• Lots of content for this class.
• Focus on IFRS which has been GAAP since 2011 for Canadian publicly traded companies

Chapter 13

• Financial liabilities vs other
• Current liabilities
• Identify and account for employee-related liabilities
• Decommissioning and restoration obligations

IFRS Related

• IAS 37 Provision, Contingent Liabilities and Contingent Assets
• IAS 16 Property, Plant and Equipment
• IAS 1 Presentation of Financial Statements

What is a Liability

IFRS

• Present obligation to transfer resource due to a past event

ASPE

• Duty to responsibility to others
• Little to no discretion to avoid the obligation
• Relates to a transaction

Obligations are legal or constructive and can be enforced. A constructive obligation is an expectation to do something but isn’t written.

An example is how Best-Buy allows 60 -day returns even though the law is 30 days and Best Buy does not state they can do 60 days.

Financial vs. Non-financial Liabilities

Financial Liability

• Deliver financial assets
• Exchange financial assets under unfavorable conditions

Non-Financial Liability

• Payable with non-financial resources (i.e. goods and services)
• Income taxes payable is considered a non-financial liability

Measurement

SFP - Statement of financial position

Current Liability Examples

• Bank Indebtedness (line of credit, revolving / flexible loan facility)
• Accounts payable (i.e., trade accounts payable)
  • Credit term of 2/10 n30 means 2% off in 10 days net of 30 days
  • Ordinary business activities
• Notes payable
  • Written promise to pay
  • Could be interest-bearing or non-interest bearing (in which case, we borrow at the present value of the note)
  • $100,000 four-month, 12% note on March 1st. Statements made on June and December.
    • on June 30th, credit interest expense amount to interest payable
  • non-interest bearing $100,000 four-month, 12% discount rate, present value (PV) of $96,154, on March 1st.
  • 96,154 = (100,000 / (1 + 12% * 4 / 12))
  • On March 1st, borrow the present value
  • On June 30th, credit interest expense amount to notes payable
• Current Maturities of Long-Term Debt
  • Classified as current liabilities unless the payment is with non-current assets
  • Due on demand loans
• Short-Term Debt Expected to be Refinanced
  • For both standards, use under an existing agreement
  • IFRS: If refinanced to >=12 months (at date on the statements), reclassify as long-term debt
  • ASPE: If the debt will be refinanced to >=12 months by the time the financial statements are issued, reclassify as long-term debt
  • Financial statements date: when statements are prepared or given
  • Reporting date: the date the financial statements are reporting on
• Cash Dividends Payable
• Preferred Dividends in Arrears
• Rents and Royalties Payable
• Taxes payable: sales tax, goods and services tax, income tax
• Employee-Related Liabilities

Taxes Payable

• Sales tax is not a value-added tax. An example is provincial sales tax (PST) that is a separate sales tax
• Goods and Services Tax (GST). If companies charge customers, they can deduct input tax credit
• Harmonized Sales Tax (HST). Same as GST.

Value-added Tax Example

Accounts receivables          3,390
  Sales revenue                      3,000
  HST payable                          390

Paid supplies $2,000 for the merchandise. Input tax credit = $260.

Hence, net HST payable = 390 - 260 = 130.

HST is refundable. Carousel scheme where Canada issues refunds when the first companies did not remit the tax.

Income Tax

• Suppose $21,000 has been estimated and no installments were made

Current tax expense       21,000
  Income tax payable            21,000

• Suppose $20,000 tax instalment was made at year end

Income tax payable        20,000
  Cash                                20,000

• Suppose $23,000 tax instalment

Income tax payable       21,000
Income tax receivable     2,000
  Cash                                            23,000

If tax instalment payments are made every 3 months, we need a year end adjusting entry.

• Case underpaid tax: Either a debit to current tax expense and a credit to income tax payable OR
• Case overpaid tax: Debit to income tax receivable and credit to current tax expense

More Current Liabilities

• Cash dividend payable
  • Corporation declared a dividend
  • Stock/share dividends are not a liability
• Rents and Royalties payable
  • from contractual agreement
• Customer advance and deposits
  • returnable cash deposits or customer advance

Employee-Related Liabilities

• Payroll deductions
  • Employee income tax
  • Canadian Pension Plan (CPP)
  • Employment Insurance (EI) premiums
  • Union Dues (discretionary)
  • Required employer contributions
    • CPP
    • EI Premium equal 1.4 times employees’ EI contribution

# employee deduction
Salaries and wages expense                6,000
  CPP contributions payable                       500
  EI premiums payable                             100
  Union dues payable                               50
  Employee income tax deductions payable        1,500
  Cash                                            850

# employer required
Payroll tax expense               640
  CPP contributions payable             500
  EI premiums payable                   140

Short-Term Compensated Absences

• statutory holidays; vacations
• Either accumulated rights or non-accumulating compensated absences (e.g. paternity leave)

Profit-Sharing and Bonus Agreements

• regular rates of pay, productivity, or company profits
• obligations are current liabilities

Decommissioning and Restoration Obligations

• Construction and operation of long-lived assets sometimes create obligations associated with the eventual retirement
• Asset retirement obligation (ARO) or site restoration obligation ; credit
• Recognized in the period incurred
• IFRS
  • constructive (like what is expected by the public) and legal
  • capitalized costs include acquisition only
  • production is inventory or product costs
• ASPE: legal obligations
  • capitalized costs might include all obligations but the production is as they occur
• ARO is a future cost, so capitalize the present value of the cost over the asset’s useful life
  • Supposed $600,000 ARO cost and a 8% discount rate in five years. Therefore 600,000 / 1.08 ** 5.
• Incremental ARO costs:
  • IFRS: inventory or production costs
  • ASPE: capitalized
  • Since ARO is a present value, charge Interest Expense under IFRS and Accretion Expense under ASPE
  • Suppose 20% of ARO is because of production-related.
    • Use 80% for the journal entry
    • For IFRS add the ARO production cost to overhead costs and for ASPE debit the drilling platform
  • Straight-line depreciation on the asset over 5 years
    • for IFRS, we know the amount beforehand
    • for ASPE, depends on the incremental capitalized costs
  • Accrue the interest

# Under IFRS
Interest expense 26,134
  ARO                         26,134
# Under ASPE
Accretion expense 26,134
  ARO                         26,134

Suppose that the ARO increased by $88,203 (present value based on the future ARO cost due to the production)

# Under IFRS
Inventory     88,203
  ARO             88,203
# Under ASPE
Drilling Platform     88,203
  ARO                              88,203

Under IFRS COGS increases whereas under ASPE Depreciation expense will increase subsequent years.

Suppose upon dismantling, there is a higher cash payment that the ARO.

ARO                           600,000
Loss on Settlement of ARO             10,000
    Cash                             610,000

Production Guarantees

Warranty is a promise to correct problems. Expense approach is still used for assurance-type warranties and revenue-approach is for service type warranties.

• Assurance-type warranty: built into the price

• Service-type warranty: separate performance obligation

• expense-approach: expense as occurred but recognize more if total cost > already-recognized expense

  • if there is an estimated warranty cost that was not incurred, expense the remaining estimate as warranty expense as at year-end and into warranty liability
  • deduct expenses related to warranty from the warranty liability account first before recognizing expensing the warranty expense account on income statement

• revenue-approach: recognize unearned revenue, expense as occurred, recognize revenue as performance obligation is satisfied

  • if future warranty cost exceeds unearned revenue, recognize a loss and a liability immediately. (onerous contract)

# During the year 2023. Assume 30,000 is the estimated warranty cost.
Accounts receivable 1,000,000
  Revenue 1,000,000
Warranty expense 10,000
  Materials, Cash, Payables 10,000
# Adjusting Entries on Dec. 31, 2023:
Warranty expense 20,000
  Warranty liability 20,000

# As actual warranty costs incur in 2024
Warranty expense 25,000
  Materials, Cash, Payables 25,000
# At year end, we need to adjust the liability account (no longer have liabilities)
# credit warranty expense to liability account
Warranty liability 20,000
  Warranty expense 20,000

Loyalty Programs

• Purchase are partially loyalty points which is unearned revenue for IFRS 15, optional under ASPE

• $100,000 products purchased, 10,000 points earned, 45% gross profit, 9,500 points estimated to be redeemed

• One point worth $1 distributed for every $10

• Loyalty Points Unearned Revenue = $9,500

• Proportion of goods/services = $100,000 * (100,000 / (100,000 + 9,500)) = $91,324

• Proportion of loyalty points = 100,000 - 91,324 = 8,676

Cash                100,000
  Sales revenue               91,324
  Unearned revenue               8,676

COGS                 55,000
  Inventory                  55,000

• Question: when do loyalty points hurt the store?

For expense method, the premiums expense is based off the difference. So (Price - Cost) multiplied by the number of units (redemption and then expected - redemption).

Contingency

• IFRS:
  • contingent liability: in notes and not recognized
  • more likely than not is a provision: this is recognized and is a liability and a loss
  • do not disclose or recognize contingent gains
  • not a provision
• ASPE: likely
  • recognize as loss

Commitments

• financial guarantee contract.

one party (the guarantor) contracts to reimburse a second party for a loss incurred if a third party (the debtor) does not make required payments when due

• ASPE: Follows the loss contingency standards
• IFRS: Fair Value, MAX(loss allowance, initial). Consider time value of money.

Financial Statement Analysis

• Current Ratio = Current Assets / Current Liabilities
• ACID test ratio = (cash + marketable securities + net receivables) / current liabilities
• Days payable outstanding = Average trade accounts payable / average daily cost of goods sold or average daily cost of total operating expenses

Chapter 14

Long-Term Debt

• Not payable within a year

Bonds

• Why issue bonds? Capital required is too large for a single lender
• Purchased in small denominations
• Bond indenture (contract)
  • Coupon rate
  • Coupon payment dates
  • Face (par) value
  • SEC example
• Issuing company sells bonds to investment banks which markets and sells to investors
• Prospectus filing and subject to securities regulation
  • Do non-publicly traded companies also need to do this
• Private sale does not require filing
• Who pays for rating?

Common Types of Long-Term Debts

• Registered Bonds
  • Issues in the owner’s name
• Bearer Bonds
  • Whoever bears the bonds is owed the money
• Secured debt
  • Mortgage bond or notes
  • Collateral trust bonds
• Income bons Revenue bonds
• Deep discount bonds or notes
• Commodity-backed debt
• Callable bonds and notes
• Convertible debt

Defeasance

• When company is not allowed to pay back debt before maturity date,
  • Legal: Give money to a trust to do it for you
  • Creditor agrees accept payment from trust (is this a must?)
  • Creditor gives up its claim to the company
• In-substance defeasance
  • Company does not inform creditor
  • no derecognition

Bonds Issued at Discount or Premium

To calculate the market price or proceeds, we need to sum the present value of the face value as well as present value of the ordinary annuity. Use a present value factor where periods is the years times the number of payments per year and the rate is the effective interest rate divided by the number of payments per year.

• IFRS: effective interest rate amortization
  • periods = coupons per year * maturity in years
  • amt = coupon per period not per year
• ASPE: effective interest rate amortization or straight line

# fair value transaction
Cash $800,000 Dr.
  Bonds Payable $800,000 Cr.

# Jul 1, 2023
Interest expense $40,000 Dr.
  Cash  $40,000 Cr.

# Dec 31
Interest Expense $40,000 Dr.
  Interest Payable $40,000 Cr.

# discounted bond of $100,000, 10%C, y=12%
Cash                    $88,700
  Bonds Payables      $88,700

# Interest expense = beginning carrying amount * effective market yield (divide by number of payments per year)
                               = 88,700 * 12% = $10,644

Dr. Interest expense                               10,644
      Cr. Cash (coupon payment)                          10,000          (=100,000*10%)
      Cr. Bonds payable                                                644

Bonds Issued Between Interest Dates

# in this example 10% coupon, semi-annually, 12% yield, $100,000 par value
Dr. Cash                                                    96,750
       Cr. Bonds payable                                     95,083
       Cr. Interest payable             1,667     (= 5,000 x 2/6 )

Zero-Coupon Marketable Securities

• marketable meaning money that is given in the future is sold at the present value
• Company issued a bond with face value of 10,000 but the cash proceeds was 7,721.80.

Non-Marketable Instruments with non-market rates

• Government grant of 100,000 with 10% discount rate?

Cash                    100,000
  Notes payable                 62,092
  Buildings                     37,908

Notes Issued for non-cash proceeds (Property, Goods, or Services)

• if marketable security, use the fair value
• otherwise,
  • could discount with cashflow
  • fair value of assets received

Fair Value Option

• Every period update to fair value
• IFRS: fair value only if it results in more relevant information
• Put unrealized gains in OCI which will be wiped when debt is paid off
  • Example: Higher credit risk means that the market value of debt is lower (higher return = higher risk)
• ASPE: allows fair value option and no OCI so recognize in net income

Extinguishment of Debt

• When debt is extinguished, it is derecognized
• Carrying value = maturity value; no gain or loss
• Repayment before maturity date
  • Prior to maturity: reacquisition price
  • Carrying amount = maturity value +- unamortized discount or premium and issuance costs
  • if carrying amount > reacquisition price: gain
  • if reacquisition price > carrying amount: loss

To calculate unamortization amount:

• straight-line method:
  • initial gain/loss divided by the number of years multiplied by number of year remaining on the bond
  • so if buying back a bond at 101 sold at a loss of 24,000 (97 of 800,000) 8 years later with a maturity of 20: 24,000 / 20 * 12 = 14,400
  • reacquisition price - face value + unamortized amount gain (subtract the loss) = loss/gain
  • 808,000 - (800,000 - 14,400) = 22,400

Exchange of Debt Instruments

• Refund
• substantially Different terms
• debt < carrying amount
• continuation of debt, with modified terms

1. Transfer non-cash assets
   • recognize a gain/loss on disposal of the non-cash asset
   • gain/loss on debt settlement needs to be recognized
   • creditor may be able to force a transfer (loan foreclosure)
2. Share transfer
3. Issue debt to another creditor, use proceeds to repay existing debt (refinancing)

A building with fair value of $16MM is transferred to settle a $20MM loan.

# Creditor
Buildings               16M
Loss on loan             4M
  Notes receivable            20M

The building had a book value of $21M

# Debtor
Building Depreciation              5M
Notes Payable                     20M
Loss on Building transfer          5M
Buildings                                26M
Gain on Debt Restructuring                4M

Share transfer

320,000 shares worth $16M is transferred. Creditor is treating it as FV-NI.

# Creditor
FV-NI       $16M
Allowance for Doubtful Accounts   $4MM  [Allowance for Expected Credit Losses]
  Notes Receivable                       $20M

# debtor
Notes Payable        $20M Dr.
  Common Shares                   $16M Cr.
  Gain on Debt Restructuring    $4M Cr.

Debt Term Modifications

• Stated interest
• Maturity date
• Face amount
• Reduction or deferral of accrued interest
• Change in currency

For it to be substantial, either the present value changes by at least 10% or the creditor changes.

On December 31, 2023, Manitoba National Bank enters into a debt restructuring agreement with Resorts Corp., which is experiencing financial difficulties. The current carrying amount of the loan is $10.5 million (the bond was issued at par). The modifications are as follows:
1. Reduce the current obligation from $10.5 million to $9 million.
2. Extend maturity date from Dec 31, 2023 to Dec 31, 2027.
3. Reduce interest rate (annual payment) from 12% to 8% (The current market rate is 9%).

Old terms have a Present Value (PV) of 10,500,000 (because already at maturity).
Use original effective interest to calculate PV of new terms which is 7,906,572.
The difference is ~ 33% so treat it as a settlement.

Notes payable 10,500,000 Dr.
  Notes payable                       8,708,425 Cr.   (market value based on yield and interest rate)
  Gain on Restructuring Debt  1,791,575 Cr.

Non-substantial,

• ASPE: Keep carrying amount the same, using the new maturity value and interest rate, solve for EIR, and calculate the new interest expense.
• IFRS: Remeasure carrying amount to the PV using market rate for the new obligations

Off-Balance Sheet Financing

• Harder to do these days
• Non-consolidated entities
• Special purpose entity or variable interest entity
  • buy assets, take risk, isolate from other company
• operating leases (ASPE only)

Debt Financial Statement Analysis

• Debt to Asset ratio = Total debt / Total assets
• Times interest earned = Income before taxes nad interest expense / interest expense

Chapter 15 Shareholders’ Equity

Basic Forms

• Proprietorship
  • Single owner
• Partnership
  • Multiple owners
• Corporation

  • = 1 owner

  • Separate legal entity
  • Taxed separately, and personal tax is at dividends
  • Owners only risk investment

Corporate Classification

• Public / Crown Corporation
  • Government units - no shares
  • Government Business Entreprises - issues shares (e.g. canada post)
• Private Sector
  • Not-for-profit
    • no shares, since no distributions of profits
  • for profit
    • shares issued
    • privately held
    • publicly traded

Incorporation Process

• Submit articles of incorporation
  • Maximum shares
  • Addresses
  • Directors
  • Share classes

Shares

• Groups or classes
• Each share is equal to another in the same class
• If no restrictions, there are basic or inherent rights
• CBCA also allows pre-emptive rights
• Basic or Inherent Rights
  • Share proportionally in profits and losses
  • Management (vote for directors)
  • Corporate assets upon liquidation
• Pre-emptive rights
  • allows shareholders to purchase new share issuances
  • protects against involuntary dilution

Types of Shares

• Common
  • Ownership interest
  • Right to elect board of directors
  • Default share type
• In-Substance Common Shares
  • Similar to common shares BUT cannot be called common shares for account purposes
• Preferred Shares
  • Assurance of dividend before common shares
  • Priority over all other types of shares over earnings and assets upon dissolution
  • No voting rights
  • No share in profit higher than stated rate
  • Features at corporation’s discretion:
    • Cumulative in dividend arrears
    • Convertible to common shares
    • Callable/Redeemable at specified dates and prices
    • Retractable - Can sell their shares back to company and mus tbe paid
    • Participating - share in profit distribution
  • CBCA does not allow shares issued with a par value
  • Expressed as a percentage of issue price
  • Shareholder investment cannot be withdrawn at shareholders’ discretion unless all prior claims have been paid

Legality of Dividend Distribution

1. No dividends unless the corporate capital is kept intact
   • Net assets should be sufficient for solvency purposes
   • CBCA Corporate Solvency Tests
     • After dividend, can the corporation pay its liabilities
     • After dividend, is the realizable value of assets less than total liabilities plus legal capital
       • Portion of company’s equity protected by law
2. Dividends must be formally approved by the board of directors
3. Dividends must agree with stipulations in the contracts (debt)

Issuance of Shares

• Initial Public Offering (IPO)
• Seasoned share issuance

# 500 shares at $10
Cash                        $5,000 Dr.
  Common shares       $5,000 Cr.
# 100 preferred shares at $10 per share
Cash                      $1,000 Dr.
  Preferred Shares          $1,000 Cr.

Shares Sold on a Subscription Basis

• Partial payment
• Share only issued until full price received
• Cash already debited
• 10 common shares, at $20, 50 people accept, 50% down, due in 6 months

Share subscriptions receivable    $10,000
  Common shares subscribed                $10,000
# first instalment
Cash                              $5,000
  Share subscriptions receivable          $5,000
# final instalment
Cash                              $5,000
  Share subscriptions receivable          $5,000
# settlement
Common shares subscribed          $10,000
  Common shares                          $10,000

In case of default, possible actions are:

• refund paid amount

Common shares subscribed $1,000
    Share subscription $500
    Accounts Payable $500

• treat paid amount as forfeited; transfer to contributed surplus
• issue fewer shares

Shares issued with other securities

• for lum-sum sales
• relative fair value method
  • estimate fair values of each class of securities, then proportionally allocates the lump-sum to each instrument
• residual value method
  • allocate lump-sum to instruments that are easier to measure, then allocate rest to the other instruments

Cost of Issuing Shares

• Capital-related (deduct from proceeds)
  • Underwriting
  • Accounting and legal fees
  • Printing
  • Taxes
• Operation-related (expenses)
  • management
  • maintaining records

Reacquisition or Repurchases of Shares

• increase ROE
• provide shares for employee share compensation
• business acquisitions or mergers
• stop takeovers
• demand to affect share price
• leverage buy-out (LBO)
• manage regulatory capital requirements
• reacquired shares are either retired or held as treasury shares (intended for re-issue)
• CBCA required shares to be cancelled and restored status to authorized but unissued
• treasury relatively uncommon in canada

if reacquisition cost < average issuance price

Dr. Share capital $1,000
  Cr. Cash $800
  Cr. Contributed Surplus $200

if > average issuance price

Dr. Share capital          $1,000  (= $10 x 100)
     Cr. Cash                                  $1,200 (= $12 x 100)

Debit $200 to contributed surplus and then to retained earnings

• Share account Book Value per share is the average issuing price

Dividends

• Date of declaration (board passes resolution)

• Date of record (eligibility of shareholders)

  • business day before ex-dividend date

• Date of payment

• share of earnings

• liquidating dividends (when operations are exhausted, think mining, oil & gas, resource extraction)

Cash Dividends

Cash dividend of 50 cents a share on 1.8MM shares on July 16 to all shareholders of record on June 24.

# after declaration (note no retained earnings account)
# JE not necessary for preferred share dividends since they are always payable for the year
Dividends Declared (- Equity) $900,000
  Dividends Payable (+ Liability)       $900,000
# nothing on entry date
# payment date
Dividends Payable           $900,000
  Cash                                  $900,000

Property (in-kind) Dividends

• Generally measured at fair value of assets given up
• Non-reciprocal transfer of non-monetary assets between an entity and its owners
• Merchandise, real estate, investments

Stock Dividends

• 1,000 common shares
• $50,000 retained earnings
• $130 per share fair value
• All shareholders received stock dividends

# 1000 * 0.1 * 130 = $13,000
# on declaration
Retained earnings               Dr. 13,000
  Stock Dividends Distributable             Cr. 13,000
# on distribution
Stock Dividends Distributable   Dr. 13,000
  Common Shares                             Cr. 13,000

Liquidating Dividends

• paid out of contributed surplus
• excess of accumulated income considered a return of shareholders’ investment
• Example 1.2M dividend with $900,000 considered a return of income

Retained Earnings   900,000
Contributed Surplus  300,000
  Dividends Payable         1,200,000

Non-cumulative and Non-participating preferred shares

• Question: is it cheaper to issue bonds or preferred shares
  • Probably bonds since the interest payments are guaranteed and fixed
  • So why would you ever issue a preferred shares if it is more expensive? just because it can be stopped temporarily?
• $50,000 to be distributed as cash dividends
• $400,000 book value
• 1,000 $6 preferred shares out standing with book value of $100,000
  • preferred dividend is 6% of book value

# non-cumulative preferred shares and non-participating
Total dividends declared $50,000
Less Preferred shares paid first $6,000
Balance available to common shareholders $44,000
# cumulative and non-participating, last 2 years are also due
total dividend declared $50,000
Less: dividends in arrears $12,000
Preferred shares current  $6,000
To common shares:   $32,000
# cumulative and participating
# need to treat the preferred share dividend as if it is part of the proportion so that the proportion of dividends is fair for common
Total dividends declared $50,000
Less; preferred in arrears: 12,000
-----------------------------
Less: preferred 6% 6,000
Less: common 6% 24,000
To preferred (20% of 8,000):  1,600
To common (80% of 8,000): 6,400

In case 1, the participation is capped

Stock Splits vs Stock Dividends

• Lower stock market price = easier to acquire
• If stock dividends are large enough, it’s basically a stock split (SEC)
• large stock dividend is more than 20% and is not mentioned about in ASPE and IFRS
• 2 for 1 stock split: 2 shares for every 1 currently issued

Components of Shareholders’ Equity

1. Share capital (provided by shareholders)
2. Contributed Surplus (provided by shareholders)
3. Retained Earnings (earned)
4. Accumulated OCI (earned)

• IFRS: detailed changes in shareholders’ equity
• ASPE: only retained earnings, contributed capital in notes

Capital Disclosure

• Amount of authorized, issued and fully paid shares
• Rights, preferences, any restrictions
• Reconciliation between opening and closing balances
• Restrictions on shares
• IFRS:
• Objectives, policies, processes for managing capital
• Summary quantitative date about what the company manages as capital, and any changes

Equity Financial Statement Analysis

• ROE = (Net Income - Preferred dividends) / (average common common shareholders’ equity)
• Dividend payout (Cash dividends) / (net income - preferred dividends)
• PE ratio = (market price per share) / (earnings per share)
• Book value per share = Common shareholders’ equity / number of common shares outstanding

Chapter 16 Complex Financial Instruments

• effect of transferring the one or more financial risks inherent in the underlying primary instrument
• PV of a forward contract is 0; so no initial investment
• main purpose is for risk management or hedging. Other purposes is speculation and arbitraging.
• Risks: market risk, credit risk (counterparty), and liquidity risk (companies paying off debt obligations)
• Measure at FV-NI
  • remeasure on SFP dates
• Purchase commitments are not derivatives unless
  • ASPE: exchange traded futures

A stock warrant gives the holder the right to purchase a company’s stock at a specific price and at a specific date. A stock warrant is issued directly by the company concerned; when an investor exercises a stock warrant, the shares that fulfill the obligation are not received from another investor but directly from the company.

Company A has 5,000 shares of Company B and bought 5,000 put options at $2/put option. Strike price is $100 per share (current value).

• Purpose: Company B is willing to lose a maximum of $2 per share and wants to limit the downside to this amount
• Investments (FV-NI). Declines would be posted to net income
• No the accounting is no transparent, because the NI and OCI are different when underlying goes down G

Futures

• Exchange-traded
• Standardized amounts and dates
• Settled through clearing houses
• Requires collateral (margin)
• Settled daily
• G/L Recognized against income

Short $1,000 grain contract settling in 30 days. Initial $100 margin.

Derivatives - Deposit   100
  Cash                            100

The value of grain increases, so our position decreases (futures contract moved against the company).

Gain or Loss                                  50
  Derivatives - Financial Assets/Liabilities      50

Suppose there is a margin call for $50

Derivatives - Deposit         50
  Cash                            50

Settled on net basis

# clearing house already settled this to the counterparty
Cash                      100
Derivatives                50
  Derivatives - Deposit        150

Derivatives Involving the Entity’s Own Shares

• IFRS: Fixed-for-fixed equity transaction (gross settlement)
• ASPE: silent, general principles would say contra equity
• When purchasing an options, debit the contributed surplus first

Contributed surplus           200
  Cash                              200

Company A agrees to purchase $50,000 US for $65,000 CAD in 30 days. There is a fair value of $500 on the issue date. On settlement the ratio is $1.25 CDN = $1 US (versus 1.3 agreement)

Derivatives       500
  Gain or Loss        500
# gross basis settlement
Cash               62,500
Gain or Loss        3,000
  Cash                             65,000
  Derivatives                         500
# net basis settlement
G/L             3,000
  Cash                      2,500
  Derivatives               500

Hybrid/Compound Investments

• preferred shares
• convertible debt
• redeemable shares
• Debt classification requires meeting financial liabilities definition
  • contractual obligation
  • deliver cash or financial asset to another party
  • potentially unfavourable exchange of financial assets
• Equity:
  • residual interest after deducting liabilities
• Offsetting?
  • Only if there is a legal right and intended to settle
• Measurement
  • Residual value approach (incremental). IFRS. Debt first.
  • Relative fair value (proportional). Equity can be valued as zero or residual method. Easier first
  • debt measured at Amortized cost

Convertible Debt

• holder has option to exchange for common shares
• raise capital without giving up ownership
• lower interest rate, since investors can ride on share value increase
• B corp. offers 3-year, 6% annual coupon, convertible bonds par = $1000. Convertible to 250 shares trading at $3/share. Similar straight line bonds carry an interest rate of 9%. 1,000 bonds are issued at par.
  • To get the present value without derivative rights, use the same coupon payment, but different discount rate

FV = $1,000,000
PV = 924,061 (straight bond)
Value of option = 1,000,000 - 75,939

Cash                    1,000,000
  Bonds Payable              924,061
  Conversion Rights           75,939

# ASPE, not recommended but if equity was valued at $0
Cash                  1,000,000
Bonds Payable           1,000,000

# conversion - assume unamortized is $14,058
Bonds Payable          985,942
Contributed Surplus     75,939
  Common Shares             1,061,881

# pay $15,000 to convert ASPE
Bonds Payable             972,476 (given)
Loss on redemption         8,968 ( subtract fair value of 981,462 from carry value)
Contributed Surplus       75,939 (given)
  Common Shares                           1,048,415
  Cash                                                   15,000

# pay $15,000  to convert IFRS
bonds payable           972,476
loss on redemption      15,000
  Common Shares                 1,048,415
  Cash                                        15,000

# retirement with offer of 1,070,000
Bonds Payable                 972,476
Loss on Redemption             8,986 (difference between offer and book value of the bond)
Contributed Surplus            75,939
Retained Earnings               12,599 (need to book value of contribution as well)
  Cash                                          1,070,000

Share Based Compensation

• direct awards of stock
• compensatory stock option plans (CSOP)
  • grants, vesting
  • paid for service, is an expense, operating transactions
  • income statement
  • not traded
• employee stock option or purchase plans (ESOP)
  • employee usually purchases the options
  • charged to equity account
  • capital transaction
  • shareholders’ equity
  • not generally traded
• share appreciation rights (SAR)
• performance-type plans

employee stock option or purchase plans (ESOP)

Employee purchases 6,000 $10 options with a premium of $1.

# options bought
Cash                        6,000
  Contributed Surplus - Options       6,000
# options exercises
Cash                                            60,000
Contributed Surplus - Options       6,000
  Common Shares                                   66,000

CSOP

According to IFRS2:10-13A, CSOP recognized at fair value (usually using black-scholes-merton model)

• Although unvested options dilute earnings, the compensation expense is allocated during vesting period, not grant.
• After vesting, as long as the option has not expired, it is dilutive

Options granted to 5 executives to purchase 2,000 shares at a price of $60. Grant date is Jan 1, 2024. Vesting is Dec 31, 2025. Compensation expense is 220,000.

Dec 31, 2025 - Vested of options
Compensation Expense    110,000
  Contributed Surplus           110,000
# 20% exercised Jun 1, 2027
Cash                     120,000
Contributed Surplus       44,000
  Common Shares                     164,000
# 80% not exercised
Contributed Surplus - stock options         176,000
  Contributed Surplus - Expired Options           176,000
# forfeiture. ASPE: estimate or expense as occur. IFRS must estimate.
# if change in estimate:
Contributed Surplus XXX
  Compensation Expense XXX
# direct stocks. Fair Value. For private companies, employees cannot realize the value.

Full Disclosure

• accounting policy used
• description of plans and modifications
• issued, exercised, forfeited, expired
• method of fair value
• compensation should reflect in net income and contributed surplus

Since we know the PV of the pure debt is 4,200,000, the yield is 3.64% according to RATE(10 * 2, -4000000 * 0.08 / 2, 4200000, -4000000) in excel.

September 30, 2023
Cash 4,600,000
  Bonds Payable                                                     4,200,000
  Contributed Surplus - Warrants                               240,000
  Contributed Surplus - Conversion Rights                160,000

Amortization Schedule for the bond (reduce carrying value by the difference coupon payment and the interest expense from the semi-annual compounded yield) until September 30 2028.

March 23, 2026
Cash                                                600,000
Contributed Surplus - Warrants     120,000
  Common Shares                                 720,000

Sep 30, 2028
Bonds                                                          4,117,705
Contributed Surplus - Conversion Rights       160,000
  Common Shares                                                       4,277.705  (/ 4,000,000 / 1000 * 80  = $13.36782943/share)

Chapter 18 Income Taxes

• IFRS: Deferred vs. ASPE: Future
• To calculate current taxes: add temporary and permanent differences back to accounting income and then multiply by the tax rate
  • Permanent differences: an accounting deduction not recognized by CRA
  • Temporary differences: accounting and tax recognition is different for certain assets and (liabilities)
• To calculate Deferred/Future Tax Expense (Benefit) create a table (CB, TB, DIFF, TAX DIFF):
  • Multiply each difference between the accounting book value and the tax base/value by the tax rate (sum of tax applicable/deductible in the future if tax rates differ) and sum the values to get the net deferred/future expense (benefit). Liabilities have negative book value for the purposes of this calculation.
  • If the value is positive, we debit D/F Tax Expense against D/F Tax Liability, and if it is negative then we credit D/F Tax Benefit against D/F Tax Asset
  • In the future, a the tax liability is reduced by crediting deferred tax benefit and a tax asset is reduced by debiting deferred tax expense

Capital Cost of Allowance Recap

• Accelerate Investment Incentive (1.5x) applies only to net additions
• UCC_end = UCC_start- CCA RATE * (UCC_0 + NET ADDITIONS * 1.5 [only if net additions > 0])`

Temporary Difference Approach - Deferred/Future Tax Expenses

• In ASPE, use FUTURE, under IFRS use DEFERRED
• If settlement results in higher tax payable, it’s a deferred tax liability (increase taxes in the future)
• if the other way, deferred tax asset (reduce taxes in the future)
• tax base/basis of an asset
  • deductible for tax purposes after carrying amount is recovered

Example

30% tax rate

end of year | Carrying Value | Tax Base | Temporary Difference | Deferred Tax Balance

• carrying value 1000, 900, 800
• deducted: 0, 200, 400
• tax base 1000, 700, 500
• difference 0, 200, 300
• deferred: 0, 200 * 30% = 60, 300 * 30% = 90

Tax Base / Tax Basis of Liability

• tax base = Carrying amount - future tax deductions
• when liability can be settled for its carrying amount without any tax consequences, tax base = carrying amount
• unearned revenue: settlement is via recognition so no tax effect

Example - Deferred Tax Liability

• Company A reported $130,000 revenue in 2023
• $100,000 was taxable revenue in 2023 (collected)
• 20,000 will be collected in 2024, and 10,000 in 2025
• 25% tax rate
• income tax payable is 10,000 in 2023, 11,000 in 2024

2023
Current Income Tax Expense                  10,000
Deferred Income Tax Expense                   7,500
  Cash                                                                  10,000
  Deferred Tax Liability (30,000 * 25%)                 7,500

2024
Deferred Income Tax Liability       5,000
  Deferred tax benefit                             5,000
# deferred tax benefit is because the expense already reduced retained earnings the year before and so an accounting benefit is being used here
Current income tax expense        11,000
  Income tax payable                             11,000

Example - Deferred Tax Asset

• 2 year assurance warranty expense
• estimated 500,000 expense
• actual costs were 300,000 in 2024, 200,000 in 2025
• income tax payable: 600,000 in 2023, 440,000 in 2024
• future tax rate is 25%
• warranty liability
  • 2023: 500,000 recognized vs. 0 actual → 25% * 500,000 = 125,000 asset
  • 2024: 200,000 recognized vs. 0 actual → 25% * 200,000 = 50,000 asset remaining
  • 2025: 0 recognized vs. 0 → 0

2023
Current income tax expense        600,000
  Income tax payable                       600,000
Deferred income tax asset         125,000
  Deferred Income tax benefit              125,000
2024
Deferred Income tax expense       75,000
  Deferred Income tax asset                 75,000
Current income tax expense       440,000
  Income tax payable                       440,000
2025
Deferred Income tax expense        50,000
  Deferred Income tax asset                 50,000

Future Tax Rebates

• use income tax rates that are expected to apply when the tax liabilities are settled or tax assets are realized
• ASPE: tabled bills that the government can pass
• IFRS: announcements are actual enactment
• discounting deferred tax assets and liabilities is not permitted
• the deferred tax liability is calculated using the future expected tax rates for each future taxable amount Example

Tax Loss Carry-forward or Carry-back

• Can carry tax loss back up to 3 years
• Can carry forward for 20 years ahead
• Can be attractive merger candidates as income can be reduced
• We carry back the loss and not the loss * tax rate
  • Suppose loss of 350,000 and that previous 3 years had total losses of 300,000
  • therefore, the carry back is calculated on the previous tax rates but is limited to 50,000

Income tax receivable 82,500     (+A)
  Current tax benefit 82,500     (+SE)  Current benefit from loss carry-back

For a carry forward, suppose the tax loss that can be carried forward is 150,000 and the future rate is 20%.

deferred tax asset        30,000
  deferred tax benefit            30,000
  # Deferred tax benefit from loss carry-forward

In a future year with taxable income, we use deferred tax expense

taxable income = (200,000 - 150,000) = 50,000
taxable = 10,000
deferred = 30,000

Current Tax Expense         10,000
  Income Tax Payable                10,000

Deferred Tax Expense        30,000
  Deferred Tax Asset                30,000

Separate Disclosure

• IFRS requires it
• ASPE: netted

Valuation Allowance

• If unlikely to benefit from loss carryforward,
• ASPE: future tax asset is recognized with an offsetting variance allowance (contra)
• IFRS: not recognized at all

Midterm Tips

• Apply knowledge to exercise questions
  • Exercises in this document, the quizzes, the assignment, group project

Chapter 17 Earnings Per Share

• The main goal of financial accounting is decision-usefulness
• Perspective of common shareholder

Does EPS communicate maintenance capex? Yes, through depreciation expense. Does EPS communicate growth in CAPEX that was useless? Yes, through lower revenues and higher depreciation.

• Paper: current expected credit loss model amplifies stock market reactions to earnings surprises (actual EPS over consensus EPS by sell-side analysts). Amplification = over-reaction.
• Bank are motivated to beat or meet EP targets by under-provisioning:
  • Over-provision (over-expense) when economy is already bad (taking a big bath)
  • Under provision next year (to appear good out there)

If companies are motivated to meet or beat EPS via manipulation, EPS loses relevance and contradicts the accounting framework. Need to update standards or enforce (provincial in Canada, SEC in USA).

Basic EPS

Income available to common shareholders (remove preferred dividends) over the weighted average number of common shares outstanding

• apply stock splits retroactively when calculating weighted average

Diluted EPS

• Considering dilutions due to complex financial instruments at play.
• Add dilutive securities one at a time based on most dilutive to least dilutive (order matters)
• Do not include securities that increase the EPS
  • If options dilute EPS but then convertible bond increases EPS, include only the options dilution

EPS IFRS vs ASPE

• ASPE does not need to report EPS calculations or disclosure
• Three lines for EPS from: continuing operations, discontinued operations, net income
• Need to show basic and diluted for both types

Price Earnings Ratio

• Useful information by relating earnings to the price the shares are trading at
• Allows “easy comparison” with other companies
• Multiplier of per share market value
• If Among similar companies one has a higher P/E, it may be overpriced

Simple vs Complex Capital Structure

• For simple ones without convertibles, just basic EPS
• For complex capital structures, securities that will potentially dilute the EPS, need to be included in the diluted EPS. Do not include anti-dilutive securities.

Income Available to Common Shareholders

• Deduct obligations to non-common shareholders such as current preferred dividends. Do not include arrears as they were included already

Weighted Average Common Shares Example

Start of year: 200,000. July 1st: 225,000. Net income: 315,000.

Basic EPS = 315000 / (200000 * 0.5 + 425000 * 0.5) = 1.008 = 1.01

Restatement of average number of shares is required before a stock dividend or split event (so past results can be normalized).

In-Class EPS Exercise

Shares outstanding Jan 1: 150,000
2-for-1 stock split, Apr 1:     150,000
Shares issued, Jul 1:   20,000
Shares repurchased, Oct 1: -50,000
Shares issued:, Dec 31: 10,000
Ending Balance:           280,000
Net Income: 476,000

3,000 $2 cumulative shares were issued for $300,000. no "dividends" were declared during 2023.

Weighted Average Number of Shares = 300,000 * 0.5 + 320,000 * 3/12 + 270000 * 91/92 + 280000 * 1/365 = 297,500. Ignore last issued since that's not even a single day.

Income to common shareholders: 470,000

Basic EPS = $1.58

Diluted EPS: If-Converted Convertible Bonds Method

Summary: Calculate situational net income by adding back the interest paid for the duration of the bond net of taxes. Calculate the diluted WACS by adding the weighted shares possibly added. So if the bond was issued during the year instead of before the 2nd day of the year, you want to pro-rate the interest expense as well as the shares diluted.

• assume conversion occurs later of the beginning of the year and the issue date
• need to add back the interest net of taxes (1 - T)
• 410,000 net income, 100,000 Weighted Average Common Shares (WACS), 30% tax
• 1 bond convertible 20,000 common shares at 6% of $1,000,000
• 1 bond convertible to 32,000 common shares at 10% of $500,000 on April 1
• Basic EPS: $4.10
• Diluted Earnings:
  • 410000 + 0.06 * 1000000 * 0.7 + 0.1 * 500000 * 9 / 12 * 0.7 = 478,250
• Diluted WACS: 100000 + 20000 + 32000 * 9/12 = 144,000
• Diluted EPS: $3.32

Diluted EPS: If-Converted Preferred Shares

Similar to convertible bonds, add back the preferred dividend to earnings for common shareholders. Dividends paid to preferred share holders are net of taxes. Therefore, there is no tax to account for.

Diluted EPS: Options and Warrants

• Assume options are exercised the later of: the beginning of the year and the issue date
• In the money options: intrinsic value (market and strike price delta is positive for the option)
  • Call: Market Price - Strike Price > 0
  • Put: Strike Price - Market Price > 0
• When the company writes the option,
  • Call: just need to issue shares
  • Put: need to purchase shares

Written Call Options - Treasury Stock Method

Impact of written call options on EPS numbers

1. Options are exercised at the beginning of the year
2. Money is used to buy back shares at the treasury at teh average market price during the year

Treasury shares are a contra equity account which means that the shares were not cancelled.

Suppose the market price is $28 and the strike price is $20 and 5000 call options sold.

Shares to be issued = (5000 - 5000 * 20 / 28) = 1429

Written Put Options - Reverse Treasury Stock Method

Impact of written put options on EPS numbers.

1. Options are exercised at beginning of the year
2. Shares are issued in the market to obtain funds to buy shares for the put option

Suppose 1,500 put options with a strike price of $30 were exercised when the market price was $20.

Shares issued: (1,500 * 30 / 20 - 1500) = 750

Diluted EPS - Comprehensive Example

• net income of $5MM year ended June 30, 2023
• 500,000 common shares outstanding
• average market price of $50
• tax rate of 25%
• written call options to buy 100,000 common shares at $45/share
• 100,000 preferred shares convertible to 150,000 common shares with $10 per share dividends
• 4% convertible bond face value of $30MM issued on par, $1000 convertible to 25 common shares

Chapter 20 - Leases

A lease should be included on the balance sheet to recognize future lease payment obligations

• Is it a lease?
  • IFRS - Contractual: identifiable asset, long-term, not a individual low-value asset
  • ASPE - Classification: meets one of three tests
• The lease liability
  • IFRS - Lease liability; present value using implicit rate or lessor
  • ASPE - Obligation under lease; asset under lease minus initial payments
• The lease asset
  • IFRS - Right-of-use Asset; lease liability plus initial payments
  • ASPE - Asset under lease; Min { PV of minimum lease payments, fair value at lease’s inception }
    • Explanation: the asset value should never be higher than the value at inception

Examples

What is a Lease?

• contractual agreement between lessor and a lessee
  • lessee has a right to use property owned by the lessor
• provisions
  • lease term or duration
  • lease payments (sales, interest rate, price index)
  • taxes, insurance, maintenance on lessee or lessor or shared
  • early termination or non-cancellable
  • default: lessee pays balance or lessor sells asset to third party and recoup shortfall from teh lessee
  • end: return to lease (simple termination), or renewal, or purchase at nominal price, or bargaining purchase option (lessee benefits)

Advantages

• 100% financing at fixed rates with no money down and fixed payments
• no obsolescent risk

Conceptual Nature of Leases

Perspectives:

1. Executory: both parties need to perform; no capitalization
2. [ASPE] Classification approach: economic substance; instalment purchases are capitalized so lease with similar characteristics should be
   • capitalize leases similar to otherwise instalment purchases
   • substantially all benefits and risks are transferred to the lessee?
3. [IFRS] Contract-based approach: asset is not a physical property but a right-to-use; liability is to make lease payments (rental payment minus expenses paid by lessor)
   • capitalize all leases except for short-term and low-value leases

ASPE allows many operating leases but IFRS has limits.

GAAP Lease Treatments

• ASPE: classification approach
  • Similar to instalment purchases
  • All benefits and risks is transferred
  • Other leases should be reported as expense and not on balance sheet
  • Meets one of three tests:
    1. transfer of ownership; is there assurance that the lessee will take ownership at the end of term
    2. economic life tests; leasing for 75% of the asset’s economic life
    3. recovery of investment by lessor; present value of the lease is 90% or more of the asset’s market price
• IFRS: contract-based approach
  • identified asset for a period of time
  • service component excluded from lease accounting
  • not short-term nor low-value (allow portfolio of similar low-value assets)

Example: Is it a lease for IFRS?

Airport operator, use of space for three years. The supplier has the right to change the location at any time. Minimal cost to customer who owns the kiosk used to sell the goods. Many areas would fit the need.

Since the space can change, it cannot be identified and so there is no lease.

Low-Value Leases and Lease Portfolios (IFRS)

• not real estate
• not manufacturing equipment
• cars for sales and management become a portfolio but are not low value
• IT equipment are low-value
• Servers with many individual modules are large values
• Office equipment and furniture are low value

Lease Payment Required for a Rate of Return

The fair value of an asset is the present value. We need to determine the annuity payment such that the factor times the payment equals the fair value minus any present value of the term-end option payment.

• Variables
  • Lessee’s credit standing
  • Length of the lease
  • Status of residual value (guaranteed or non-guaranteed)
  • Income tax effects
• Initial costs added to investment ot be recovered (similar to initial capex in a DCF)
• Deduct: PV of the purchase option and PV of the residual value

Example

We want a 10% return on $100,000 investment in an asset that is to be lease for 5 years. Annual rent is due in advance each year (annuity due). No purchase option, bargain purchase option, or residual value.

Option one (Exam)

Look up the factor in the annuity due table for a rate of 10% with a maturity of 5 years. Divide the present value by this factor to get the annual payment.

Option Two (In-practice)

PV = 100,000 = x + x/(1+0.1) + x/(1+0.1)^2
100000 = x(1 + 1/...) = (1 + (1 - (1 + r)^-(n - 1)/r))
100000 = x * 4.1699
x = $23,982

PV of Lease Payments Calculation

• Minimum rental payments
• Amounts guaranteed: maximum amount required by lessor to pay at the end of the lease
• Bargain purchase option (BPO): pay significant lower amount at the end of lease
• Need to subtract executory costs by the lessor

1. Implicit rate: PV of minimum lease payments plus un-guaranteed residual value = Fair value of underlying
2. Lessee’s incremental borrowing rate (equivalent funds were borrowed for a similar term and similar security)

• ASPE: minimum of the two rates (ensure that the lessee does not get a lower PV)
• IFRS: use implicit rate of lessor

Right-of-use assets under IFRS

The initial value of the right-of-use asset is the PV of the payments plus the PV of the residual value or purchase option discounted at the lessor-implicit rate

1-Sep | contract initiated with first payment
Right-of-use Asset        23,769
  Lease Liability                18,769
  Cash                           5,000

31-Dec  | 4 months depreciation
Depreciation Expense       1,320
  Accumulated-Dep ROU Asset      1,320

31-Dec | 4 months interest
Interest Expense    1,667
  Interest Payable        1,667

Lease Liability Example

Example

It’s January 1st, rental payments of 25,981.62, no options at the end of the term, fair value of $100,000 and lasts for 5 years without residual value. Straight-line depreciation methods. Lessee pays executory costs except for $2,000 baked into the payment. Borrow rate is 11% however Lessor uses 10% which is known to Lessee.

• Discount rate: for IFRS it is 10%, under ASPE it is MIN(10%, 11%)
• Guaranteed amount is 0
• Lease payment is 25,981.62 - 2,000 = 23,981.62

PV works out to 100,000 using a financial calculator or the annuity due table.

Therefore, amount to be capitalized is $100,000 and initial liability is 100,000 - 23,981.62 = 76,018.

# Jan 1 2023 IFRS
Right-of-Use Asset    100,000
  Lease Liability             76,018
  Cash                        23,982
# Jan 1 2023 ASPE
Equipment under lease 100,000
  Obligations under lease    76,018
  Cash                                23,982

Maintenance Expense      DR 2,000
  Cash                                CR 2,000

# lease payment
Maintenance Expense DR 2,000
Lease Liability or Obligations under lease  DR 23,982
  Cash                  CR 25,982
# returned to lessor
Acc. Dep 100,000
  Right of use Asset or Equipment under lease     100,000
# purchase ownership
Right of use Asset or Equipment under lease     DR 105,000
  Acc. Dep CR 100,000
  Cash CR 5,000

For the interest expense adjustment entry, don’t credit payable but rather the obligations or the liability.

9yr useful life
7 year term
4,300,000
8% incremental borrowing rate vs. 6% implicit
100,000 end payment

Annuity due
The lease payment is PMT(6%, 9, 4300000 - 100000/1.06^7, 0, 1) = -$715,441
The PV of the lease payments is 4,240,810 and PV of the lease is 4,300,000
This is a right-of-use lease that should be capitalized since it is not short-term or low-value. There is an identifiable asset.

Right-of-use Asset Dr. 4,300,000
  Lease liability         Cr. 3,584,559.36
  Cash                      Cr. 715,441

Interest expense 215,074 (6% of lease liability)
  Lease liability 215,074
Depreciation expense              Dr. 477778
  Accumulated depreciation          Cr. 477778

Lease Inducements

If there is no lease inducements ($100 paid every Jan 1)

# Jan 1st
Dr. Prepaid rent   $100
  Cr. Cash                      $100
# Dec 31
Dr. Low-value lease expense (IFRS) or rent expense (ASPE) $100
  Cr. Prepaid rent                                $100

With inducement (last 2 months free), figure out total rent ($300 * 22 = 6,600). Monthly rent expense = 6600/24 = 275.

# at every monthly payment date
Dr. Prepaid rent expense     $25
Dr. Low-value lease expense (IFRS) or rent expense (ASPE) \
                             $275
  Cr. Cash                            $300
# last two months
Dr. Low-value lease expense (IFRS) or rent expense (ASPE) $275
  Cr. Prepaid rent expense $275

Lessor Accounting

Three types of companies: manufacturer (e.g. automobile), independent finance (e.g. private debt), traditional financial institutions (banks)

# start of lease / first payment
Dr. lease receivable (gross investment = total non-discounted rental receivables less executory costs)
  Cr. {Asset Name} acquired for lease
  Cr. Unearned interest income (total interest on the asset)
# year-end interest accrual
Dr. Unearned interest income (net investment * implicit rate)
  Cr. Interest income
# lease payment received
Dr. Cash
  Cr. Lease Receivable (payment - executory)
  Cr. Maintenance and Repairs Expense (executory)

How to solve problems

• Use Annuity due table to get the PV of the monthly payments received.
  • This will be the asset acquired for the lease
• The initial unearned interest is the difference between total cash receivable and the present value
• The present value net of the first payment is what the accrual interest applies
• Cash payment go towards lease receivable and executory costs
• For residual values, increase the lease receivable and include it when calculating the PV

# sign contract
Dr. Lease receivable 119,908
  Cr. Equipment Acquired for Lessee     100,000
  Cr. Unearned Interest Income            19,908
# first payment
Cash 25,982
  Lease Receivable      23,982
  Maintenance and Repairs Expense   2,000
# interest accrual at year end
Unearned interest income Dr. 7,602 ((100,000 - 23981.62) * 10%)
  Interest Income                 Cr. 7,602
# second payment
Cash 25,982
  Lease Receivable 23,982
  Maintenance and Repairs Expense 2,000
# end of year 2
Unearned Interest Income Dr. 5,964
  Interest Income Cr. 5,964

Lease Comprehensive Example

Two years, end of year payments. $13,000 option to purchase at end of term. Fair value of $135,000. Residual value of $13,000. Lessee pays $5,000 per year in insurance costs. 10% rate of return by the lessor.

• Lease payment = (135,000 - 13,000 / 1.1^2) / (Annuity [Due] Factor) = 71595
• Lease receivable: the fair value plus the residual value
• Lessor:
  • Need to expense executory costs
  • Interest income is the interest on the net investment
  • Unearned interest income once lease has been initiated
• Right-of-use asset
  • PV of the lease payment plus PV of the exercise price = 135,000

Chapter 19 - Pensions and Post Employment Benefits

• post-employment benefits (IFRS)
• Employee Future Benefits (ASPE)

Quick Guide

• Past Service Costs
  • Interest applies on the days it has been an item (the current year end date minus any amendment date; usually 1 years worth of interest)
• Contributions
  • Increases the plan’s assets
  • If made during the year, lowers the net interest expense by the pro-rated amount (July 1st = half the interest gained)
• Remeasurement Losses/Gains and Actuarial Losses/Gains
  • ASPE: this difference will impact the Defined Benefit Expense
  • IFRS: this difference will only impact OCI and not Defined Benefit Expense

Defined Benefit Plan

• fixed payout regardless of plan’s performance
• therefore, employer assumes risk of the plan’s shortfall

Changes in Defined Benefit Obligation

• Current services cost
  • DBO increases
  • Present value of future contributions required due to employee’s services in the current period
• Past service costs
  • DBO addition or reduction based on info (amendments)
• Interest cost
  • Increase the DBO for the interest cost of the beginning DBO balance and the past service amendments active during the year (pro-rated)
• Payments to retirees
  • Subtract the DBO
• Remeasurement gains and losses
  • Return on plan’s assets differs from projected return
  • IFRS: OCI
• Actuarial gains and losses
  • assumptions that have changed
  • IFRS: OCI assumption

Plan Assets

• Increase the plan assets
  • Contributions from employer
    • contributory: employee contributions reduce defined benefit expense
  • Actual earnings on assets
• Decrease
  • Payments to retirees

DBO Versus Plan Assets

• Measured at the date of the annual financial statements
• DBO > Plan Asset: Net Defined Benefit Liability (underfunded plan)
• DBO < Plan Assets: Net Defined Benefit Asset (overfunded plan)

Pension Accounting Worksheet (Template)

Other Defined Benefit Plans that Vest or Accumulate

• health care, life insurance, long-term disability, dental and eye care, legal and tax services, tuition assistance, free or subsidized travel

Other Defined Benefit Plans that do not Accumulate

• no attempt to accrue the benefit, costs, or liabilities
• recognize as event occurs

Presentation of Benefits

• SFP
  • If there is one or more defined benefit plans, show separately
  • can only be combined if all result in defined benefit liability or defined benefit asset
  • no guidance
• Income Statement (no guidance)
  • 1. total as a single benefit cost (most companies do this)
  • 2. Report as separate components
  • 3. part of similar expenses

Pension Disclosures

• ASPE
  • dates of actuarial valuations, difference between surpluses/deficits of balance sheet and plan, fair values, Description, major changes,
• IFRS
  • In addition to ASPE, characteristics and risks, details on amount included in net income, plan’s effect on future cash flow,

Changing the Accounting Policy

• Accounting policy: Switching from FIFO to weighted average
  • specific principles, practices, and application
  • change is required by a primary source of GAAP
  • voluntary change that results in a more reliable presentation
• Accounting estimate: Depreciation estimate change
  • adjustment to the carrying value due to change in assumption
• Correction of a prior period error(s)
  • Omissions or misstatements

Retrospective Restatement

ASPE allows only full restatement whereas IFRS allows partial restatement

1. Figure out the years affected and which balances need to be adjusted.
   • 2021 → restate ending balances. Provide net income statement impact.
   • 2022 → restate ending balances. Provide net income statement impact.
   • 203 (open) → restate beginning balances and continue accounting to close the books
2. Accounts

Retrospective Restatement Example 1

20,000 depreciation not recorded for the previous (2022) year where books have been closed. Assume unadjusted earnings was 350,000.

• 2022 ending balance / 2023 beginning balance needs to be adjusted
• accounts affects: accumulated depreciation - building via depreciation expense, retained earnings, future/deferred taxes
  • since the carrying value of the building is restated to be lower, the future deferred taxes has to be reduced as well due to a lower temporary difference
  • concept: if income before taxes is lower, then so is the deferred tax expense and thus the future tax liability is also lower (debit)

Dr. Future Tax Liability 6,000
Dr. Retained Earnings 14,000
  Cr. Accumulated Depreciation 20,000

Chapter 22 - Cash Flow

Chapter 23 - Other Measurement and Disclosure Issues

• Misleading disclosure
• Selective disclosure
• Untimely disclosure
• Insider trading
• SEDAR+: disclosures for Canadian capital markets

Full Disclosure Principle

• report all financial facts that are significant enough to influence the judgement of an informed reader
• too much information results in unreadable statements
• proprietary cost: cost associated with competitors using disclosure against the company
• labour cost of accounting
• ESG is mandatory starting 2024

Segmented Reporting

• Rogers Communications Inc. operates in wireless, cable, and media business
• Motivation: demand by investors
• Operating segment
  • must meet:
    • engages in business activities which it earns revenues and incurs expenses
    • its results are regularly reviewed by the company’s chief operating decision-maker
    • discrete financial information available on it
  • reportable (at least one of these tests):
    • revenue is 10% or more of the combined revenue
    • P&L test: absolute profit or loss is 10%+ of the greater of the combined profit of profitable segments and the combined loss of unprofitable segments
    • asset test: 10% or more of combined assets
    • extra factors:
      • must explain significant portion of the company’s business
      • 10 segments may be practical limits
      • management can override tests if they believe the information would useful

Centrally Incurred Costs

• costs that are interrelated in nature such as the president’s salary
• remove centrally incurred costs from each reportable segment
• disclose revenues from external customers and inter-segment transactions separately

Segmented Reporting Example

1. Revenue test: 10% * 790,000 = 79,000. Segments B and C meet this
2. Profit test: 129,000. Loss test: 10,000. Only C is greater than 12,900.
3. Asset test: 10% * 710,000 = 71,000. Only C meets this.
4. Unaffiliated sales: (B + C revenues) / (790,000 total) = 83.5%

Interim Reporting

• periods of less than one year
• discrete view: treat as a separate accounting period
• integral view: deferrals and accruals should consider what will happen for the entire year

Related Party Transactions

• When two businesses engage in transactions with another party that can significantly influence its policies
• e.g. common owner, individuals/family members
• transactions cannot be presumed to be an arm’s length transactions because there may not be a competitive free-market dealing
• IFRS: RPT is a required disclosure
• ASPE: economic substance - remeasurement

Remeasurements under ASPE to carrying value

• booked as a charge or credit to equity.