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What is the fair value hierarchy?
Level 1: Uses quoted prices from active markets for identical assests to determine fair vale. This is the prefered method.
Level 2: Quoted prices from an active market for similar assets or quoted prices from less than active markets
Level 3: Covers unobservable inputs such as managements estimates of expected future cash flows or abnormal earnings, which are then used in valuation model approaches to fair value measurment.
What is the entry to record purchase of bond?
- Dr: Marketable securities - bonds
- Cr: Cash
What is the entry if you have a loss on bond while still holding bond?
- Dr: Unrealized holding loss
- Cr: Marketable adjustment - Bond
What is the entry if there is a gain on the bond?
- Dr. Marketable adjustment - Bond
- Cr: Unrealized holding gain
What is the marketable adjustment account?
- A contra asset marketable securities account.
- So that investments are always carried at fair value.
What are the four requirements for a capital lease?
- 1. Lease transfers ownership of the asset by end of lease term.
- 2. Lease contains a bargain price purchase option
- 3. Noncanceable lease term is 75% or more of economic life of the asset
- 4. Present value of minimum lease payments equals or exceeds 90% of the current fair market value of leased asset
- Date Interest Cash Liability Lease
- Portion Payment Reduction Liability
Interest portion calculation for amortization scheduel
Lease liablity X interest rate
Liability reduction =
Cash payment - interest portion
Balance sheet effects due to capital lease?
- Assests go up
- Liabilities go up: Current and long term
- ROA goes down
- D/E goes up
- and you will now have depreceation expense
Journal entry to record capital lease obligation?
- DR: Capital leases
- CR: Obligation under capital leases (Liability)
Journal entry to record capital lease expenses?
- DR: Interest expense
- DR: Obligation under capital lease
- CR: Cash
- DR: Depreceation expense
- CR: Accumulated depreciation
What is the journal entry if lease is operating lease?
- DR: Rent expense
- CR: Cash
Why would an analyst want to do constructive capitalization of leases?
Due to the capitalization of the lease showing the companies true financial position on the balance sheet
How to calculate constructive capital lease from operating lease?
- Take the average decrease in last 3 years:
- Minues each year seperatly and then divide by 2.
- Then subtract that number from last years payment
- Take total payments and divide by that number to make sure it gives us the number of years on lease remaining.
Tax is based on the?
GAAP is based on the?
Income tax payable
- Tax expense is based on book income =
- IBT X Tax rate
- Income tax payable=
- Taxable income X tax rate
- or value on tax return
Effective tax rate formula
Tax expense/book income
Book income formula
Fed tax expense/tax rate = BI
- Sales prices between subsidiaries
- How to lower taxes
means the company doesnt think the income will be as good this year
Unrecognized tax benefits
Entry to record income tax expense
- DR: Income tax expense
- either DR: DTA - depends on problem
- CR: Income tax payable
- CR:either DTL - depend on problem
Types of incentive based compensation
- Salary: Base compensation
- Short term incentives : Based on accounting numbers. Revenue, EBIT, any measure of profits, costs, ROA,ROE
- Long Term incentives: Based on pay for performance. Also based on stock based compensation. This bridged the gap between management and owners. ROA over 3 years
Pros and cons of accounting based incentive meausre
- Incentive to work harder and improve companies earnings.
- Earnings management problems.
- Change in policies by management to manipulate numbers.
- Focus on only short term performance.
- Management will manipulate earnings around bonus tiers. (Cookie jar reserves)
- Can manage earnings up or down based on bonus threshold.
Pros and cons of short term incentives VS long term incentives
- Long term - Stock options are a pro for tech industry where companies do not have cash flow to pay employees. Can motivate managment to improve stock price.
- Long Term - Stock appriciation rights do not dilute shares
- Long Term: When options are exerised it causes ownership to be diluted.
- Short Term: Both accounting and non accounting figures can be manipulated in short term incentives (Bonuses)
Current GAAP for stock option valuation
# of options x FV (Black sholes model) / # of vesting years
Journal entry to record stock option value
- DR: Compensation expense
- CR: PIC-SO
Journal Entry if stock options are exercised
- DR: Cash (Option price)
- DR: PIC - SO
- CR: Common Stock (PAR)
- CR: PIC - in excess of par
3 items needed to properly back dating stock options
- 1. Pay right taxes
- 2. Appropriate accounting
- 3. No fraud in record keeping