FSA MODULE 34

Question 1

34.1 Who is the lessee?

Answer 1

The person who uses the asset and makes the rental payments

Question 2

34.1 who is the lessor?

Answer 2

the person who legally owns the asset and rents it out

Question 3

34.1 More detail on lessee and lessor:

Answer 3

Question 4

34.1 What are the two types of leases? How are they characterised? How are they recorded?

Answer 4

Finance leases are recorded as balance sheet asset and liability
- I/S we will see it’s amortisation and interest

operating leases = are the ones that significantly changed in 2019 (before 2019 they were off balance sheet (put the rental of the lease through the I/S as paid)

NOW THEY ARE BACK ON THE BALANCE SHEET (but the treatment is totally different under IFRS and US GAAP)

short term and low value - not on the balance sheet (any time we make a payment we reduce cash and record payment in the IS)

Question 5

34.1 Lessees: describe the treatment of finance leases under IFRS and US GAAP:

Answer 5

They are very consistent with their treatment of finance leases

CALCULATE the PV of the lease payment - record a balance sheet long term asset - and record a BS liability
- 2019 onwards we dont treat it as a tangible asset (under PPE), we treat it as an intangible asset, under ROU (right of use)

Goes into the BS and we amortise it through the income statement over the life of the asset

Also create a BS liability - split between long term liability and current liabilities

Question 6

34.1 What the two things hitting the income statement for finance leases?

Answer 6

Interest, and the amortisation of the ROU asset

Question 7

34.1 How are operating leases treated under IFRS?

Answer 7

Same treatment as finance leases

Question 8

34.1 How are operating leases treated under US GAAP?

And what is the significant implication of this?

Answer 8

Big difference - AMORTIZATION

fixed payment - interest = in other words, the amortisation is equal to PRINCIPAL

IMPLICATION = balance sheet asset and liability will decline over the life of the lease at the same rate - they will always equal each other !

Under IFRS - they will equal each other at the beginning and end of the leases life but not during

DO NOT GO THROUGH THE INCOME STATEMENT - so will get a big difference with US GAAP

Question 9

34.1 Under IFRS - how will the BS carrying value and IS expense look over a 5 year finance lease ?

Answer 9

Question 10

34.1 Under IFRS, what does the financing liability and cash flow effect look like? (BS)

Answer 10

balance sheet payment is declining by the principal payment each year

100000 payment is split between interest and principal - INTEREST THROUGH CFO AND PRINCIPAL THROUGH CFF

Question 11

34.1 For an operating lease under US GAAP, how will the financing liability, I/S expense, and cash flows be effected?

Answer 11

ROU is the same as the principal payment each year !

Each year’s amortisation is the same as the principal payment

SO ROU AND CLOSING LIABILITY WILL ALWAYS EQUAL

100000 goes through the I/S
- CFO will be higher, as you have the full payment of the lease expense going through
- but there is less interest in the I/S

Question 12

34.1 For LESSOR accounting, how are finance leases treated?

Answer 12

See them as an ASSET - not a liability, because we see cash flows coming in form the lessor’s POV

derecognise - taking carrying value out of balance sheet, putting the net of that into the I/S

Question 13

34.1 For LESSOR accounting, how are operating leases treated?

Answer 13

as a rental agreement - so lessor keeps the asset in their BS

Question 14

34.1 How would you calculate the I/S gain or loss for finance leases?

Answer 14

Question 15

34.1 How would the finance lease calcs look for the lessor’s side of a finance lease?

Answer 15

flip side of the liability

Question 16

34.1 What goes through CFO for the lessor in a finance lease?

Answer 16

100,000 - all of principal and interest combined !!!

nothing to CFF

Question 17

34.1 How would the finance lease calcs look for the lessor’s side of an operating lease?

Answer 17

Question 18

34.1 What are the income statement impacts of an operating lease?

Answer 18

Question 19

34.1 Lessor I/S comparison: between finance and operating lease

Answer 19

Question 20

34.2 Describe some terminology as to employees compensation:

E.g. what is vesting?

Answer 20

Question 21

34.2 How are defined contribution pension plans accounted for in financial statements?

Answer 21

taken out of cash in the balance sheet, and increase the expense in the I/S (treated the same as salary under ‘compensation’

Question 22

34.2 What are defined benefit pension plans?

Answer 22

Question 23

34.2 What is the balance sheet liability/asset for pension plans?

Answer 23

funded status = net of the fair value of plan assets, less the pv of DB obligation (PVDBO)
- the PV of the fixed payments made to us when we retire (typically based on final salary)

Question 24

34.2 What are service costs?

Answer 24

service costs = increase in pvdbo because employees have worked one extra year

Question 25

34.2 What is past service cost?

Answer 25

past service cost = T&Cs of the plan have been amended. and it affects the benefits that have been learnt in prior periods (any change in the pvdbo caused by amending benefits will go to the IS)

Question 26

34.2 what is the net interest (income) or expense?

Answer 26

We have to net the interest and the expected return on assets interest expense = opening PVBDO x DR expected return on plan assets = expected return at the start of the year x DR NET THEM TOGETHER - for net interest income or expense 3. remeasurement gains and losses - actuarial change in assumptions - affects PVBDO - can be a gain or loss, increase in PVBDO reduces stockholders equity, and vice versa -

Question 27

34.2 What does OCI affect?

Answer 27

stockholders equity

Question 28

34.2 How does a change in funded status translate into the other financial statements? UNDER US GAAP

Answer 28

Note: under US GAAP the interest costs and expected return on plan assets are shown separately (under IFRS they are netted together) interest cost = opening PVPBO X DR expected return on plan assets = opening fair value of plan asset x expected return (ER and DR can be different in US GAAP) past service costs = goes straight into OCI and is amortised actuarial gains and losses - IFRS calls the remeasurements

Question 29

34.2 Broadly, how can we compare the treatment of changes in funded status under IFRS and GAAP?

Answer 29

B/S asset/liability and the change is the same as IFRS Difference = location of changes I/S or OCI

Question 30

34.2 Describe the difference in treatment of past service cost between IFRS and US GAAP in funded status change calculations?

Answer 30

IFRS: immediately expensed US GAAP: goes to OCI and is then amortised

Question 31

34.2 Where is the IS expense from change in funded status taken, under IFRS?

Answer 31

to COGS, and for those who are not directly impacting the production line, goes to SG&A

Question 32

34.2 What is share-based compensation comprised of, and what are the benefits and costs?

Answer 32

Question 33

34.2 What is an outright stock grant?

Answer 33

Question 34

34.2 What is a stock grant with restrictions?

Answer 34

'vest over a 4-year period' - you work for 4 years to get the shares, eg

Question 35

34.2 in this example, what would go to I/S and B/S in immediate vesting?

Answer 35

Question 36

34.2 in this example, what would go to I/S and B/S in a 3-year vesting period?

Answer 36

each period is 3m going through the income statement and reducing retained earnings by 3m but we increase common stock and additional paid in capital (APIC) splitting it between each of these balances

Question 37

34.2 What are employee stock options? How is annual compensation expense calculated? How is this expense charged to the financial statements? On exercise of the options, how does this affect the financial statements?

Answer 37

Whichever method you use, the major driver of the stock option price is the VOLATILITY of the underlying asset increase volatility assumption, you Get a bigger option value compensation expense = option's Fair value, divided by the vesting period - for annual compensation expense

Question 38

34.2 Example: showing stock options. Describe impacts BEFORE any options are exersized

Answer 38

IS = 30m expensed each year BS = retained earnings go down by 30m because of the IS expense, to keep the balance sheet balanced, we must increase APIC by 30m

Question 39

34.2 Example: showing stock options. Describe impacts BEFORE any options are exersized

Answer 39

10m shares x 10 Euro raises 100m euro, cash increases in assets on balance sheet, and so into equity: - 10m euro in common stock added, - and the rest 90m into APIC

Question 40

34.2 What is the presentation and disclosure required of leases, pensions and share-based compensation?

Answer 40

Question 41

34.0 For an operating lease, the leased physical asset appears on the balance sheet of:

Answer 41

the lessor

Question 42

34.0 For an operating lease, the lessor must disclose:

Answer 42

impairments of the leased asset.

Question 43

34.1 what are the differences between a finance lease and an operating lease?

Answer 43

Question 44

34.1 What are the differences for the lessor with operating and finance leases?

Answer 44

CFA memory trick: Think of the lessor like a bank in a finance lease: they lend the asset, expecting payments + interest. Think of the lessor like a landlord in an operating lease: they just rent it out and keep ownership.

Question 45

34.1 What is IFRS 16? What must be disclosed by both the lessee and lessor under IFRS 16?

Answer 45

IFRS 16 is the International Financial Reporting Standard for leases. It fundamentally changed how companies account for leases on their balance sheets. CFA L1 INTUITION: “Operating leases now look like finance leases on the balance sheet.” More assets, more liabilities Income statement: depreciation + interest instead of straight-line rent Cash flow: principal portion moves from CFO → CFF BOTH MUST DISCLOSE: maturity analysis of future payments

Question 46

34.2 Under IFRS, which type of lease least likely requires a lessee to create a right-of-use (ROU) asset and a lease liability?

Answer 46

Low value leases: Both operating leases and finance leases report an ROU asset and a lease liability, and both are accounted for identically. Under U.S. GAAP, operating and financing leases also report both an ROU asset and lease liability; however, the accounting for the two types is slightly different. Exceptions exist for low-value assets and leases with durations of less than one year under IFRS (U.S. GAAP has no monetary value criteria).

Question 47

34.2 For a lessor, operating leases result in:

Answer 47

Depreciation on the leased asset For a lessor, the asset remains in their balance sheet if treated as an operating lease, and is depreciated over its life. There is no derecognition of the asset, so there is no gain or loss at the outset of the lease. Payments from the lessee are treated as rental income.

Question 48

34.2 For a lessor, cash flows from a lease are classified as:

Answer 48

Operating

Question 49

34.2 A net pension asset or liability can be associated with:

Answer 49

a defined benefit pension plan only. Defined benefit pension plans can be overfunded and result in a net pension asset, or they can be underfunded and result in a net pension liability. Defined contribution plans do not result in balance sheet assets or liabilities because they are neither owned by the sponsoring firm nor obligations of the sponsoring firm.