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10-1 Solutions CHAPTER 10 LIABILITIES: OFF-BALANCE-SHEET FINANCING, LEASES, DEFERRED INCOME TAXES, AND RETIREMENT BENEFITS Questions, Short Exercises, Exercises, Problems, and Cases: Answers and Solutions 10.1 See the text or the glossary at the end of the book. 10.2 One premise underlying this statement is that the notes provide sufficient information to permit the analyst to make an informed judgment about the nature of the obligation or commitment and its associated risks. Current disclosures of off-balance-sheet commitments aggregate similar transactions, making an informed judgment about individual items difficult. Even if the disclosure permitted an informed judgment, the question arises as to whether information processing costs for analysts would decrease if firms actually recognized these items as liabilities. The counter argument to recognition of off-balance-sheet liabilities is that they differ in their risk characteristics relative to liabilities appearing on the books; thus disclosure in the notes is more appropriate than recognition in the balance sheet. 10.3 Using an executory contract to achieve off-balance-sheet financing results in the recognition of neither an asset (for example, leased assets) nor a liability (for example, lease liability) on the balance sheet. Using an asset sale with recourse results in a decrease in an asset (for example, accounts receivable) and an increase in cash. In both cases, no liability appears on the balance sheet. 10.4 The party with the risks and rewards of ownership effectively owns the asset, whatever the legal niceties. The asset should appear on the balance sheet of the owner. The capital lease criteria attempt to state unambiguously who has economic ownership. 10.5 The distinction depends upon which criteria of the lease made it a capital lease. The major difference is that at the end of a lease term the asset reverts to the lessor in a capital lease, whereas at the end of the installment payments, the asset belongs to the purchaser. The criteria for capitalizing a lease are such that the expected value of the asset when it reverts to the lessor is small, but misestimates can occur. In most other respects, capital leases and installment purchases are similar in economic substance.
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Solutions 10-2 10.6 The differences are minor. The lessee's asset is Leased Asset on the one hand and Actual Asset (Plant or Fixed Assets) on the other. The liability will have different titles. The effect on income and balance sheet totals is the same for both transactions. 10.7 Expenses are gone assets. The measure of expense over the life of a lease is the total outflow of cash to discharge the obligation. The accounting for leases, either operating or capital, does not change the total cash outflow, only the timing of the recognition of asset expirations.
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