PPT Liabilities OffBalanceSheet Financing PowerPoint presentation
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Liabilities: Off-Balance-Sheet Financing
Liabilities: Off-Balance-Sheet Financing Off-Balance-Sheet Financing Off-Balance-Sheet Financing: Examples Off-Balance-Sheet Financing: SPE Creating A Special Purpose. PowerPoint PPT presentation
Title: Liabilities: Off-Balance-Sheet Financing
Off-Balance-Sheet Financing SPE
- A SPE is an entity created by a company for one
Creating A Special Purpose Entity
- An independent third party of a company creates a
SPE on behalf of the company (referred to as the
sponsor) by investing x (i.e. 10) of the
Off-Balance-Sheet Financing SPE (contd.)
- With the cash available, the SPE purchases the
accounts receivable of the sponsor.
Off-Balance-Sheet Financing SPE (Contd.)
of the SPE guaranteed by the sponsor are not
reported in the balance sheet of the sponsor.
cash from sale of A/R to its SPE) without
reporting the liabilities of the SPE guaranteed
by the sponsor.
Securitization by A Special Purpose Entity
- The SPE can issue securities such as bonds
backed by the purchased accounts receivable (i.e.
use the A/R as collateral to borrow money).
issued by the SPE.
Off-Balance-Sheet Financing leases
- A Lease is an agreement conveying the right to
use property, plant, or equipment for a stated
period of time. (Source SFAS No. 13)
Accounting for Leases
- A lease involves a lessee and a lessor.
- A lessee acquires the right to use the property,
plant and equipment (PPE) and a lessor gives up
the right.
Advantages of Leasing from Lessees’ Viewpoint
1. Financing benefits a. The lease provides 100
financing (no down payment is needed). For
companies with cash shortage, lease is a
good alternative to purchase b. The lease
contract may contain fewer restrictive
provisions than other debt agreement and c. The
lease agreement creates a claim that is against
only the leased asset. not against all assets.
Advantages of Leasing from Lessees’ Viewpoint
(contd.)
often spread over the lease term (rather than the
economic life of the property).
sheet, and therefore does not affect financial
ratios.
1. A way of indirectly making a sale. 2. An
alternative means of engaging in a profit
opportunity. The lease agreement enables the
lessors.
General Criteria for classifying leases
- Column B Criteria Applicable to
Lessor Only
payments is reasonably assured (i.e.
predictable).
of unreimbursable cost yet to be incurred by
the lessor under the lease.
- Column A Criteria Applicable
to Both Lessee and Lessor
- a.The lease transfers ownership of the property
to the lessee by the end of the lease term.
- b.The lease contains a bargain purchase option
- c.The lease term is equal to or greater than 75
of the estimated economic life of the leased
property.
- d.The present value of the minimum lease
payments (MLP) is equal to 90 or more of the
fair value of the leased property to the lessor.
Classification by the lessee
- Capital lease
- Lease that meets one or more of the criteria
in column A.
of asset recognize leased asset and lease
liabilities under capital lease.
Column A.
Key Terms Related to Leases
- Bargain Purchase Option
- A provision allowing the lessee to purchase
the leased property at the end of the life of the
lease at a price so favorable that the exercise
of the option appears, at the inception of the
lease, to be reasonably assured.
Key Terms Related to Leases (contd.)
- Fair Value of Leased Property
- Price for which the property can be sold in an
arm’s length transaction between unrelated
parties.
the selling price. For others, the fair value is
the cost of the asset to the lessor.
Key Terms Related to Leases (contd.)
- Minimum Lease Payments(MLP) Payments that are
required to be paid by the lessee to the lessor
over the life of the lease.
Accounting for Leases -Treatment of operating
lease
- Terms and provisions of lease agreement
between landlord company (lessor) and tenant
Lease (contd.)
- 3.The equipment reverts to the Landlord Company
at the end of the 5 years
is 12.5 per year.
implicit in the lease is 12.
payments of 50,000 each at 12 is 4.037349
50,000 201,867.45
Application of Criteria for Determination of
Lease Classification by Lessee
- Classification Criteria Criteria Met?
Remarks
Discount Rate used in computing the present value
of MLP (cont.)
lessee and a lessor when different discount rates
Capital Lease An Example
transfer of ownership, a bargain purchase option
or a guaranteed RV.
Gardner company (lessor) and Martin
company (lessee) dated January 1,20×6
noncancelable and requires equal payments of
32,923.45 at the end of each year.
3.The equipment reverts to Gardner at the end
of the 4 years 4. Martin Company’s (lesee)
incremental borrowing rate is 12.5 per
year. 5.For Gardner Company (lessor), the
interest rate implicit in the lease is 12.
Martin Company knows this rate. 6.Martin
Company uses the straight-line method to
record depreciation on similar equipment’s.3
The Accounting Treatments for Capital Lease-Lessor
- 7. The present value of an ordinary annuity of
four payments of 32,923.45 at 12 is
100,000, calculated as follows
Title reverts to lessor
Yes 100 of
estimated life
(on p17) .
Journal Entries for the Capital Lease Example
- The journal entries to record the acquisition of
the leased asset, the amortization
(depreciation) for 4 years by the lessee are as
follows
100,000
Journal Entries for Capital Lease Example (Contd.)
Journal Entries (contd.)
amortization)of leased equipment on 12/31/x6
Acc. Depreciation Leased Equip.
Journal Entries (contd.)
Expense 9,489.19a Lease Payable
23,434.26b Cash 32,923.45
12 (100,000-20,923.45) 12
9,489.12
Expense Leased Equip. 25,000 Acc.
Depreciation Leased Equip 25,000
Journal Entries (contd.)
- 20x8Interest Expense 6,677.17
- Lease Payable 26,246.38
- Cash 32,923.45
- Depreciation Expense L. E. 25,000
- Acc Depreciation L.E 25,000
- 20x9Interest Expense 3,527.54
- Lease Payable 29,395.91
- Cash 32,923.45
- Depreciation Expense L. E. 25,000
- Acc Depreciation LE 25,000
Journal Entries (contd.)
- Selected account balance at the end of the
lease term
Summary of lease payments and interest expense of
the Capital lease Example
- Payments at End of Year
Summary of Lease Payments and Interest Expense of
Martin company (contd.)
- a. Column 5 at beginning of year 12. the
effective interest expense
Issues in Accounting for Leases
- By reporting lease as operating lease, companies
can obtain the usage of an asset (i.e. leased
asset) without reporting the liability (i.e.
lease payable).
company can structure a lease contract to be
qualified as an operating lease by setting the
present value of MLP to be less than 90 (i.e.
89.99) of the fair value of the leased asset
Issues in Accounting for Leases the present
value of MLP
lease payment and the discount rate used.
of
determining the lease payment.
The Revisit of Accounting for Leases
- Under the rules-based GAAP for leases, two
similar lease contracts with a mere 0.01
difference on the present value of MLP could
result in different reporting.
than 90 of the fair value of asset will report
the lease as a capital lease.
The Revisit of Accounting for Leases
accounting for leases and eliminate narrow
July, 2006 as a joint project with the
International Accounting Standards Board.
Income Tax Accounting
- The differences between accounting income and
taxable income include permanent and temporary
differences.
included in financial reporting but are never
taxable.
Income Tax Accounting
- Examples of Permanent Differences
- 1. Accounting revenues which are not taxable
- a. Interest on municipal bonds.
- b. Portion of dividends received from
(i.e. 70 exemption for if investor owns less
that 20 of investees shares).
Permanent Differences (contd.)
- Examples (contd.)
- 2. Accounting expense but is never tax
deductible
incentive plans.
accounting expense
depletion.
Permanent Differences (contd.)
- Accounting Treatment for permanent differences
- Not included in the journal entries as deferred
tax liabilities/assets.
Permanent Differences
- Temporary Differences
- Revenues or expenses are included in accounting
income in one period but are included in tax
income in a different period. These differences
will eventually be reversed.
Difference between IRC and GAAP
- Depreciation
- GAAP any systematic depr. method
- IRC MACRS
- Installment Sales (future taxable)
- GAAP on accrual basis
- IRC on cash basis
Difference between IRC and GAAP (contd.)
- Warranty Expense (future deductible)
- GAAP accrual basis (estimated and
recognized at the end of each period)
of each period.
defaulted.
Temporary Difference Example A
- Depreciation method
- For tax filing purpose MACRS, 4-year life For
financial reporting purpose straight-line
method, 5-year life
10,000 and a zero residual value.
Temporary Difference Example A (contd.)
- a. 10,00050 0.5 2,500
- b. 7,50050 3,750
- c. 3,75050 1,875
- d. 1,87550 937.5 lt (1,875/1.5 1,250)
Temporary Difference Example A (contd.)
- Assuming a 30 tax rate, the following table
presents the annual temporary difference and the
deferred tax liability
Temporary Difference Example A (contd.)
- T-account of the deferred tax liability
- Deferred Tax Liability
- 20×3. 37.5 150..20×1
- 20×4. 225 525..20×2
- 20×5. 412.5
- 0..20×5
Interperiod Income Tax Allocation
- Example B the following information is available
Interperiod Income Tax Allocation
- Reversed Amount (F/R depr.gtTax Depr.)
- 20×1 500
20×2 700
20×3 200
Total 1,400
Interperiod Income Tax Allocation (contd.)
- Alternative Accounting Treatments
- I. No Allocation of Deferred I/T Liam.
- Income Tax Exp. 2,700
Income Tax Payable 2,700
principle) Deferred Approach(APB No. 11)
Income Tax Payable 2,700
Deferred Income Tax Lia. 420a
aa plug in number (i.e. 3,120-2,700)
Interperiod Income Tax Allocation (contd.)
- Alternative Accounting Treatments (contd.)
- III.With Allocation- Liability Approach
(SFAS 109)
Income Tax Payable
Interperiod Income Tax Allocation
Interperiod Income Tax Allocation
(contd.)Example C (contd.)
- T-account of Deferred income tax lia.
- Deferred I/T Liam.
- 20×2..150 420.20×1 20×3..210
lia. Of 20×2 lia. Of 20×3
Interperiod Income Tax Allocation
(contd.)Example C (contd.)
- Note c is also presented in the following table
- a. Due to future taxable income gt future acc.
Interperiod tax Allocation with Different
Pension Plans
- A pension plan is an agreement between a company
and its employees that the company promises to
Defined Benefit Plans
- A defined benefit plan may be funded or unfunded.
Defined Benefit Plans (contd.)
- For an unfunded plan, no periodic payments are
made to an external agency.
unfunded plans.
Defined Benefit Plans (contd.)
- The amounts needed to fund a pension plan are
estimated by actuaries.
contributory or non contributory.
Pension Obligation
- Pension obligation (liability)
- The deferred compensation that companies have
Capitalization vs. Non Capitalization
- Capitalization Pension liability is recognized
in the balance sheet.
reported in the footnote (off-balance-sheet
Capitalization vs. Non Capitalization
approach.
Accounting for Defined Benefit Pension and Other
Postretirement Plans-an amendment of FASB
Statement NO. 87,88,106 and 132 (R) also adopts
the partial capitalization approach.
Capitalization vs. Non Capitalization
- The new pension accounting standard intends to
improve pension reporting by requiring companies
recognize the funded status of defined benefit
postretirement plans on the financial statement.
plan assets and the projected pension obligation.
Pension Liability
- When pension liability occurs (regardless paid or
not), pension expense should be recognized.
benefits are paid.
liability.
Pension Liability (contd.)
- The funded assets are considered as a pledged
collateral against pension liability.
Pension Liability (contd.)
- Therefore, the under or overfunding pension plans
does not affect pension liability at all.
Pension Cost
- The determination of pension cost (expense) is
extremely complicated because it is a function of
the following components
Cost
or Loss
Accounting for Pension Example
- Assume that on January 1, 20×2, Zarle Company
adopts SFAS No. 158 to account for its defined
benefit pension plan.
the year 20×2
Example (contd.)
- Plan assets, January 1, 20×2, are 100,000.
- Projected benefit obligation, January 1, 20×2, is
100,000.
Example (contd.)
- Using the data presented above, the work sheet
presents the beginning balances and all of the
pension entries recorded by Zarle Company in
20×2.
obligation and the pension plan assets are
recorded in the first line of the work sheet in
the memo record.
Environment and Theoretical Structure of
Financial Accounting
Example (contd.)
- The journal entry on 12/31/x2 is
- Pension Expense 9,000
- Cash 8,000
- Prepaid/Accrued Pension Cost 1,000
- Funded status Pension assets Pension lia.
111,000 112,000 (1,000).
statement is also equal to 1,000, same as the
funded status (required by SFAS 158).
110,000) are reported on the balance sheet
