Chapter 03
Chapter 03
Chapter 03
Activities
3
CHAPTER
Obligations whose
settlement requires use of Obligations not
current assets or the payable within one
incurrence of another year or the operating
current liability within one cycle, whichever is
year or the operating longer.
cycle, whichever is
longer.
Liabilities
Alternative Classification
Obligations
Obligationsthat
thatarise
arisefrom
from
Operating
Operating operating
operatingactivities--examples
activities--examples
Liabilities are
areaccounts
accountspayable,
payable,unearned
unearned
Liabilities revenue,
revenue,advance
advancepayments,
payments,
taxes
taxespayable,
payable,postretirement
postretirement
liabilities,
liabilities,and
andother
otheraccruals
accrualsof
of
operating
operatingexpenses
expenses
Obligations
Obligationsthat
thatarise
arisefrom
from
financing
financingactivities--examples
activities--examples
Financing
Financing are
areshort-
short-and
andlong-term
long-termdebt,
debt,
bonds,
bonds,notes,
notes,leases,
leases,and
andthe
Liabilities
Liabilities the
current
currentportion
portionofoflong-term
long-termdebt
debt
Liabilities
Important Features in Analyzing Liabilities
Lease Disclosure
Lessee must disclose: (1) future MLPs separately for capital
leases and operating leases — for each of five succeeding
years and the total amount thereafter, and (2) rental expense
for each period an income statement is reported
Off-Balance-Sheet Financing
Off-Balance-Sheet financing is when a lessee structures a
lease so it is accounted for as an operating lease when the
economic characteristics of the lease are more in line with a
capital lease—neither the leased asset nor its corresponding
liability are recorded on the balance sheet
Leases
Frequency of Capital and Operating Leases
Leases
Accounting for Leases – An Illustration
Lease Facts
• A company leases an asset on January 1,
2000 -- it has no other assets or liabilities
• Estimated economic life of leased asset
is 5 years with no salvage value -- company will
depreciate the asset on a straight-line basis over its life
• Lease has a fixed non-cancelable term of 5 years
with annual MLPs of $2,505 paid at the end of each year
• Interest rate on the lease is 8% per year
Leases
Accounting for Leases – Illustration (continued)
Straight-line depreciation
$2,000 per year ([$10,000 - $0]/5 years)
Leases
Accounting for Leases – Illustration (continued)
Income Statement Effects of Alternative Lease Accounting
Operating
Lease Capital Lease
Leased Lease
Date Cash Asset Liability Equity
1/1/2000 0 $ 10,000 $ 10,000 $ -
12/31/2000 (2,505) 8,000 8,295 (2,800)
12/31/2001 (5,010) 6,000 6,454 (5,464)
12/31/2002 (7,515) 4,000 4,466 (7,981)
12/31/2003 (10,020) 2,000 2,319 (10,339)
12/31/2004 (12,525) 0 0 (12,525)
Leases
Effects of Lease Accounting
Leases
Effect of Converting Operating Leases to Capital Leases on Key
Ratios-Best Buy 2004
Postretirement Benefits
Postretirement Benefits Facts
Defined -- Employer-provided benefit(s) to employees after
retirement
Investment
Postretirement Benefits
Illustration of Pension Accumulation and
Disbursement for a Defined Benefits Plan
Annual payments into the fund Funds required at employees’ Annual benefits of
required to accumulate to retirement: $20,000 paid to
$134,200 in 15 years with Present value of 10 payments employee for 10 years
a discount rate of 8% of $20,000 per annum with a
per annum discount rate of 8% per annum
Contributions = Benefits =
$134,200
$4,942 per annum $20,000 per annum
15 years 10 years
Accumulated benefit obligation (ABO) – actuarial present value of pension benefits payable
to employees at retirement based on their current compensation and service to-date
Project benefit obligation (PBO) – actuarial estimate of future pension benefits payable to
employees on retirement based on expected future compensation and service to-date
Vested benefit obligation (VBO) – actuarial estimate of future pension benefits payable to
employees at retirement based on current compensation & benefits vested to employees
Funded Status – Difference between the value of the plan assets and the PBO
Note: Plan is overfunded (underfunded) when value of plan assets exceeds (is less than) PBO
Net Economic Position – PBO less the value of the plan assets
Postretirement Benefits
Economic Pension Cost
Economic pension cost -- net cost arising from changes in net economic position
for a period; includes both recurring and nonrecurring components along with return
on plan assets
• A pension plan with a single employee, J. Smith, who joins the plan
exactly 5 years ago on January 1, 1996; Smith is due to retire on
Dec. 31, 2020, and is expected to live for 10 years after retirement
• J. Smith’s current compensation is $10,000 per year; actuarial
estimates indicate compensation is expected to increase 4% per year
over the next 20 years
• Pension plan specifies the following formula for determining an
employee's pension benefit: “Annual pension is equal to one week’s
compensation at time of retirement for each year with the plan”;
employees vest 4 years after joining the plan
• At Dec. 31, 2000, the fair value of assets in the pension fund is $2,000;
in 2001, the employer contributes $200 to the pension fund
• Return on pension assets is 22% in 2001; long-term
return is expected to be 10% per year
• Discount rate is 7% per year
Postretirement Benefits
Pension Accounting Example – Pension Obligation
Determining Pension Obligations under Different Assumptions—J. Smith Example
2000 Formula
2001 Formula
Actual Projected Projected Assumption Change
Actuarial Plan
At Dec. 31, 2020 (Retirement)
Salary per year $10,000 $21,911 $21,911 $26,533 $26,533
Pension per year 962 2,107 2,528 3,061 4,592
Value of pension 6,753 14,798 17,757 21,503 32,254
At Dec. 31, 2000
Present value of 1,745 3,824
pension
At Dec. 31, 2001
Present value of 4,091 4,910 5,946 8,919
pension
• Expected return on plan assets — $200 (10% of $2,000) in the J. Smith example
• Deferral and amortization of net gains and losses — deferred net gains or losses is
$796 ($1,036 actuarial loss less $240 nonrecurring return), of which $21 (1/20 of the
excess of $796 over 10% of $3,824) is amortized in 2001 for the J. Smith example
• Deferral and amortization of prior service cost — prior service cost of $2,973 is
deferred and $149 (1/20 x $2,973) is amortized in the J. Smith example
• Deferral and amortization of transition loss or gain — no transition gain or loss in the
J.Smith example
3M
Postretirement Benefits
Reconciliation of Economic and Reported Changes- 3M
Postretirement Benefits
Effect of Actuarial Assumptions on Benefit Obligation and Cost
Direction of Effect on
Assumption Direction
of Change Economic* Reported*
Benefits of SPEs: