meets criteria similar to those used to determine whether PP&E leases should be capitalized. In contrast, to US GAAP, IFRS guidance for leases can be applied to many intangibles. When intangible assets are created through advertising (such as brands) or basic research, the R in R&D, (such as intellectual property) with one exception, these assets can t be recognized on balance sheets under US GAAP and IFRS. This is because standard setters have concluded they can t be measured reliably. Thus, costs associated with research are always expensed as incurred. However, the one exception under US GAAP is the costs to develop advertisements: costs can be capitalized until the advertisements are first used, at which time costs are expensed. When intangible assets are created through development, the D in R&D, with a few exceptions, the costs associated with the development are also expensed as incurred under US GAAP. The exceptions that are most prevalent center on costs associated with software development. Software developed for internal use and software developed to be sold to customers can both be capitalized, but the criteria differ. By contrast, under IFRS costs associated with internally developing any intangible must be capitalized once the development process is far enough along so six criteria are met. These criteria establish that it is probable the intangible will meet its intended purpose; the company is committed to using or selling it; and the remaining development costs can be estimated reliably. This difference in accounting guidance under US GAAP and IFRS can significantly affect financial-statement comparisons of global competitors. For example, at year end December 31, 2012, Daimler reported 7.2 billion euros of capitalized development costs under IFRS. These costs would have been previously expensed if Daimler reported under US GAAP. Depreciating, amortizing and depleting Depreciation, amortization, and depletion measure the portion of an asset s historical cost allocated to usage or the passage of time during the asset s useful life. Throughout the world, depletion refers to using up natural resources. In some countries, including the US, depreciation generally refers to using up tangible assets and amortization to using up intangible assets. In other countries, however, amortization is a synonym for depreciation.
4 4 Navigating Accounting Aside from these differences in terms, the entries for using up PP&E, intangible assets, or natural resources are structurally the same. For example, to record depreciation expense, we increase the expense and increase accumulated depreciation. To record amortization expense, we increase the expense and increase accumulated amortization. These are the only depreciation and amortization entries for companies that don t manufacture the products they sell. Manufacturing companies have two types of long-term assets: (i) production-related longterm assets such as manufacturing equipment, factories and intellectual property associated with production and (ii) non-production-related long-term assets such as the corporate headquarters and administrative computers. The depreciation and amortization entries are quite different for nonproduction asset types. However, these differences can easily be understood using the four questions and OEC Map approach we have been using throughout the course to record entries. We will first demonstrate this approach for depreciation associated with non-production-related PP&E. The resulting depreciation entry will be the one you have recorded often in earlier chapters: increase depreciation expense and increase accumulated depreciation. That is, all along we have been depreciating non-production-related assets. Recall our responses to the four questions: 1. Should an asset be recognized? Generally, we would expect future benefits to be created when a company uses non-production-related assets. For example, we would expect future benefits to be realized when sales staff use company cars to see customers or employees at the corporate headquarters use computers. However, these benefits can t be measured reliably and, in particular, determining when, if ever, the benefits are realized is problematic. Thus, the answer to this question is no: an asset is not recognized when non-production-related assets are depreciated. 2. Should an asset be de-recognized? Yes, benefits associated with the asset being depreciated have been used up so there are fewer future benefits than at the start of the current period. The ones used up this period need to be de-recognized. 3. Should a liability be recognized? No obligation is incurred when depreciating an asset. 4. Should a liability be de-recognized? No obligation is met when depreciating an asset. The second question is the only one we answered affirmatively, which means net assets and thus owners equity decreases when a non-production-related asset is depreciated. From the OEC Map, we can easily determine that an expense is recognized. What is different with production-related depreciation? The answers to all of the questions above except the first will be the same. Should we recognize an asset when production-related assets are depreciated? Yes: An asset should be recognized. Using the production-related asset helped produce inventory, whose future benefits will be realized when products are sold. So the distinguishing difference is we can now determine when the future benefits have been realized: when the product is sold. This was not true for non-production-related assets. More generally, the cost of all resources used to produce products are recorded to inventory, including the costs of using up related PP&E - depreciation. These costs are assigned to individual products in inventory through a process called product costing that is beyond the scope of this chapter.
5 5 To summarize, when production-related PP&E is used up to help produce products, one asset, inventory, is recognized and another, PP&E, is derecognized (by increasing accumulated depreciation). These effects offset each other and so there is no change in net assets and thus no change in owners equity and no expense. The depreciation assigned to inventory will ultimately be expensed through cost of sales when products are sold. Here is an example that will help you understand the similarities and differences between depreciating production and non-production related long-term assets: Smart Manufacturing Company has two identical computers that are depreciated at the same rate, $1,000 per year. One of these is used in Smart s factory to help produce products and the other at the corporate headquarters. Here are the entries to record the annual depreciation: Smart Company's Depreciation Depreciating computer used at corporate headquarters Depreciation expense $1,000 Accumulated PP&E depreciation $1,000 Depreciating computer used at factory Inventories $1,000 Accumulated PP&E depreciation $1,000 Notice the credit is the same for the two computers, indicating a decrease in net PP&E for both production-related and non-production-related PP&E. However, the debits differ, indicating the cost associated with using the factory computer has been transferred to inventory and the cost associated with using the headquarters computer has been recognized in net income as an expense. Drill deeper - beyond the scope of this chapter. Here we have skipped over several intermediate entries within inventories: the depreciation is first recorded to an overhead inventory account, along with other overhead costs; these overhead costs are then transferred to work-in-process inventory accounts along the costs associated with materials and labor; when production is completed, costs associated with the completed products are transferred from work in process inventory to finished goods inventory. Ultimately when products are sold, costs are transferred from finished goods inventory to cost of sales. Impairing and revaluing A long-term asset becomes impaired under IFRS and US GAAP when its carrying value (book value) is overstated relative to its recoverable amount - the amount that will be recovered in the future. However, the recoverable amount is defined differently under IFRS and US GAAP, which means an asset can be impaired under one system but not the other. However, even when an asset is deemed impaired under the two systems, there can be differences in the way the impairment is measured: the amount the asset s carrying value is decreased when the impairment is recognized.
6 6 Navigating Accounting Drill deeper - beyond the scope of this chapter. A deeper discussion of the differences in accounting for impairments under US GAAP and IFRS is beyond the scope of this chapter and introductory courses. To learn more, watch the Navigating Accounting video: Measurement Decisions menu items Adjusted historical cost: impairment losses and US GAAP : While the amounts recognized as impairments can differ under IFRS and US GAAP, the entries to recognize impairments are structurally the same. Here are the entries Smart Company records to recognize a $500 impairment to PP&E and a $300 impairment to identifiable intangible assets: Smart Company's Impairments Recognizing an impairment to PP&E Debit Credit Impairment losses $500 Accumulated PP&E impairments $500 Recognizing an impairment to identifiable intangible assets Debit Credit Impairment losses $300 Accumulated amortization of Identifiable intangible assets $300 Under US GAAP, impairments of long-term assets can t be reversed if a previously impaired asset s fair value increases above its carrying value at a future date. By contrast, under IFRS, except for goodwill impairments, reversals are generally permitted (up to the accumulated impairments previously recognized). Under US GAAP, long-term assets (other than financial instruments) can t be revalued upwards when their fair values increase above their carrying values. Instead, long-term assets are recognized at their adjusted historical cost: historical cost less accumulated depreciation and accumulated impairments. By contrast, under IFRS, companies have the option to report most long-term assets at adjusted historical cost or revalued to fair value. If they elect the fair value option, the assets must be revalued regularly enough to ensure their carrying values at the balance sheet date don t differ significantly from their fair values. You might be thinking companies would jump at the opportunity to revalue their assets upward, especially because they are frequently required to recognize impairment losses when assets fair values decrease. Yet, very few companies elect the revaluation option under IFRS. Why not? The answer illustrates how reporting incentives can affect accounting decisions and why you need to understand the financial-statement consequences of accounting choices available to companies to understand their choices: When a company revalues an asset upward, it increases the asset, or more precisely a companion adjunct account that increases the carrying value, and increases a reserve account to recognize a gain in other comprehensive income (OCI). Thus, while the gain increases comprehensive income, it doesn t affect net income, which is the measure compensation performance targets are typically based on.
7 7 However, thereafter depreciation is based on the higher, revalued asset value, which means net income decreases relative to what it would have been. When the revalued asset is disposed of, the gain previously recognized as an OCI reserve can be transferred directly to retained earnings or left in the accumulated OCI reserve account. However, it can t be recognized in net income. Thus, electing the revaluation option doesn t increase net income when carrying values are revised upwards but lowers future net income. As a result, managers who are rewarded for achieving targets based on net income have an incentive to elect the adjusted historical cost option and not revalue assets based on fair values. This said, their can be other considerations that outweigh this incentive. In particular, the revaluation method decreases financial leverage (because assets and owners equity both increase and liabilities are not affected). Disposing While the account names differ, the entries to record PP&E and intangible disposals are conceptually the same. We recorded the entry for a PP&E disposal in an earlier chapter, assuming at the time that the asset was accounted for under the adjusted historical cost option rather than the revaluation option. Here is an example of a similar entry for an intangible asset disposal. Smart Company records the following entry when it sells a trademark for $100 cash that had a carrying value of $110: $200 historical cost less $70 of accumulated amortization and $20 of accumulated impairments: Smart Company's disposal of an identifiable intangible asset Cash and cash equivalents $100 Accumulated amortization of Identifiable intangible assets $70 Accumulated impairment of Identifiable intangible assets $20 Gain/loss on identifiable intangible asset disposals $10 Identifiable intangible assets (historical cost) $200 As indicated earlier, if the asset had been accounted for under the revaluation method, the company would have the option to record another entry that transfers the related balance in the accumulated OCI reserve account to retained earnings.
8 8 Navigating Accounting LONG-TERM DEBT Accounting for long-term debt centers on six events or circumstances: Issuing Accruing interest Reclassifying principal Paying principal and interest Restructuring debt Early extinguishment Drill deeper - beyond the scope of this chapter. Debt restructurings and early extinguishments occur infrequently and are beyond the scope of this chapter, as are redeemable and convertible debt. We will also only be discussing bonds briefly here. They are explained in considerable detail in a Navigating Accounting video: Bonds Similarly, while we will be discussing entries related to interest and principal payments, we won t be discussing the way interest and principal payments are derived from contractual features in debt agreements. These computations are explained in another Navigating Accounting video: Debt Basics Issuing When companies issue debt they receive cash or other proceeds. We studied the entry for issuing debt for cash in the balance sheet chapter: increase cash and increase long-term debt. Earlier in this chapter we discussed the entry for acquiring PPE with 100% debt financing. Another way to describe this entry is issuing debt in exchange for PP&E proceeds: increase PP&E and increase longterm debt. When recording these entries, we ignored debt issuance costs and assumed we weren t issuing bonds. The issuance entries are slightly different in these situations. As explained in the Bonds video cited above, when bonds are issued, the increase to long-term debt is split into two accounts. All you need to know about these accounts now is they arise because bonds are issued to a market and during the time it takes to build demand for the bonds in this market, interest rates usually change in ways that result in the two accounts. By contrast, debt besides bonds, is typically issued to a bank, insurance company, pension fund or other financial institution rather than to a market. These issuances are called private placements and the debt is referred to as short-term or long-term notes. These placements also include syndicated debt issuances where a lead bank arranges for a limited number of other financial institutions to contribute part of the proceeds.
9 9 The debt issuance entries we recorded in earlier chapters were all private placements, rather than bonds. Similarly, the remainder of this chapter focuses exclusively on private placements. When debt is issued there are issuance costs. These include commissions, legal fees, and other costs incurred to issue debt. Issuance costs are accounted for differently under US GAAP and IFRS. For example, suppose Smart Company pays $5 million to a lead bank to raise $100 million through a private placement to a few pension funds and insurance companies. Thus, Smart Company nets $95 million cash after paying the debt issuance costs. As indicated below, under IFRS, the debt issuance costs are expensed immediately as financing costs. By contrast, under US GAAP, they are capitalized at issuance and subsequently expensed over the term of the debt: Smart Company's Debt Issuance under US GAAP AND IFRS US GAAP Debit Credit Cash and cash equivalents $95 Deferred issuance cost (asset) $5 Long-term debt $100 IFRS Debit Credit Cash and cash equivalents $95 Financing costs (includes interest expense) $5 Long-term debt $100 Accruing interest Interest is the amount lenders charge borrowers for the use of money during a specified period, usually expressed as a percentage of the amount owed the lender at the beginning of a period. The percentage applied is called the interest rate for the period. Interest computations are explained in the Debt Basics video cited earlier. In this chapter, we assume interest expense is accrued as an end-of-period adjusting entry before it is paid the next period. (If the payment is made by the last day of the reporting period, there is no need for an accrual.) Here is an example. Assume Smart Company borrowed $100 on January 1, 2013 and that Smart is obligated to repay the lender the $100 borrowed plus $5 interest on January 1, The interest is the amount charged by the lender for the use of the $100 during Thus, on December 31, 2013, which is the end of Smart s fiscal year, Smart is legally obligated to pay the lender $5 of interest the next day. Thus, Smart must recognize a liability associated with the interest obligation. However, the passage of time that gave rise to this obligation didn t result in an asset being recognized; an asset being de-recognized; or a liability being derecognized. Accordingly, net assets and thus owners equity decreased. Following the OEC Map, we see that Smart must recognize an expense, which is typically called interest expense by companies following US GAAP and financing costs by IFRS companies. Here is the December 31, 2013 entry to accrue interest expense:
10 10 Navigating Accounting Smart Company's adjusting entry to accrue interest expense Financing costs (includes interest expense) $5 Accrued interest $5 Typically, accrued interest is classified as current and does not need to be reclassified to a current liability, unlike the principal portion of the debt obligation, as we will see next. Reclassifying principal We have seen in earlier chapters that investors analyze working capital and current ratios at the end of reporting periods, along with other information, to assess the likelihood companies can meet their near-term obligations. To facilitate these assessments, companies are required to classify any debt obligations that must be met within the next year as current liabilities. Thus, the portion of the principal that is scheduled to be repaid during the next year must be reclassified as a current liability, which is usually called the current portion of long-term debt. For the Smart Company example, on December 31, 2013 Smart reclassifies the $100 of principal that will be paid on January 1, 2014 from long-term debt to the current portion of long-term debt. Here is the entry: Smart Company's adjusting entry to reclassify principal Long-term debt $100 Current portion of long-term debt $100 Paying interest and principal The entries to pay previously accrued interest and principal are straightforward. Here are the entries Smart Company records on January 1, 2014: Smart Company's debt payments Pay interest Accrued interest $5 Cash and cash equivalents $5 Pay principal Current portion of long-term debt $100 Cash and cash equivalents $100 The principal payment, also referred to as repayment of borrowings, is classified as a financing activity on the cash flow statement under both US GAAP and IFRS. The interest payment must be classified as an operating cash flow under US GAAP, but may be classified as either an operating or financing cash flow under IFRS.
11 11 LEASES Leases are contracts between lessees and lessors. Lessees acquire the right to use property owned by lessors in exchange for lease/rent payments or other consideration. If you are not familiar with the concept of a lease, it is best to get a brief background before studying the accounting for leases. Watch just the first six minutes of the Navigating Accounting video: Capitalizing Operating Leases When PP&E is leased and the lease is classified as a capital lease (called a finance lease under IFRS), the entry to record the lease is very similar to the entry we presented earlier to record a purchase with 100% debt financing. An asset is recognized, representing the right to use the leased property during the lease term and a liability is recognized, representing the lessee s obligation to make lease payments during the lease term. The primary difference between purchasing PP&E with debt financing versus leasing is the amount recorded as PP&E for a capital lease is generally less than what would have been recorded if the same PP&E had been purchased with debt. There are two reasons there are fewer future benefits and therefore a lower asset value for leased PP&E: First, purchasing the asset conveys all of the rights and benefits of ownership. Second, leasing the asset limits the future benefits to the lease term, which is generally shorter than the asset s economic life associated with ownership. The amount recorded for a capital lease is generally more difficult to determine than the amount recorded for a purchase of the same asset. With a purchase, the cash paid or the amount that would have been paid in cash is recorded. For a capital lease, the present value of the future lease payments must be determined. The present value concept is explained in a Navigating Accounting video cited later in the chapter. For now, you can think of it as the amount the company would have to put in an interest bearing bank account at the start of the lease to ensure this deposit plus interest would exactly cover the future lease payments during the lease term. The present value of the payments would be less than the sum of the payments, providing the bank account earns interest. Here is the entry Berger Properties would record if it leased, rather than purchased, the building discussed earlier and the present value of the future lease payments was determined to be $30 million: Berger Properties leases a building under a capital lease PPE: capital lease asset $30 LTD: capital lease obligation $30 Because PP&E and long-term debt are recorded at the commencement of a capital lease, the accounting entries thereafter are structurally identical (but with smaller numbers) to those that would have been recorded if the company had purchased the PP&E with debt financing. This means that if you understand how to account for PP&E and long-term debt, you know how to account for capital leases.
12 12 Navigating Accounting In this section, we will: (i) briefly discuss the criteria for classifying leases as capital versus operating; (ii) explain how the amount recognized as an asset and liability is determined when a lease is classified as a capital lease; (iii) explain the entries for capital leases and operating leases; and (iv) briefly describe the most prominent features of the changes proposed by standard setters. Classifying leases Under IFRS, a lease is classified as a finance lease (referred to as a capital lease under US GAAP) if the lease transfers substantially all of the risks and rewards of ownership to the lessee, otherwise it is classified as an operating lease. Determining whether this criterion is met can require significant judgment in some contexts, meaning experts might reasonably disagree on the classification. Similar to IFRS, the US GAAP classification criteria center on the extent to which the risks and rewards of ownership are transferred to the lessee, but they are much more prescriptive, leaving very little room for judgment. Leases are classified as capital leases under US GAAP if one of the following conditions are satisfied: 1. The lease transfers ownership to the lessee at the end of the lease term. 2. The transfer seems likely even if it is not stated explicitly because the lessee has a bargain purchase option. 3. The lease extends for at least 75% of the asset s life. 4. The present value of the contractual lease payments equals or exceeds 90% of the fair market value of the asset at the time the lease is signed. Present values will be discussed later. These criteria try to ensure that most of the risks of ownership have been transferred to the lessee when a lease is capitalized. The problem with this objective is that considerable risk can be transferred when longer leases are classified as operating because they barely fall short of the criteria thresholds. Also, because companies would generally prefer not recognize the lease liabilities, they have an incentive to design lease contract to be classified as operating leases. Measuring initial value of a capital lease When a lease is classified as a capital lease, the lessee must determine the amount that will be recognized as an asset and liability. Under US GAAP, the lessee recognizes the present value of the minimum payments specified in the lease contract (excluding insurance, maintenance, and taxes paid by the lessor), discounted at the lessee s borrowing rate (or the lessor s implicit rate when it is available to the lessee and less than the implicit rate.) Present value is one of the most important concepts in finance. If you are not familiar with present value computations, here s a Navigating Accounting video that explains them: Present Values and Future Values Next, we introduce an example that we will refer to during the remainder of the leases discussion.
13 13 Example facts On January 1, 2013, Smart Company commences a five-year non-cancellable lease with a $100 payment due each January 1, Smart has yet to determine how the lease should be classified. Smart intends to use the leased asset at the same rate over the lease term. It is not practical for Smart to determine the implicit rate computed by the lessor and so Smart uses its incremental borrowing rate, 5% per year, to determine the present value of the lease at its commencement date: $ Recording entries for leases For a capital lease, the entries are structurally the same as those for purchasing the leased asset with 100% debt financing. However, the numbers are smaller in the lease entries because the lessee doesn t get all of the rights of ownership and the lease term is usually shorter than the economic life of the leased property. For an operating lease, the lessee simply recognizes an expense and payment each year, perhaps at different dates. If the leased asset is expected to be used the same amount each year and the payments are constant, as they are in the Smart example, the expense each year is one payment. More generally, the expense is determined by multiplying the total payments for the entire lease term by the portion of the total usage consumed during the year. If Smart classifies the lease as capital, at the commencement of the lease, January 1, 2013, Smart recognizes a lease asset and liability of $432.95, which is the present value of the minimum annual payments. If Smart classifies the lease as operating, at the commencement of the lease, January 1, 2013, no entry is recorded (but one would be recorded if a lease payment was required at the start of the lease): Smart Company's January 1, 2013 entry If lease classified capital Recognize lease asset and liability PPE: capital lease asset $ LTD: capital lease obligation $ If lease classified operating No entry Smart could have classified some of the obligation as current portion when the lease was recognized at the commencement date. Instead, we are going to transfer part of the long-term obligation to the current portion at the end of 2013, which is an acceptable alternative if this is the first reporting date after the commencement of the lease.
14 14 Navigating Accounting While the first payment is not due until January 1, 2014, adjusting entries are required on December 31, 2013, the fiscal year-end. If the lease is classified as capital, there are three entries on this date: Recognize amortization expense related to the using up part of the lease asset. Because the leased asset is expected to be used constantly over the five-year lease term, the amortization expense is 1/5 of the $ capitalized at the commencement date: $ Recognize interest expense associated with the lease obligation, which is determined by multiplying the outstanding balance of the lease obligation at the start of the year, $432.95, by the discount rate, 5%, which equals $ Transfer part of the long-term obligation to the current portion. This will be the principle portion of the payment that will be made January 1, 2014, which is determined by subtracting the $21.65 interest portion from the $100 total: $ If the lease is classified as operating, $100 of expense is accrued. Here are the entries: Smart Company's December 31, 2013 entries If lease classified capital Accrue interest on lease obligation Financing costs (includes interest expense) $21.65 Accrued interest $21.65 Recognize amortization on lease asset Amortization expense $86.59 Accumulated capital lease amortization $86.59 Transfer part of long-term obligation to current portion LTD: capital lease obligation $78.35 Current portion of capital lease obligation $78.35 If lease classified operating Recognize operating lease (rental) expense Operating lease expense $100 Other accrued liabilities $100 The payments are recorded the next day, January 1, 2014: Smart Company's January 1, 2014 entries If lease classified capital Interest portion of lease payment Accrued interest $21.65 Cash and cash equivalents $21.65 Principal portion of lease payment Current portion of long-term debt $78.35 Cash and cash equivalents $78.35 If lease classified operating Lease payment Other accrued liabilities $100 Cash and cash equivalents $100
15 15 If the lease is classified as capital, the interest portion of the payment will decrease each year and the principal portion increase, as illustrated in the following amortization schedule: Smart Company's capital lease obligation amortization schedule Year Beginning long-term capital lease obligation Interest expense accrued during current year Payment due first day of the next year Principal portion of payment transferred to current portion of capital lease obligation Ending longterm capital lease obligation 2013 $ $21.65 $ $78.35 $ $ $17.73 $ $82.27 $ $ $13.62 $ $86.38 $ $ $9.30 $ $90.70 $ $95.24 $4.76 $ $95.24 $0.00 As illustrated in the table below, two expenses are associated with capital leases: interest and amortization. For the capital and operating lease alternatives, the total amount expensed over the lease term is the same as the total payments, $500. However, the pattern of the expenses differs, with the capital lease expense decreasing as its interest component decreases. Smart Company's expenses if lease capital versus operating Year Interest expense Amortization related to capital expense related to lease obligation capital lease asset Total expense if capital lease Total expense if operating lease 2013 $21.65 $86.59 $ $ $17.73 $86.59 $ $ $13.62 $86.59 $ $ $9.30 $86.59 $95.89 $ $4.76 $86.59 $91.35 $ Total $67.05 $ $ $ Proposed updates to leasing standards We close this chapter with a brief discussion of proposed changes in accounting for leases. Accounting for leases from the perspectives of both the lessor and lessee has been extremely controversial for years and will change significantly in the near future if proposed changes to US GAAP and IFRS are enacted. By far the biggest concern about the current models for lease accounting under US GAAP and IFRS is that the vast majority of non-cancellable leases are not recognized on lessees balance sheets because they are classified as operating leases rather than capital leases (referred to as finance leases under IFRS). This is true even though for operating leases the lessee s right to use the related PP&E meets the definition of an asset; the lessee s obligation to make lease payments meets the definition of a liability and both the asset and liability can be measured reliably. For years, standard setters, with strong support from financial analysts and academics, have been trying unsuccessfully to do away with operating leases. They have faced great resistance from the business community, especially from industries where leasing is extensive, because bringing operating leases onto the balance sheet can increase financial leverage dramatically. This said, there seems to be a reasonably good chance new standards will be enacted in the next few years.
16 16 Navigating Accounting Under both US GAAP and IFRS, the proposed updates are similar and will significantly affect many companies financial statements if enacted. The biggest proposed change is that lease assets and lease liabilities equal to the present value of the lease payments will be recognized at the commencement date for all leases longer than twelve months. The lease payments will differ slightly from the minimum payments currently used for present value computations for capital leases. However, ignoring these differences, Smart Company would recognize an asset and liability for $ under the proposed standard, regardless of how the lease would be classified. For many companies, especially airlines and retailers, this will increase the recognized liabilities by more than 50%. Under the proposed updates, there will still be two types of leases: Type A and Type B: If the underlying asset is NOT property (e.g., not land or buildings), the lease is classified Type A, unless one of the following criteria is met: (i) the lease term is an insignificant part of the underlying asset s economic life or (ii) the present value of the lease payments is insignificant relative to the fair value of the underlying asset at the commencement of the lease. If either of these criteria is met, the lease is classified as Type B. This means most plant and equipment will be classified Type A. If the underlying asset is property, the lease is classified as Type B, unless one of the following criteria is met: (i) the lease term is for the major part of the economic life of the underlying asset or (ii) the present value of the lease payments accounts for substantially all of the fair value of the underlying asset at the commencement date. This means most property (e.g, land and buildings) will be classified a Type B. Although some of the measures will change slightly, the proposed accounting for Type A leases is conceptually the same as the current accounting for capital leases. In particular, the entries will be structurally the same and their financial-statement effects will be the same, meaning the same line items will be affected in the same direction. The assets and liabilities recognized at the commencement of the lease will be the same regardless of whether a lease is classified as Type A or Type B. And the liability will be the same for both types at all subsequent reporting dates. However, the assets will differ for the two types after the commencement date. As indicated above, for Type A leases the asset will be depreciated at the same rate it would be currently as a capital lease. By contrast, for Type B, the depreciation will be the amount needed to ensure the lessee would amortize the total lease cost on a straight-line basis over the lease term. For example, if Smart s lease is classified as Type B, the expense recognized each year would be $100. It would be recognized as a single expense on the income statement, but have separate balance-sheet effects for the lease asset and liability. Here are the proposed Type-B expense entries for the first two years of Smart s lease. Notice the interest component is the same as the interest expense recognized earlier for the capital lease, but the depreciation differs:
17 17 Smart Company's first two expense entries if lease is Type B 2013 Lease expense $ Accrued interest $21.65 Accumulated lease amortization $ Lease expense $ Accrued interest $17.73 Accumulated lease amortization $82.27 In closing, although accounting for leases is expected to change in the near future, understanding the current accounting will provide you a solid foundation for interpreting the financial implications when the updates to the accounting standards become effective.
Accounting for Manufacturing 1 Accounting for Manufacturing and Inventory Impairments TABLE OF CONTENTS Accounting for manufacturing 2 Production activities 2 Production cost flows 3 Accounting for production
171 The most important exchange rates applied in the consolidated financial statements developed as follows in relation to the euro: Currency Average rate Closing rate Country 1 EUR = 2014 2013 2014 2013
Present Value Concepts Present value concepts are widely used by accountants in the preparation of financial statements. In fact, under International Financial Reporting Standards (IFRS), these concepts
LEASES SCOPE/EXCLUSIONS What is a lease? A lease is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of
by Juma Kisaame, 2014 (http://practicalaction.org/microleasing/docs/dfcu.pdf) 2015-04-29 IAS 17 Leases IAS 17 definition Lessor = OWNER of property A lease is an agreement whereby the lessor conveys to
- Comparison Series Issue 8 Leases Both and are principle-based frameworks and, from a conceptual standpoint, many of the general principles are the same. However, the application of those general principles
SIGNIFICANT GROUP ACCOUNTING POLICIES Basis of consolidation Subsidiaries Subsidiaries are all entities over which the Group has the sole right to exercise control over the operations and govern the financial
Accounting for Leases Section: Accounting and Financial Reporting Title: Accounting for Leases Number: 05.281 Index POLICY.100 POLICY STATEMENT.110 POLICY RATIONALE.120 AUTHORITY.130 APPROVAL AND EFFECTIVE
Deferred Expenses and Long-lived Assets» How Do I Use the Numbers» Exercises www.navigatingaccounting.com EXERCISES la.hun.010 Analyzing measurement and recognition: Extending HBS Kansas City Zephyrs Case
D.S.RAWAT FCA ACCOUNTING FOR LEASES - COMPARISON OF INDIAN ACCOUNTING STANDARD AND US GAAP The comparison of lease accounting as per the Indian GAAP (AS-19) US GAAP SFAS-13 is based on (1) The similarities
First time Adoption of Australian Equivalents to IFRS AASB 1 An entity s first Australian-equivalents-to-IFRS (AIFRS) financial report applies for reporting periods beginning on or after 1 January 2005
Proposed Accounting Standards Update Issued: August 17, 2010 Comments Due: December 15, 2010 Leases (Topic 840) This Exposure Draft of a proposed Accounting Standards Update of Topic 840 is issued by the
SUMITOMO DENSETSU CO., LTD. AND SUBSIDIARIES Consolidated Financial Statements Report of Independent Public Accountants To the Board of Directors of Sumitomo Densetsu Co., Ltd. : We have audited the consolidated
Financial Statements SEIKAGAKU CORPORATION AND CONSOLIDATED SUBSIDIARIES Consolidated Balance Sheets March 31, 2001 and 2000 Assets Current assets: Cash and cash equivalents... Short-term investments (Note
CHAPTER 21 O BJECTIVES After reading this chapter, you will be able to: 1 Explain the advantages of leasing. 2 Understand key terms related to leasing. 3 Explain how to classify leases of personal property.
A&W Food Services of Canada Inc. Consolidated Financial Statements December 30, and January 1, (in thousands of dollars) February 12, 2013 Independent Auditor s Report To the Shareholders of A&W Food Services
Chapter 9 Plant Assets Plant Assets are also called fixed assets; property, plant and equipment; plant and equipment; long-term assets; operational assets; and long-lived assets. They are characterized
CASH FLOW STATEMENT & BALANCE SHEET GUIDE The Agriculture Development Council requires the submission of a cash flow statement and balance sheet that provide annual financial projections for the business
Lease Accounting Updated January 2014 Page 1 Lease Accounting The pending changes in lease accounting have been a hot topic item since 2009, when the Financial Accounting Standards Board (FASB) and International
Volex Group plc Transition to International Financial Reporting Standards Supporting document for 2 October 2005 Interim Statement 1. Introduction The consolidated financial statements of Volex Group plc
POLICY 1. Objective To adopt Full Accrual Accounting and all other applicable Accounting Standards. 2. Local Government Reference Local Government Act 1995 Local Government (Financial Management) Regulations
CONSOLIDATED Financial Statements Federated Co-operatives Limited / OCTOBER 31, 2012 In Millions of CAD $ FEDERATED CO-OPERATIVES LIMITED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME year ended October
NEED TO KNOW Leases The 2013 Exposure Draft 2 LEASES - THE 2013 EXPOSURE DRAFT TABLE OF CONTENTS Introduction 3 Existing guidance and the rationale for change 4 The IASB/FASB project to date 5 The main
Consolidated Financial Statements of the Company The consolidated balance sheet, statement of income, and statement of equity of the Company are as follows. Please note the Company s consolidated financial
Our 2014 financial statements The consolidated financial statements of plc and its subsidiaries (the Group) for the year ended 31 December 2014 have been prepared in accordance with International Financial
Consolidated financial statements of MTY Food Group Inc. Independent auditor s report...1 2 Consolidated statements of income... 3 Consolidated statements of comprehensive income... 4 Consolidated statements
1 (14) Summary of significant accounting policies The principal accounting policies applied in the preparation of Neste's consolidated financial statements are set out below. These policies have been consistently
- 27 - Japan Vilene Company, Ltd. and Subsidiaries Notes to Consolidated Financial Statements Year Ended March 31, 2015 1. BASIS OF PRESENTATION OF CONSOLIDATED FINANCIAL STATEMENTS The accompanying consolidated
Consolidated Statement of Financial Position Sumitomo Corporation and Subsidiaries As of March 31, 2016 and 2015 ASSETS Current assets: Cash and cash equivalents 868,755 895,875 $ 7,757 Time deposits 11,930
CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2013 CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2013 NIS IN THOUSANDS INDEX Page Auditors' Reports 2-4 Consolidated Statements of Financial
Note 1 to the financial information Basis of accounting ITE Group Plc is a UK listed company and together with its subsidiary operations is hereafter referred to as the Company. The Company is required
Summary of significant accounting policies Basis of preparation DSM s consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) as adopted
03-Seidman.qxd 5/15/04 11:52 AM Page 41 3 An Introduction to Business Financial Statements In this chapter, we build on the basic knowledge of how businesses are financed by looking at how firms organize
Summary of Certain Differences between and SUMMARY OF CERTAIN DIFFERENCES BETWEEN AND The combined financial statements and the pro forma consolidated financial information of our Group included in this
Defining Issues March 2014, No. 14-17 FASB and IASB Take Divergent Paths on Key Aspects of Lease Accounting At their March 18-19 meeting to redeliberate the proposals in their 2013 exposure drafts (EDs)
March 1, 2016 NDS 2016-02 New Developments Summary FASB issues new lease accounting standard Long-awaited guidance brings most leases on balance sheet for lessees Overview On February 25, the FASB released
Topic 9 Preparing a Successful Financial Plan LEARNING OUTCOMES By the end of this topic, you should be able to: 1. Describe the overview of accounting methods; 2. Prepare the three major financial statements
June 2014 UNDERSTANDING CANADIAN PUBLIC SECTOR FINANCIAL STATEMENTS www.bcauditor.com TABLE OF CONTENTS Who Will Find this Guide Helpful 3 What a Set of Public Sector Financial Statements Includes 5 The
International Accounting Standard 17 (IAS 17): Leases By PAUL YOUNG, CGA This article is part of a series on International Financial Reporting Standards published on PD Net. Introduction Accounting for
FEBRUARY 14, 2001 Financial Accounting Series EXPOSURE DRAFT (Revised) Proposed Statement of Financial Accounting Standards Business Combinations and Intangible Assets Accounting for Goodwill Limited Revision
CONSOLIDATED FINANCIAL STATEMENTS TABLE OF CONTENTS MANAGEMENT S STATEMENT OF RESPONSIBILITY FOR FINANCIAL REPORTING 65 INDEPENDENT AUDITOR S REPORT 66 CONSOLIDATED FINANCIAL STATEMENTS 67 Consolidated
CHAPTER OUTLINE Spotlight: J&S Construction Company (http://www.jsconstruction.com) 1 The Lemonade Kids Financial statement (accounting statements) reports of a firm s financial performance and resources,
Consolidated Financial Statements For the year ended February 20, 2016 Nitori Holdings Co., Ltd. Consolidated Balance Sheet Nitori Holdings Co., Ltd. and consolidated subsidiaries As at February 20, 2016
Consolidated Financial Statements of the Company The consolidated balance sheet, statement of income, and statement of equity of the Company are as follows. Please note the Company s consolidated financial
Acal plc Accounting policies March 2006 Basis of preparation The consolidated financial statements of Acal plc and all its subsidiaries have been prepared in accordance with International Financial Reporting
Illustrative Financial Statements Prepared Using the Financial Reporting Framework for Small- and Medium-Entities Illustrative Financial Statements This component of the toolkit contains sample financial
Consolidated Statements of Profit or Loss Sales: Products 1,041,794 1,071,446 8,928,717 Post sales and rentals 1,064,555 1,068,678 8,905,650 Other revenue 89,347 91,818 765,150 Total sales 2,195,696 2,231,942
Transition to International Financial Reporting Standards Topps Tiles Plc In accordance with IFRS 1, First-time adoption of International Financial Reporting Standards ( IFRS ), Topps Tiles Plc, ( Topps
Chapter 10 Operational Assets: Acquisition and Disposition QUESTIONS FOR REVIEW OF KEY TOPICS Question 10-1 The term operational asset is used to describe the broad category of long-lived assets that are
PYROGENESIS CANADA INC. AMENDED FINANCIAL STATEMENTS FOR THE INTERIM PERIOD ENDED JUNE 30, 2011 The unaudited interim condensed consolidated financial statements of (the Company ) for the three and six
Note 2 SIGNIFICANT ACCOUNTING POLICIES BASIS FOR THE PREPARATION OF THE FINANCIAL STATEMENTS The consolidated financial statements have been prepared in accordance with International Financial Reporting
IASB EMERGING ECONOMIES GROUP 8th MEETING December 11-12, 2014 ISSUES FOR DISCUSSON: OTHER NON-FINANSIAL ASSETS AND RELATED MATTERS National Organization for Financial Accounting and Reporting Standards
Answers Professional Level Essentials Module, Paper P2 (UK) Corporate Reporting (United Kingdom) December 2013 Answers 1 (a) Angel Group Statement of cash flows for the year ended 30 November 2013 Profit
HKAS 12 Revised May November 2014 Hong Kong Accounting Standard 12 Income Taxes HKAS 12 COPYRIGHT Copyright 2014 Hong Kong Institute of Certified Public Accountants This Hong Kong Financial Reporting Standard
The Depository Trust Company Unaudited Condensed Consolidated Financial Statements as of March 31, 2016 and December 31, 2015 and for the three months ended March 31, 2016 and 2015 THE DEPOSITORY TRUST
1. A company purchased land for $72,000 cash. Real estate brokers' commission was $5,000 and $7,000 was spent for demolishing an old building on the land before construction of a new building could start.
The Basics of Lease Accounting Joe Sebik, VP - Global Originations & Structuring J. P. Morgan Leasing, Inc. (212) 899-1249 firstname.lastname@example.org Howard Thompson, Director - Pricing & Economics Key
IAS - 17 Leases International Accounting Standard No 17 (IAS 17) Leases This revised standard replaces IAS 17 (revised 1997) Leases, and will apply for annual periods beginning on or after January 1, 2005.
ACCOUNTING BY THE LESSOR AND LESSEE A lease is a contract between a lessor (the owner of the property) and a lessee (the user of the property). Normally the lessee makes periodic payments in exchange for
Consolidated Financial Statements Nippon Unipac Holding and Consolidated Subsidiaries Period from March 30, 2001 (date inception) to September 30, 2001 Nippon Unipac Holding and Consolidated Subsidiaries
LEASE ACCOUNTING -LESSEE POLICY PERSPECTIVE A Lease is defined as an agreement conveying the right to use property, plant, or equipment (land and/or depreciable assets) for a stated period of time. This
Notes to Consolidated Financial Statements Year ended March 31, 2014 Mitsui Oil Exploration Co., Ltd. and Consolidated Subsidiaries 1. Basis of Presenting Consolidated Financial Statements The accompanying
The Kansai Electric Power Company, Incorporated and Subsidiaries Consolidated Financial Statements for the Years Ended March 31, 2003 and 2002 and for the Six Months Ended September 30, 2003 and 2002 The
Financial Statements Notes to the parent company financial statements 1. Parent company accounting policies Basis of preparation The separate financial statements of the Company are presented as required
Sri Lanka Accounting Standard LKAS 17 Leases CONTENTS SRI LANKA ACCOUNTING STANDARD LKAS 17 LEASES paragraphs OBJECTIVE 1 SCOPE 2 3 DEFINITIONS 4 6 CLASSIFICATION OF LEASES 7 19 LEASES IN THE FINANCIAL
UNCONTROLLED IF PRINTED NAVY CANTEENS ACCOUNTING POLICY Applicability: This procedure is applicable to all RANCCB directors and Navy Canteens, managers and staff in all Navy Canteens business units. Legislation:
Effects analysis for leases (IASB-only) 1 BC329 The IASB is committed to assessing and sharing knowledge about the likely costs of implementing proposed new requirements and the likely ongoing associated
Consolidated Statement of Profit or Loss Sales: Products 864,699 1,041,794 $ 10,114,505 Post sales and rentals 941,610 1,064,555 10,335,485 Other revenue 79,686 89,347 867,447 Total sales 1,885,995 2,195,696
Interim Condensed Consolidated Financial Statements Pivot Technology Solutions, Inc. For the Three Months Ended (Unaudited) (Expressed in Thousands of U.S. Dollars) INTERIM CONDENSED CONSOLIDATED STATEMENTS
Intermediate Accounting Thomas H. Beechy Schulich School of Business, York University Joan E. D. Conrod Faculty of Management, Dalhousie University PowerPoint slides by: Bruce W. MacLean, Faculty of Management,
Accounting for Classification is Key! Article by Helen Fee, BSc, PgD, FCA, Examiner in Professional 2 Advanced Corporate Reporting Introduction Entities hold land and buildings for a variety of reasons
1 2 Nature of operations: Toyota is primarily engaged in the design, manufacture, and sale of sedans, minivans, compact cars, sport-utility vehicles, trucks and related parts and accessories throughout
IFRS IN PRACTICE IAS 7 Statement of Cash Flows 2 IFRS IN PRACTICE - IAS 7 STATEMENT OF CASH FLOWS TABLE OF CONTENTS 1. Introduction 3 2. Definition of cash and cash equivalents 4 2.1. Demand deposits 4
1. Basis of Preparation The accounts have been prepared in accordance with Hong Kong Financial Reporting Standards ( HKFRS ). The accounts have been prepared under the historical cost convention as modified
Accounting 500 4A Balance Sheet Page 1 I. PURPOSE A. The Balance Sheet shows the financial position of the company at a specific point in time (a date) 1. This differs from the Income Statement which measures
Consolidated Financial Statements FUJIFILM Holdings Corporation and Subsidiaries March 31, 2015 with Report of Independent Auditors Consolidated Financial Statements March 31, 2015 Contents Report of Independent