FRA Q-bank questions equipment, guarantee, statements, standards, accounting

mdfb79

Hi all,


Lucky Strike Mining Corp. (LSMC) reports in a footnote to the financial statements that it is party to a variable interest entity (VIE) through which it leases heavy equipment. LSMC has chosen not to report a residual value guarantee of $120 million for the equipment because it is not required to do so under accounting standards. However, the standards will change next year. What is the appropriate analytical treatment of this residual value guarantee?

A) Increase long-term liabilities and long-term assets by $120 million.

B) Ignore the liability because current accounting standards do not require it to be included on the balance sheet. Include it in next year’s balance sheet adjustments.

C) Increase long-term liabilities by $120 million and decrease equity by $120 million.


Your answer: A was correct!

Increase long-term liabilities and long-term assets by $120 million.

Just wondering can someone explain why the answer is correct?

Rasec

I got it right b/c the other two didn't make sense. But still can't figure out why should we do A.

If it is residual value, then we only need to consider the amortization amount right?
How come we need to increase Liabilities and Assets?

comp_sci_kid

You have to add the value of the heavy equip to both the Asset and Liability side to make the A=L+E equation balance.

While it is hard to see that LSMC will be the beneficiariy of the Asset, they certainly will be liable through their quarantee of the equipment and therefore must consolidate the VIE. Again, if you add to L with no adustment to E, we would need to add to A to make the equation balance.