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LM08 Topics in Long-Term Liabilities and Equity 2025 Level I Notes © IFT. All rights reserved 1 LM08 Topics in Long-Term Liabilities and Equity 1. Introduction ........................................................................................................................................................... 2 2. Leases ....................................................................................................................................................................... 2 3. Financial Reporting for Postemployment and Share-Based Compensation Plans .................... 8 4. Presentation and Disclosure ........................................................................................................................12 Summary ...................................................................................................................................................................15 Required disclaimer: IFT is a CFA Institute Prep Provider. Only CFA Institute Prep Providers are permitted to make use of CFA Institute copyrighted materials which are the building blocks of the exam. We are also required to create / use updated materials every year and this is validated by CFA Institute. Our products and services substantially cover the relevant curriculum and exam and this is validated by CFA Institute. In our advertising, any statement about the numbers of questions in our products and services relates to unique, original, proprietary questions. CFA Institute Prep Providers are forbidden from including CFA Institute official mock exam questions or any questions other than the end of reading questions within their products and services. CFA Institute does not endorse, promote, review or warrant the accuracy or quality of the product and services offered by IFT. CFA Institute®, CFA® and “Chartered Financial Analyst®” are trademarks owned by CFA Institute. © Copyright CFA Institute Version 1.0
LM08 Topics in Long-Term Liabilities and Equity 2025 Level I Notes © IFT. All rights reserved 2 1. Introduction The learning module covers:  Financial reporting of leases from the perspective of lessors and lessees  Financial reporting of defined contribution, defined benefit, and stock-based compensation plans  Presentation and disclosures relating to long-term liabilities and share-based compensation 2. Leases A lease is a contract in which a lessor grants the lessee the exclusive right to use a specific underlying asset for a period of time in exchange for payments. Below is a pictorial representation of what constitutes a lease. An asset’s owner is called a lessor. The entity or person wishing to use the asset is called the lessee. The lessor allows the lessee to use the asset for a pre-determined period. In return, the lessee makes periodic payments to the lessor over the period for the right to use the asset. This period can be as long as 20 years, or as short as a month. Advantages of Leasing Following are some of the advantages to leasing an asset compared to purchasing it.  Less cash is needed upfront. Leases typically require little to no down payment.  Since leases are a form of secured borrowing, they generally have low interest rates.  Lower risks associated with ownership such as obsolescence. Lease Classification as Finance or Operating Leases are classified as finance or operating. A finance lease is similar to purchasing an asset while an operating lease is similar to renting an asset. A lease is classified as a finance lease if any of the following five criteria are met. 1. The lease transfers ownership of the underlying asset to the lessee. 2. The lessee has an option to purchase the underlying asset and is reasonably certain it will do so.
LM08 Topics in Long-Term Liabilities and Equity 2025 Level I Notes © IFT. All rights reserved 3 3. The lease term is for a major part of the asset’s useful life. 4. The present value of the sum of the lease payments equals or exceeds substantially all of the fair value of the asset. 5. The underlying asset has no alternative use to the lessor. If none of the criteria are met, then the lease is classified as an operating lease. Financial Reporting of Leases The financial reporting of leases depends on:  Whether the party is the lessee or lessor  Whether the party reports with IFRS or US GAAP  Whether the lease is a finance or operating US GAAP and IFRS share the same accounting treatment for lessors but differ for lessees. IFRS has a single accounting model for both operating leases and finance lease lessees, while US GAAP has different accounting models for each. Lessee Accounting—IFRS Under IFRS, there is a single accounting model for both finance and operating leases for lessees.  At inception, recognize a lease liability and corresponding right-of-use (ROU) asset on the balance sheet, both equal to the present value of lease payments.  The lease liability is subsequently reduced by each lease payment using the effective interest method. Each lease payment is composed of: o Interest expense = Lease liability x discount rate o Principal repayment = Lease payment – Interest expense  The right-of-use asset is amortized, often on a straight-line basis, over the lease term. (Although the lease liability and ROU begin with the same carrying value, their balance sheet values tend to diverge over time because of the differences in the calculation of principal repayments that reduces the lease liability and the amortization expense that reduces the ROU asset.) The following list shows how the lease transaction affects the financial statements.  Balance sheet: The lease liability is reported net of principal repayments and the ROU asset is reported net of accumulated amortization  Income statement: Interest expense and amortization expense are shown separately.  Cash flow statement: The principal repayment component is reported as cash outflow under financing activities. The interest expense can be reported under either
LM08 Topics in Long-Term Liabilities and Equity 2025 Level I Notes © IFT. All rights reserved 4 operating or financing activities. Example: Lessee Accounting - IFRS (This is based on Example 2 from the curriculum.) A company is offered the following terms to lease a machine: five-year lease with an implied interest rate of 10% and an annual lease payment of EUR100,000 per year payable at the end of each year. PV = EUR379,079. The asset will be amortized over the five-year lease term on a straight-line basis. The company reports under IFRS. What would be the impact of this lease on the company’s: 1. balance sheet at the beginning of the year? 2. income statement during the following year? 3. statement of cash flows during the following year? Solution to 1: The company will report a lease liability and a ROU asset of EUR379,079. Solution to 2: In Year 2, the company will report an interest expense of EUR31,699 and an amortization expense of EUR 75,816. The calculations are shown in the tables below: Lease Payment Interest Expense (10% × Lease Liability) Principal Repayment (Payment – Interest) Lease Liability FO.1 FO.2 FO.3 FO.4 Year 0 379,079 Year 1 100,000 37,908 62,092 316,987 Year 2 100,000 31,699 68,301 248,685 Year 3 100,000 24,869 75,131 173,554 Year 4 100,000 17,355 82,645 90,909 Year 5 100,000 9,091 90,909 0 Total 500,000 120,921 379,079 Amortization Expense ROU Asset Straight-Line F.1 F.2 Year 0 379,079 Year 1 75,816 303,263 Year 2 75,816 227,447 Year 3 75,816 151,631 Year 4 75,816 75,816