PV Concepts - Leases

Under sales-type leases and direct-financing leases, gains and interest revenue are recognized using the interest method. The difference between the PV of lease payments and book value of leased asset is your profit. Amortized that over the life of the lease (or life of the asset, whichever is shorter) by multiplying the interest rate by monthly lease payment and applying that to interest, take the remainder and apply that to the carrying value of the lease, like it's no big deal.

Knowing the difference between Operating and Capital leases seems like an important distinction the AICPA wants to test. There are four criteria that you should know that make a lease "Capital". I'm dying to provide this link to a Roger CPA video I found on youtube. I wish there were more, but that's all they posted.

Leases and the SFAS's that cover it

Just for reference here are the key SFAS's that cover leases:
SFAS 13 - Accounting for Leases (Nov 1976)
SFAS 23 - Inception of the Lease
SFAS 27 - Classification of Renewals or Extensions of Existing Sales-Type or Direct Financing Leases
SFAS 28 - Accounting for Sales with Leasebacks
SFAS 29 - Determining Contingent Rentals
SFAS 91 - Nonrefundable Fees & Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases
SFAS 98 - Accounting for Leases
SFAS 145 - Rescission of FASB Statements 4, 44, and 64 Ammendment of FASB No. 13, and Technical Corrections (Apr 2002)
SFAS 146 - Accounting for Costs Associated with Exit or Disposal Activities

I included the issue dates for SFAS 13 and SFAS 145 above because they were the only ones Wiley did that for. I'm about to start the module, and I guess I'll find out soon why, or if, that's important.

More Present Value - Pensions

SFAS 87, SFAS 112, SFAS 88, SFAS 106, SFAS 132(R) and SFAS 158 all cover pensions and postretirement benefits.

To get started here are a few terms, these may not make sense now, but will show up on a few CPA problems:

• Defined Contribution Plan - A plan that specifies a company's contribution. The accounting for this is apparently simple. The sponsor company only needs to make one journal entry. Out of 41 practice problems in the Pensions module in my Wiley book, not a single one involved defined contribution plans. That's probably because it's not as complex as...
• Defined Benefit Plan - It's a plan that specifies the benefits paid to employees at retirement. Contributions are calculated based on actuarial estimates. The accounting for this is very complex. A sponsor company needs to make multiple journal entries. Out of 41 practice problems, about half involved this type of plan. The other half involved other postretirement plans which share a lot of common characteristics.
• Accumulated Benefit Obligation (ABO) - PV of benefits based on current and past compensation levels. Not future.
• Projected Benefit Obligation (PBO) - PV of benefits based on future compensation levels.
• Fair Value of Plan Assets - market value of the securities and other investments in the pension fund
• Vested Benefits - benefits already earned by employees by reason of retiring or meeting some other requirement. The employee has a right to these benefits whether she continues working or not.
• Prior Service Cost - costs of benefits based on past service. When a new plan is implemented or an existing plan is amended, the company has to go back and add past costs to current balances as if they had those costs on the books all along.
• Service Costs - PV of all pension benefits earned by a company's employees in the current year. This increases PBO. Usually given in a problem.
• Interest Cost - Increases PBO by passage of time. Usually the problem will give you a discount rate and a beginning PBO. Multiply these to get interest cost.
• Actual or Expected Return on Plan Assets - They'll usually give you a rate of return and the FV of plan assets. Multiply these to get return.

Net Periodic Pension Expense - this is a fancy name for pension expense. A lot goes into NPPE, so I looked at an old Becker book, and I found the mnemonic "SIR-AGE" helpful.

• S - Service cost (current), usually given
• I - Interest cost. discount rate * beginning PBO
• (R) - Return on plan assets. This will decrease NPPE (it's a return on the market).
• A - Amortization of Prior Service Costs.
• (G) - Gain or loss amortization. A gain will decrease NPPE (just like a return).
• E - Existing net obligation (liability) or net asset amortization

These are the six components that go into Net Periodic Pension Expense. Here's a little more detail about each:

• Service Cost - Usually given, but is simply the difference between beginning and ending Unrecognized Prior Service Cost
• Interest Cost - Discount rate * FV of plan assets
• Return on Plan Assets - Expected rate of return * beginning PBO. Remember to subtract the return on plan assets from NPPE. A return decreases expense, just like a gain.
• Amortization of Prior Service Cost - Usually given, but if the problem gives 12/31/yr. 2 unrecognized PSC and 12/31/yr. 1 unrecognized PSC, simply subtract these to get the amortization of the PSC
• Gain/Loss Amortization - A gain will decrease expense and a loss will increase it. For example, one of the problems in my Wiley book gives unrecognized net loss, market-related asset value (M-RAV), and PBO. Take the larger of PBO and M-RAV. Whichever is larger, multiply it by 10%. Got it? Then subtract the unrecognized net loss from that number. Take the difference and divide it by the average remaining service period (usually given). This is a summary of the "Corridor Approach" confusingly described in SFAS 87, para. 187-189. Do a problem to get a better idea. Agree?
• Existing Net Obligation/Net Asset Amortization - If PBO > FV of plan assets, you have an obligation; if FV > PBO, you have an asset. If PBO > FV, then take the difference and divide it by EITHER 15 years OR the average employee job life, whichever is greater.

That's a summary that may not make sense until after studying the Pensions module.

Disclosures

Under SFAS 87 and SFAS 106, the funded status of pension plans was only required to be reported in the footnotes. SFAS 158 came out in Sept. 2006 (finally, I know) to require funded status to be reported right on the Balance Sheet. SFAS 158 also eliminated delayed recognition of certain components allowed under 87 and 106. Lastly, 158 requires a company to consider tax effects.

I was surprised to learn that a company must disclose the effects of a one-percentage-point (not two or ten, some questions seriously try to throw you off this way...) increase or decrease in the trend rates for health care costs for the aggregate of the service and interest coasts components and the accumulated postretirement benefit obligation for the following year and years after. I haven't seen a practice problem that actually requires that to be computed, but there are a few that simply ask if you know that. This is required under SFAS 132(R) starts on pg. 24. SFAS 132(R) requires a list of disclosures including: amount of unrecognized prior service cost and fair value of plan assets.

I should add that this post is meant for people who have already studied this module and would like a summary or regular person's interpretation. It's also meant for me to see if I have retained the information well enough. If there are any mistakes, please point them out.

Thanks to the four people who may have read this far.

Present Value of Bonds

The accounting treatment for bonds is covered mostly by APB 21, SFAS 157 and SFAS 159. I say mostly because the accounting treatment for bonds is scattered across a few standards. APB 21 covers interest for long-term payables and the presentation of discounts and premiums. The Appendix illustrates the present value concept (we'll go over that shortly). SFAS 157 provides guidance on measuring the fair value of liabilities. (we'll go over that in some detail). SFAS 159 covers the Fair Value Option (I haven't read that, I'll have to come back and edit this). SFAS 47 addresses what should be included in the footnotes about long-term obligations in general. SFAS 91 tells you what should be included in origination costs (most likely everything).

A big thing this section on the CPA exam seems to emphasize is buying bonds between interest payment dates. This involves calculating interest payments (easy), premium/discount (still easy), amortization of the premium/discount (not bad with practice), interest accrual (sucks), and amortization of the interest accrual based on either the interest method or straight-line method (this is why CPAs get paid so much).

The CPA exam also tests on disclosure.

SFAS 47 is pretty easy. In the footnotes, you want to include the balances for sinking fund requirements and outstanding long-term payables for 5 years out. So if the year-end financials are for 12/31/10, you want to include sinking fund balance requirements AND outstanding long-term payables for 12/31/10 through 12/31/14. We'll worry about 12/31/15 next year, but don't skip on 12/31/14.