1. Which of the following items is most likely to appear on a company's balance sheet?

A. Weighted average coupon rate for long-term debt

B. Specific details for leases treated as finance leases

 C. Separate carrying values for short- and long-term debt

Explanation

Presentation of liabilities

Shown on balance sheet Shown on footnotes

Details on each bond issue (ie, maturity, stated

Total carrying value of noncurrent
rate, effective rate) and finance leases
debt
Required payments for the next five years
Total carrying value of current debt
(including leases)
(ie, due within 12 months)
Collateral pledged
Total carrying value of leases
Lines of credit and other contingent financing
payable for finance leases
sources

A company normally presents a single line on its balance sheet for the total carrying value of its long-term debt and includes a similar line under
current liabilities for its short-term debt. The footnotes to the financial statements contain (for each liability) details such as maturity, coupon rate,
and effective interest rate (Choice A). The footnotes also provide detailed information on leases that the company treats as finance leases
(Choice B).

CFA Institute curriculum does not address whether IFRS or US GAAP specify mandatory disclosures for noncurrent liabilities. Instead, it presents
a general "best practices" guide to what analysts can expect to see in a company's financial statements concerning those liabilities.

Things to remember:
Companies normally present minimal information concerning their noncurrent liabilities on their balance sheets; in general, there is one line each
for long- and short-term debt. Detailed information regarding a company's liabilities is contained in the footnotes to its financial statements.

Describe the financial statement presentation of and disclosures relating to long-term liabilities and share-based compensation
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2. Which of the following is most likely a reason for a company to lease, rather than purchase, an asset? The company does not have to:

A. report a lease liability on the balance sheet.

B. report a leased asset on the balance sheet.

 C. risk disposing of the asset at a below-market residual value.

Explanation

Leasing an asset gives the lessee the right to use the asset for a fixed time in exchange for periodic payments to the lessor (ie, owner of the
asset). There are several motivations for a company to lease an asset instead or purchasing it.

Less costly upfront: Leasing, unlike buying, typically does not require an up-front down payment.
Looser restrictions: Leasing an asset circumvents the need to finance an expensive purchase with borrowed funds, which typically include
strict covenants.
Less asset disposal risk: The lessee does not have to worry about disposing of the assets at below-market salvage (ie, residual) values.

Accounting rules require lessees to record the fair value of a lease as an asset and liability at the inception of the lease (Choices A and B).

Things to remember:
Motivations for leasing instead of purchasing an asset include less up-front costs, more flexible terms, and reduced exposure to a decline in the
leased asset's value.

Explain the financial reporting of leases from the perspectives of lessors and lessees
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3. Under IFRS, at the inception of a lease, a lessee would most appropriately record a(n):

A. expense equal to the average periodic lease payment.

 B. long-term asset equal to the present value of lease payments.

C. long-term liability equal to the total amount of future lease payments.

Explanation

Financial statement impact to the lessee

Governing standard Balance sheet Income statement Cash flow statement

Reduction of lease liability: CFF

IFRS: all leases Asset Depreciation Interest payments:
US GAAP: finance lease Liability Interest IFRS: CFF or CFO
US GAAP: CFO

Asset
US GAAP: operating lease Single expense item Entire lease payment: CFO
Liability

In a lease contract, the lessee makes periodic payments to the lessor for the right to use an asset for a specified period. Under IFRS, all leases
are treated like asset purchases financed with borrowed funds (similar to the treatment of finance leases under US GAAP). At inception, the
lessee records on its balance sheet a long-term asset and liability equal to the present value of the future lease payments (Choice C). The
lessee depreciates the asset during the term of the lease.

The periodic lease payments are apportioned toward interest payments and liability reduction each period. In this respect, a lease is conceptually
very similar to amortizing a long-term loan.

(Choice A) Under US GAAP, the amount of the average periodic lease payment in an operating lease is recorded as an expense each period on
the income statement. Operating leases are treated like rental agreements.

Things to remember:
Under IFRS, all leases are treated like asset purchases financed with borrowed funds. At inception, the lessee records a long-term asset and
liability equal to the present value of the future lease payments. The asset is depreciated periodically throughout the term of the lease, and
periodic lease payments are apportioned toward interest payments and liability reduction each period.

Explain the financial reporting of leases from the perspectives of lessors and lessees
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4. A company maintains a defined benefit plan for its employees. It recently determined that its employees' life expectancy has increased, which
will increase the company's pension liability. The amount of the increased liability can only be estimated. Under US GAAP, the company most
appropriately reports the increased liability on its financial statements:

A. in the footnotes only, since it cannot determine the amount of increase.

 B. as part of other comprehensive income and amortizes the increase over time.

C. as part of other comprehensive income but does not amortize the increase over time.

Explanation

Treatment of defined benefit (DB) plan items for IFRS and US GAAP

IFRS US GAAP

Increase in service costs

Increase in service costs
Pension liability – interest
Income statement Pension liability – interest expense
expense
Pension surplus – interest income
Expected return on plan assets

Actuarial gains/losses (not amortized over time) Actuarial gains/losses (amortized

Other comprehensive
Difference between actual return on plan assets and return over time)
income (OCI)
included in net income Past service costs

Determining the amount of a company's future defined benefit (DB) plan obligation involves making estimates based on actuarial assumptions for
cost variables such as life expectancy during retirement. Changes to these assumptions cause the company to increase or decrease its future
obligation. These changes translate into gains or losses in the period when the change occurs.

IFRS and US GAAP both require the company to recognize the gain or loss in other comprehensive income (OCI), but they differ in how the
company treats the OCI item in subsequent years. US GAAP require the company to amortize the gain or loss ratably over time. The effect of
amortization is that reported pension expense is more consistent from year to year. IFRS do not permit this "smoothing" technique.

(Choice A) Estimates of pension liability based on variables such as life expectancy are examples of actuarial assumptions. Both IFRS and US
GAAP permit use of actuarial assumptions to determine the amount of pension expense that companies can recognize.

(Choice C) IFRS do not permit amortization of pension items included in OCI. Those items remain in OCI until the company recognizes the gain
or loss. This typically causes a company reporting under IFRS to show more variability in year-to-year pension expense.

Things to remember:
Companies use actuarial assumptions to calculate pension expense and liabilities. IFRS and US GAAP differ in how they require companies to
treat changes in pension liability due to actuarial gains and losses. For items included in OCI, US GAAP require companies to amortize the gains
and losses ratably to "smooth" pension expense each year, while IFRS prohibit such amortization.

Explain the financial reporting of defined contribution, defined benefit, and stock-based compensation plans
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5. The impact on a lessor's financial statements in the first year of a lease that was newly classified as a sales-type lease rather than a direct-
financing lease is most likely higher:

A. leverage.

 B. return on equity.

C. depreciation expense.

Explanation

A finance lease removes the leased asset from the lessor's balance sheet and treats the lessee as the owner. This means that the lessee, not
the lessor, depreciates the asset; therefore, the lessor's depreciation expense decreases rather than increases (Choice C).

A finance lease also assumes that the lessee "purchased" the asset with funds borrowed from the lessor. The purchase "price" is the present
value of the lease payments. For the lessor, this creates an asset (eg, lease receivable) that replaces the leased item; therefore, the lessor's total
assets are unchanged. Leverage is defined as assets divided by owners' equity, and since the numerator does not increase, leverage does not
increase (Choice A).

US GAAP (but not IFRS) further classify a finance lease as either a direct-finance or a sales-type lease. When the present value of all lease
payments equals the asset's carrying value at the beginning of the lease, the lease is a direct-finance lease. When the payments' present value
exceeds the lessor's carrying value at commencement, the lease is a sales-type lease.

With a sales-type lease, the lessor recognizes the difference between the present value and carrying value as a gain in the first year of the
lease. This gain increases the lessor's net income. Return on equity (ROE) equals net income divided by owners' equity, so ROE is higher with a
sales-type lease than with a direct-finance lease.

Things to remember:
US GAAP classify a finance lease as either a direct-finance or sales-type lease. A sales-type lease requires the lessor to recognize as gain the
difference between the present value of the lease payments and the leased asset's carrying value. This gain increases the lessor's net income, as
well as ratios in which net income is the numerator.

Explain the financial reporting of leases from the perspectives of lessors and lessees
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6. IFRS most likely permit lessees to report the:

A. entire lease payment as a cash outflow under operating activities.

B. reduction of lease liabilities as a cash outflow under investing activities.

 C. interest portion of the lease payment as cash outflow under financing activities.

Explanation

Financial statement impact to the lessee

Governing standard Balance sheet Income statement Cash flow statement

Reduction of lease liability: CFF

IFRS: all leases Asset Depreciation Interest payments:
US GAAP: finance lease Liability Interest IFRS: CFF or CFO
US GAAP: CFO

Asset
US GAAP: operating lease Single expense item Entire lease payment: CFO
Liability

In a lease contract, the lessee makes periodic payments to the lessor for the right to use an asset for a specified amount of time. Under IFRS, all
leases are treated like asset purchases financed with borrowed funds. At inception, the lessee records a right-of-use asset and a lease liability
equal to the present value of the future lease payments.

After inception, periodic payments are separated into two categories:

A portion is applied toward reducing the lease liability principal and is recorded as a cash outflow under financing activities.

The rest of the monthly payment counts as interest and is recorded as a cash outflow under financing activities or operating activities.

Note that the interest portion of the lease payments is classified under financing or operating activities under IFRS but is strictly classified as
operating activities under US GAAP.

(Choice A) Under IFRS, the principal portion of the lease payment cannot be classified as an operating activity.

(Choice B) Under IFRS, the reduction of the lease liability is treated as a cash outflow from financing, not investing.

Things to remember:
Under IFRS, the principal portion of the periodic lease payment is classified as a cash outflow under financing activities. The interest portion of
periodic lease payments can be classified as a financing activity or operating activity. In contrast, US GAAP strictly classified the interest portion
as an operating activity.

Explain the financial reporting of leases from the perspectives of lessors and lessees
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7. A company reporting under US GAAP leases a factory building under a long-term operating lease contract. On the income statement, the
ongoing expenses pertaining to the lease should most appropriately be reported:

 A. in equal amounts each period, under a single line item.

B. in different amounts each period, under a single line item.

C. in different amounts each period, under depreciation expense and interest expense.

Explanation

Financial statement impact to the lessee

Governing standard Balance sheet Income statement Cash flow statement

Reduction of lease liability: CFF

IFRS: all leases Asset Depreciation Interest payments:
US GAAP: finance lease Liability Interest IFRS: CFF or CFO
US GAAP: CFO

Asset
US GAAP: operating lease Single expense item Entire lease payment: CFO
Liability

In a lease contract, the lessee makes periodic payments to the lessor for the right to use an asset for a specified amount of time. Under US
GAAP, long-term leases can be classified as finance or operating.

Operating leases are treated like a rental agreement. Each period, the lessee records on the income statement a single expense, which is
equal to the average periodic lease payment. For example, if a 10-year operating lease's total contractual amount is CAD 120 million, then the
monthly income statement expense will be CAD 1 million (or CAD 120 million / 120 months), regardless of the actual lease payments each month
(Choice B).

Finance leases are treated liked an asset purchase financed with borrowed funds. Each period, the lessee records on the income statement the
depreciation expense from the leased asset and the interest expense from the "debt."

(Choice C) In a finance lease, not an operating lease, the expense can be separated into depreciation expense and interest expense on the
income statement. Furthermore, interest expense is different each period.

Things to remember:
Finance leases are treated like an asset purchase financed with borrowed funds. Each period, the lessee records depreciation expense from the
leased asset and interest expense from the "debt" on the income statement. Operating leases are treated like a rental agreement. Each period,
the lessee records on the income statement a single expense, which is equal to the average periodic lease payment.

Explain the financial reporting of leases from the perspectives of lessors and lessees
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8. A manufacturing company maintains a defined benefit plan for its employees who are directly involved in the manufacturing process. The
company most appropriately recognizes contributions made for those employees:

A. immediately as a separate operating expense.

B. as a separate operating expense only when the employees retire.

 C. as cost of goods sold when it sells goods that those employees made.

Explanation

Defined contribution plans (DC) Defined benefit plans (DB)

No future benefit guaranteed Employer promises future benefits

Employee bears responsibility for performance Employer bears responsibility for performance
Financial impact limited to expensing contributions made to Performance of plan assets can significantly impact
participants' accounts financial reporting
Accounting is straightforward and simple Accounting is complicated
No significant differences between US GAAP and IFRS Significant differences between US GAAP and IFRS

A defined benefit (DB) plan is a pension plan that guarantees employees income when they retire. The benefit for each employee is formula-
driven and can be based on several variables, including years of service and average compensation. To provide this benefit, employers contribute
an amount each year into one separate investment account that is maintained for the benefit of all employees.

DB plan contributions are deductible expenses, but IFRS and US GAAP treat pension contributions as a type of wage expense. Wage expenses
for employees in a direct production capacity, such as this company's manufacturing employees, are included as a cost of inventory.
Inventory costs are not expensed immediately. Instead, they are included in cost of goods sold (COGS) when the company sells the inventory.

(Choice A) Contributions to a DB plan are deductible when made. The company does not wait until the employee begins receiving pension
benefits to deduct prior contributions.

(Choice B) For a manufacturing company, pension contributions are included as wage expenses. Wage expenses for manufacturing employees
are included as part of inventory and expensed as COGS. Wage expenses for nonmanufacturing employees are part of selling, general and
administrative expenses. The company's footnotes to its financial statements provide more detail on the different components of wage expenses.

Things to remember:
For a manufacturing company, contributions to a defined benefit plan are usually deductible when made. However, they do not appear as a
separate expense; instead, they are a component of wage expenses. Both IFRS and US GAAP provide that wage expenses for manufacturing
employees are included in inventory costs and are recognized as cost of goods sold.

Explain the financial reporting of defined contribution, defined benefit, and stock-based compensation plans
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9. Under US GAAP, a lessee reports periodic payments for the second year of a finance lease. Compared to using an operating lease, the lessee
will most likely report:

 A. less cash flow from financing activities.

B. less cash flow from operating activities.

C. more cash flow from investing activities.

Explanation

Long-term leases under US GAAP: lessee's perspective

Type Balance sheet Income statement Cash flow statement

Reduction of lease liability:

Asset Depreciation
Finance lease ↓ CFF
Liability Interest
Interest payments: ↓ CFO

Asset
Operating lease Single expense Entire lease payment: ↓ CFO
Liability

In a long-term lease contract, the lessee makes periodic payments to the lessor for the right to use an asset (ie, right of use [ROU]) for a specified
period. Under US GAAP, long-term leases can be classified as finance or operating.

Finance leases are treated like asset purchases financed with borrowed funds (from the lessor). At inception, the lessee simultaneously records
an ROU asset and a lease liability, both equal to the present value of the future lease payments. After inception, a portion of each periodic
payment is applied toward reducing the liability (ie, principal reduction), which reduces cash from financing activities. Therefore, cash flow
from financing (CFF) is less under a finance lease. The rest of the monthly payment counts as interest and reduces cash from operating
activities (CFO).

Operating leases are treated like rental agreements. In each period, the entire periodic payment is treated like rent expense and reduces cash
from operating activities on the cash flow statement. Therefore, CFO under an operating lease is less than CFO under a finance lease (Choice
B).

(Choice C) After inception, periodic payments do not affect cash flows from investing activities regardless of lease type.

Things to remember:
Under US GAAP, a finance lease results in more cash from operating activities and less cash from financing activities compared to an operating
lease. Under a finance lease, the portion of the periodic payment that reduces the lease liability is considered a cash outflow from financing
activities; the portion applied toward the interest payment is considered a cash outflow from operating activities.

Explain the financial reporting of leases from the perspectives of lessors and lessees
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10. A company issued coupon-paying bonds with a face value of £5 million. It used the proceeds to purchase one of its suppliers. The company
uses IFRS for financial reporting. In its statement of cash flows, it can report its coupon payments on the bonds as:

A. cash from financing (CFF) or cash from investing (CFI).

B. cash from investing (CFI) or cash from operations (CFO).

 C. cash from financing (CFF) or cash from operations (CFO).

Explanation

Cash flows consist of both outflows and inflows. From an issuer's (ie, borrower's) perspective, the proceeds from issuing a bond are a cash inflow,
whereas interest and principal payments on the bond are outflows. Both GAAP and IFRS classify receipt and payment of bond principal as cash
from financing (CFF). US GAAP classify all interest payments (ie, outflows) as cash from operations (CFO), but IFRS permit companies to
classify those payments as either CFO or CFF.

Owning another company's bonds is an investment. Interest received on those bonds is directly linked to that investment, so IFRS allow interest
received to be classified as cash from investing (CFI). However, this does not apply to interest paid on debt, even if the borrower uses the
proceeds from the bond for an investment, as in this case. Interest paid is either CFO or CFF, but never CFI, so (Choices A and B) are incorrect.

Things to remember:
US GAAP classify all interest payments as CFO, regardless of how the borrower used the proceeds of the debt on which it paid the interest. IFRS
permit companies to classify interest payments as either CFO or CFF, but not as CFI.

Describe the financial statement presentation of and disclosures relating to long-term liabilities and share-based compensation
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11. A company has a defined contribution pension plan and reports under IFRS. Which of the following items relating to the plan's participant
accounts are most likely to be disclosed on the company's income statement?

A. Gains or losses on plan investments

 B. Company contributions made to participants' accounts

C. Interest and dividends earned and paid on plan investments

Explanation

Defined contribution plans (DC) Defined benefit plans (DB)

No future benefit guaranteed Employer promises future benefits

Employee bears responsibility for performance Employer bears responsibility for performance
Financial impact limited to expensing contributions made to Performance of plan assets can significantly impact
participants' accounts financial reporting
Accounting is straightforward and simple Accounting is complicated
No significant differences between US GAAP and IFRS Significant differences between US GAAP and IFRS

A defined contribution (DC) plan is a type of employee retirement plan. Unlike a defined benefit (DB) plan, a DC plan does not guarantee the
employee any benefit at retirement. Instead, the employer establishes the plan and selects diverse investments that participants (ie, employees)
can invest in, allocating their account balance based on their individual risk and return preferences.

The funding in a DC plan can be contributions from the employer, the participant's own contributions (ie, salary deferrals), or a combination of
these. In all cases, the participant, not the employer, is responsible for the account's performance. All investment gains or losses, as well as
dividend or interest income generated by those investments, benefit the participant, not the employer (Choices A and C).

An employer receives a tax deduction for any contributions that it makes to participants' accounts. Deductibility applies whether the contributions
are contractually required (eg, collective bargaining agreements) or voluntary (eg, profit-sharing plans).

Things to remember:
A defined contribution plan imposes no responsibility on the employer for investment performance. Employers do not share in participant
accounts' gains or losses. The only financial impact on employers is the tax deduction for any contributions that it makes to participant accounts.

Explain the financial reporting of defined contribution, defined benefit, and stock-based compensation plans
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12. After entering a finance lease agreement, the lessor most appropriately records periodic:

A. lease income.

 B. interest revenue.

C. depreciation expense.

Explanation

Financial statement impact on the lessor

Balance sheet Income statement Cash flow statement

Remove leased asset Record interest revenue Lease payments received: CFO
Finance lease Recognize lease receivable
Record gain or loss

Retains leased asset Record lease income Lease payments received: CFO
Operating lease
Record depreciation

CFO = cash flow from operating activities, CFI = cash flow from financing activities

In a lease contract, the lessor grants the lessee the right to use an asset over a specific period of time in exchange for scheduled regular
payments. For accounting purposes, most leases are classified as finance leases, although some exceptions (eg, airport terminals) are treated as
operating leases.

From a lessor's perspective, a finance lease is economically equivalent to financing an asset sale to the lessee (customer). At inception of the
lease, the lessor removes the leased asset from its balance sheet and simultaneously records a receivable. Subsequently, the lessor reports
interest revenue earned from the financing provided to the customer.

In contrast, operating leases are treated like rental agreements. The lessor retains the asset at inception and subsequently records rental (ie,
lease) income and depreciation (Choices A and C).

Things to remember:
From a lessor's perspective, a finance lease is economically equivalent to financing an asset sale to the lessee. At inception of the lease, the
lessor removes the leased asset from its balance sheet and simultaneously records a receivable. Subsequently, the lessor reports interest
revenue earned from the financing provided to the customer.

Explain the financial reporting of leases from the perspectives of lessors and lessees
LOS

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