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COMM 321
Peter Blake

Chapter 13 – Non-Financial and Current Liabilities Liabilities – obligations that are enforceable; can be conditional/unconditional Unconditional obligation (ex. req. to pay interest on borrowed money)– always recorded; if amount is uncertain: under IFRS: use best estimate at reporting date, under PE GAAP: disclose in notes Conditional obligation – are dependent on other events; only record if event is more likely than not Constructive obligation (ex. Dell offer 3 yr phone support) – legal obligations based on past behavior; must be included; entity acknowledges a potential economic burden Current liabilities – obligations due within the greater of 1 year and the operating cycle Bank indebtedness – bank loans due on demand or within 1 yr of B/S date (ex. operating line, term loans but loan covenants have been violated such as EBITDA, D/E test, etc); loan can be called; goes in C/L *Loan convenant – conditions you have to meet for loan to remain in good standing Notes payable – written promises; notes due within 1 year + current portion L-T notes **Current portion of L-T debt – the amount of principal that must be repaid in the next 12 months (ex. mortgage pmt are $1000/mth, current portion is not $12,000; interest portion is not included must review amortization table) Dividends payable – dividends declared but not yet paid; cumulative dividends in arrears (not yet declared) disclosed in notes  only pay once declare (oldest ones first) Sales tax payable – record when sell; Ex. Sell for $1,000 + 13% HST Accounts Receivable 1130 Sales Tax Payable 130 Revenue 1000 Non-financial Liabilities (obligations) 1. De-commissioning costs – included in PPE; current and L-T portions disclosed at NPV (borrowing rate); use best estimate. (restoring mining site; dismantling offshore oil platform) 2. Warranties – record estimated expense in same period as related sale; may use revenue method (IFRS); set up a portion of revenue as unearned and recognize over warranty period 3. Customer loyalty programs – record as an expense/liability in the period earned (when sale occurs); can use revenue method if possible 4. Contingencies (mainly lawsuits) & Commitments – uncertain obligations either in terms of whether obligation exists or the amount. PE GAAP: record liability only if obligation exists AND the amount is known IFRS: record obligation if more than likely than not it exists; estimate amounts if necessary; Any contingent gains only recorded if virtually certain they will be received Financial Guarantees – entity guarantees another entity’s debt or performance PE GAAP: same rules as for contingencies but must disclose full amount of the guarantee IFRS: guarantee initially recorded at fair value (premium charged by guarantor) & then subsequently at greater of unamortized premium or the best estimate of amount that will ultimately be paid out to honor the guarantor. Current Liabilities – Disclosure Requirements -usually present C/L before L-T Liabilities but IFRS allows other formats (ex. After C/A to arrive at WC) -within C/L may present in order of maturity, liquidity preference (rank in liq.), or most useful to readers -must disclose amts owing to officers, shareholders, or related companies separately (usually in notes) -disclose info. and reconciliations (for IFRS only) wrt provisions, contingencies, significant commitments -must disclose security provided to any banks, creditors, as well as any significant covenants, and whether any covenants have been violated (or are in good standing) Chapter 14 – L-T Liabilties (mainly handout, but some notes) Debt restructuring – creditor agrees to settle debt (early) or to modify terms (ex. rate, term) 1. Settlement of Debt (for cash, assets, shares) - remove loan from B/S -> usually for gain - if assets given up, record gain (loss) on asset disposal 2. Modification of Terms (reduces interest rate, extends repayment terms) - usually accounted for prospectively (i.e adjust payments etc, going forward) BUT if modification is big (PV of new terms > 10% different from PV of old terms) then treat as settlement of old debt (with gain(loss) on settlement) & entering into new debt Off Balance Sheet Financing -SPV (special purpose vehicle -> CFA – warning sign) raises debt on strength of “sponsor” ex. Enron (AA Rating) -accountants must use judgment to determine when this is actually debt of sponsor  disclose in notes to F/S *** Final: Summarize capital info -> where/what find? L-T Liabilities Disclosure Requirements OK to have one line on B/S referencing a note but note must contain every significant individual liability, maturity date, interest rate, repayment terms, restrictive covenants (ex. maintain EBITA), assets pledged as security or collateral, existence of sinking fund (U.S -> must set up sinking fund to borrow $$), principal repayments required for each of next 5 years & in detail Principal payments due in next 12 months should be in C/L L-T debt that is being refinanced may only remain in L-T Liabilities if it has been refinanced (signed agreement) by the balance sheet date. Chapter 20 – Leases In business, companies make money by using assets, not owning. Leasing is a popular alternative. Terms: - Lessor gives the leasee the right to use the lessor’s asset for a specific lease term in exchange for periodic lease payments - Monthly (usually) payment - Purchase option at end of lease term (at FVNI) - Bargain purchase option (e.g. buy for $1 at end of lease) - Residual guarantee (lessee guarantees the asset will be worth a specific amount at end of lease) - Executor costs (incidental fees associated with asset; ex. utilities/maint. fees, condo – prop. taxes) Typical Lease Calculations: (L-T Lease) $10,000 asset; 6 year economic life; 5 year lease term; 8% return; annual payments at end of year 1. If assume no residual value (no residual risk) Calculation of lease payment: 2. If assume residual value of $2000. PV of residual at 8%: Annual payment: Business objectives Lessor’s objective: financial return (i.e borrow at 5%, lease at 8%) ~ make 3% IFRS (“other Finance Lease”) -> financial-type lease or selling product if it manufactures -> use lease to increase sales -Sales-type lease *IFRS: “dealer type” lease+ – make money through gross profit on sale + some return on lease Lessee’s objective: need asset & cash is a constrained resource. Therefore use leasing as an alternative. - Can get 100% financing (vs. banks - > usually can’t get 100%) - Lease payments match cash inflows from asset - Protection from obsolescence (computers -> new technology -> restructure lease; get new asset) o Lessors better able to deal with older equipment Accounting issue – some leases pass the risks and rewards of ownership from lessor to lessee - If they do, the F/S must reflect the transfer - Therefore asset and liability appear on F/S of lessee ** Tests to determine if risks/rewards of ownership have passed** Don’t need to know IFRS 1. Reasonable assurance that the lessee will own the asset at end of lease [ex. existence of bargain purchase option] 2. Lease term is >= 75% of asset’s economic life (IFRS: “most of assets economic life”) 3. PV of minimum lease payments >= 90% of assets FV (IFRS: “recovers substantially all of its investment”) 4. Leased assets are so specialized, only useful to Lessee Min. lease payments: min rental payments (exclude executor costs) + bargain purchase option + residual guarantees Discount rate: PE GAAP – lower of rate implicit in lease & Lessee’s incremental borrowing rate IFRS: use implicit rate If available, otherwise incremental borrowing rate If lease meets any of 4 tests, it’s a capital lease (IFRS – finance lease); otherwise operating lease Chapter 18 Income Taxes Accounting Income (according to GAAP) vs. Taxable Income (in accordance w/ tax legislation) Temporary Differences vs. Personal Differences Taxable Income Accounting Income Dividends received from Never Included Included Canadian companies Permanent Fines for late tax returns Not deductible Expense Differences Social club dues Not tax deductible Expense Equity method earnings Not included Included Premiums and proceeds Not included or deducted Included on key men life insurance Taxable Income Accounting Income Depreciation vs CCA Only CCA deducted Depreciation included Warranty expense vs Claim – deduct for tax Expense – acct’g estimate Temporary warranty claims Differences - Unearned revenue Deduct for tax Deferred reversible Prepaid expenses Tax deductible when paid Deferred Impairment write downs Only when realized Deducted Unrealized holding gains Only when realized May get included Accounting for Income Taxes 1. Taxes Payable Method (Allowed by PE GAAP only) - current year expense and liability are the # amounts relating to current year’s taxable income (&tax return) 2. Future Income Taxes Method (deferred taxes) - mandatory for IFRS; allowed by PE GAAP - expense and liability in the current year relate to current year’s accounting income Ex. ABC Corp accounting income $1,240,000; tax rate 34%; 2011 depreciation was $180,000, CCA was $290,000, warranty expense was $40,000, warranty claims were $25,000, dividends received from Canadian companies totaled $110,000, club membership dues were $15,000, year-end prepaid insurance was $18,000 (0 in 2010) *** If 12,000 in 2010, can ONLY deduct 6k. Accounting Income (before tax) $1,240,000 Less: Permanent Difference Dividends Received ($110,000) Club Memberships 15,000 (95,000) $1,145,000 Temporary Differences Depreciation $180,000 CCA (290,000) Case 2: (90,000) Warranty Expense 40,000 Warranty Claims (25,000) Prepaid Insurance (18,000) (113,000) 87,000 Taxable Income $1,032,000 $1,232,000 -->Taxes payable for the year 2011 350,880 448,880 Entry: Income Tax Expense – Current $350,880 Income Taxes Payable $350,880 Ultimately, the tax expense wrt this year will be (1,145,000)(34%) = $389,300 ($350,880 currently payable) To set up the future income tax payable: Income Tax Expense – Future $38,420 Future Income Tax Liability $38,420 (also deferred liability) *** Note that temp. diff * 34% = 38,420 Case 2 (CCA < Depreciation) Taxable Income = 1,232,000; Current Taxes Payable = (1,232,000)(34%) = 448,880 Ultimate taxes payable relating to this year will still be $389,300. Quasi receivable (Qrv): Can tax “asset” be recorded on B/S? Only if it’s more likely than not that the company can take advantage of tax benefit. (i.e. will have sufficient savings) Assuming it’s more like than not, entry will be: Income Tax Expense – Current $418,880 Future Tax Asset (Deferred Taxes) 29,580 Income Taxes Payable $418,880 Income Tax Expense – Future 29,580 (or Benefit - Future) Continue case 2 into 2012 & assume only 2 temporary differences (no perm. differences); depreciation 180,000 and CCA of 280,000 and EBIT 1mil. Taxable Income = 1m + 180k – 280k = 900k Taxes payable = (900k)(34%) = 306,000 Ultimately, taxes payable will be (1m)(34%) = 340,000 2012 Entry Income Tax Expense – current 306,000 Income Tax Expense – future 34,000 Income Taxes Payable 306,000 Future Income Tax Asset 29,580 Future Income Tax Liability 4,420 Change in Tax Rate - Applied prospectively but impacts Future (deferred) Income Tax Asset or Liability. Asset/Liability must reflect the rate it is expected to be realized at. Income Tax Loss Carryover Benefits Law: companies that incur a loss can use the loss to reduce income taxes paid in previous/future years. Canada – can carry loss back 3 years or forward 20 years. - Normally losses are carried back first since generates instant cash Example: ABC Corp has the following tax data. Year Taxable Income (Loss) Tax Rate Taxes Paid 2000 100k 30% 30,000 2001 150,000 34% 51,000 2002 75,000 38% 28,500 2003 (400k) - Assume applies loss to all previous years first (can go back 3) – use up $325k “worth” of loss Income Taxes Receivable $109,500 Income Tax Benefit $109,500 - Can set up remaining tax bought --> rate * 75k loss iff. “more likely than not” benefit will be realized (must have earnings) - Assuming it is, asset is recorded at the rate expected to be in effect when benefit is realized - Assuming govt. announced new rate will be 25%, then the benefit will be 75,000 * 25% = $18,750. Deferred Tax Asset $18,750 Future Income Tax Benefit $18,750 Presentation and Disclosure - Income tax assets and liabilities must be disclosed separately – cannot be netted unless legally able to offset current in current; L-T in L-T o Excess installments paid through income taxes payable must be in C/A - Future or Deferred Income Tax Assets/Liabilities Only worry about **IFRS: report in L-T sections PE GAAP: identify which temp. differences relate to current & which to non-cu
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