There are certain contentious accounting issues and principles that are still very much in debate for a better solution for reporting of transaction in the financial statements of companies. Amongst these are accounting for leases, pensions, equity and multiple entities. Under the following headings the accounting treatments of these are discussed along with suggestions for further improvement of report. It is noted that the accounting regulation for these transaction has been amended several times and effort has been made to provide up to date information.
Accounting for Leases
SFAS 13 Accounting for Leases recognizes two types of leases which are recorded by businesses in different ways based on the nature and characteristics of the transaction. FASB ASC 840-10-15 underlines criteria for recognition of capital leases:
- transfer of ownership at the end of the lease price
- option to purchase the asset at a bargain price at the end of the lease price
- the use of asset expands over75% of its useful economic life and
- total of lease payments are almost 90% of the fair value of the asset.
Further, differentiation is also made by FASB of capital leases based on criteria of uncertainty as sales-type lease, direct financing lease, or leveraged lease (FASB ASC 840-30-30). If recognized as capital lease, the lessee records it as an asset under non-current assets depreciated over a period of use and a liability of capital lease which is amortized using interest method, at the present value of lease payments that are expected to be made.
The lessor records the transaction by debiting receivables and crediting sales by the minimum lease payments received from the lessee. Furthermore, the cost of asset is shown as cost of sales and credit amount of assets. Under capital lease, benefits and risks are transferred to the lessee. Moreover, FASB provides However, if PV exceeds the fair value of the asset then asset and liability must be recorded at its fair value (Schroeder, Clark, & Cathey, 2010). On the other hand, under payments for operating lease (FASB ASC 840-10-25-43d) are only recognized as expense in the income statement. However, if there is an upward change in the rental then it is included as deferred liability or as an asset if its decreases. It is suggested that operating lease should be treated in the same way as capital lease which would eliminate the possibility of off-balance sheet financing.
Accounting for Pensions
SFAS 87 Employer’s Accounting for Pension suggests that an expense is recorded in the income statement for the amount obligated by employers towards pension plans. The amount disclosed in the income statement is the net cost of the pension plan implemented by the employer. The pension expense includes the service cost which is the present value of the benefits attributed to the pension fund during the present period. It also includes the interest on projected benefit obligation during the current period and finally a deduction is made for the both invested and non-invested accrued benefits till the present date (FASB ASC 715-30-25).
Moreover, there should be recognition of a prepaid asset if the amount contributed to the pension trust is less than the pension expense; whereas an accrued liability will be contribute if the pension expense is less than the amount contributed to the pension trust (Schroeder, Clark, & Cathey, 2010). Additional special consideration is given to the amortization of service cost before the pension plan was implemented by the business. Accounting for pensions is criticized for lack of reflection of economic value of funds on the balance sheet and limited information disclosures by companies (Levitt, 2005). Therefore, it is suggested that both these problems are addressed by the regulators to increase transparency and accuracy.
Accounting for Equity
FASB ASC 505-10-05 defines “Equity, sometimes referred to as net assets, is the residual interest in the assets of an entity that remains after deducting its liabilities”. The cost of stock based compensation given to employees must be expensed in the period keeping in view that the book value has not increased (FASB ASC 323-10-23 to 25). FASB ASC 505-20-30 requires that “the corporation shall transfer from retained earnings to the category of capital stock and additional paid-in capital an amount equal to the fair value of the additional shares issued” for accounting of stock dividends or stock splits by corporations.
While for shareholders, the cost of shares held is adjusted by the number of stocks received. Two methods 1) at par and 2) at cost are allowed under GAAP for accounting of repurchase of treasury stocks. At par method requires credit of treasury stocks repurchased and reduction in paid-in capital if the value is in excess to the price in the market and vice versa. At cost method allowed crediting the cost of treasury stocks and upon resell gain over par value is added to pain-in capital (Oliver & Moffeit, 2000). Moreover, equity based payments to non-employees must be recorded at the fair value of options offered to the receiver (FASB ASC 505-50-30).
One of the suggestions that could be made is related to the valuation of stock options and recognition of its related expense. Since, stock options have realization in the future therefore, its value must be adjusted according to the market value rather than at the time of issuance.
Accounting for Multiple Entities
Accounting for multiples entities includes different aspects of business combinations which can take place. Business combinations occur when two or more companies form a single entity by combining their assets. There are two allowed methods for recording such transactions namely – purchase and pooling interest. Accounting treatment is different for both methods. Purchase accounting requires recording of assets at their fair market value (FASB ASC 805-10-20 refer to it as an exit value) and any positive difference between paid amount and market values is recorded as goodwill whereas negative difference is recorded as non-current liability (Schroeder, Clark, & Cathey, 2010).
Goodwill is impaired if the fair value of assets is less than the carrying value of assets and no amortization is allowed any more. The value of goodwill is subsequently adjusted and loss is recognized in the income statement. Income of acquired entity is added from the date of acquisition (Schroeder, Clark, & Cathey, 2010). The pooling interest method is not allowed under SFAS 141(R) anymore and therefore, it is omitted from this discussion.
Moreover, FASB ASC 805-20-25 permits “as of the acquisition date, the acquirer shall recognize, separately from goodwill, the identifiable assets acquired, the liabilities assumed, and any no controlling interest in the acquire” and these costs are included in post combination financial statements based on GAAP. Although, SFAS 141 does require certain elements of segment reporting to be made in the financial reports but it does not necessitate publishing of individual reports under business segment reporting which is recommended in this report. This would allow shareholders to assess financial performance of subsidiaries which may be carrying huge losses on their statements but are not pointed out in the consolidated reports.
SFAS 115 Accounting for Certain Investments in Debt and Equity Securities is primarily concerned with the recording of investment in an associate company and other types of equity securities. Investment in associate companies which does not involve acquiring control or exertion of influence and the holding in the target entity remains between 20-50%. This is the criteria laid down in FASB Interpretation No. 35 (FASB, 2011). This transaction is recorded using equity method which requires recording of the investment in associate company at original cost and the balance increase by the income received from the target company and dividends paid.
The problem lies with ascertaining the degree of influence that the acquirer company can exert on the decisions made by the associate company. For this it is suggested that details of ownership and board of directors are provided for both entities. Furthermore, FASB ASC 805-40-05 explains reverse acquisition when private equity acquires equity interests of the public entity in exchange for its own equity interests to be acquired by the public entity. In this case, basis for business combinations as per ASC 805-20 and 805-30 applies but accounting purposes the public entity is the acquire and the private entity is the acquirer.
References
FASB. (2011). FASB Accounting Standards Codfication.
Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC). (2011). Leases – Subtopic Overall 10 – Sec 15 Scope and Scope Exceptions FASB ASC 840-30-30.
Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC). (2011). Leases – Subtopic Capital Leases 30 – Sec 30 Initial Measurement FASB ASC 840-10-25-43d.
Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC). (2011). Leases – Sub Topic Overall 10 – Sec 25 Recognition – Topic 43, Lessor Application of Lease Classification Criteria FASB ASC 715-30-25.
Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC). (2011). Compensation Retirement Benefits – Sub Topic Defined Benefit Plans 30 – Sec 25 Recognition FASB ASC 505-10-05.
Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC). (2011). Equity – Sub Topic Overall 10 – Sec 5 Overview and Background FASB ASC 323-10-25.
Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC). (2011). Investments—Equity Method and Joint Ventures – Subtopic Overall 10 – Sec 25 Recognition FASB ASC 505-20-30.
Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC). (2011). Equity – Subtopic Stock Dividends and Stock Splits 20 – Sec 30 Initial Measurement FASB ASC 505-50-30.
Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC). (2011). Equity – Subtopic Equity-Based Payments to Non-Employees 50 – Sec 30 Initial Measurement FASB ASC 805-40-05.
Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC). (2011). Multiple Entities – Subtopic Reverse Acquisitions 40 – Sec 25 Overview and Background FASB ASC 805-20-25.
Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC). (2011). Multiple Entities – Subtopic Identifiable Assets and Liabilities, and Any Noncontrolling Interest 20 – Sec 25 Recognition FASB ASC 805-30-25.
Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC). (2011). Multiple Entities – Subtopic Goodwill or Gain from Bargain Purchase, Including Consideration Transferred 30 – Sec 25 Recognition.
Levitt, B. (2005). Pittsburgh Brewing Says It’s in Deep Trouble. Pittsburgh Post Gazette.
Oliver, J. R., & Moffeit, K. S. (2000). Corporate Share Buybacks. Web.
Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2010). Financial Accounting Theory and Analysis: Text and Cases. New York: John Wiley and Sons.