Learning Module 8
Topics in Long-Term Liabilities and Equity
Key Outcomes Summary & Practice Problems
What you must be able to do
Curriculum Year: 2026
Explain the financial reporting of leases from the perspectives of lessors and lessees.
Explain the financial reporting of defined contribution, defined benefit, and stock-based compensation plans.
Describe the financial statement presentation of and disclosures relating to long-term liabilities and share-based compensation.
1 · Leases
A lease conveys the right to use an asset for a period of time in exchange for consideration. For a contract to qualify as a lease, it must (1) identify a specific asset, (2) give the customer the right to obtain substantially all of the economic benefits from that asset, and (3) give the customer — not the supplier — the ability to direct how the asset is used. Leasing is widespread: the IASB found that in 2014 more than 14,000 public companies were lessees, owing over USD3.3 trillion in future lease payments.
Advantages of leasing vs. purchasing: less cash needed up front (minimal down payment); cost effectiveness, since the lessor can simply repossess the asset on non-payment, making the effective rate typically lower than an unsecured loan; and convenience/lower obsolescence risk for the lessee. For the lessor: interest income over the lease term and an expanded addressable market, since customers prefer paying in installments.
1. Ownership of the asset transfers to the lessee
2. Lessee has a purchase option it is reasonably certain to exercise
3. Lease term covers a major part of the asset's useful life
4. PV of lease payments ≈ substantially all of the asset's fair value
5. The asset has no alternative use to the lessor
If none apply → operating lease. Same 5 criteria under IFRS and US GAAP, for both lessee and lessor.
Company C pays JPY100M/year for 2 years for exclusive use of a specific machine; PV of payments = JPY186M; fair value = JPY190M; no purchase option; 4-year remaining life; machine usable by many other customers
PV/FV = 186/190 = 98% → criterion 4 met → Finance lease
If fair value were instead JPY300M: 186/300 = 62% → no criterion met → Operating lease
One model for all leases (finance and operating). At inception: record lease liability + right-of-use (ROU) asset, both at PV of future lease payments. Liability reduced via effective interest method (interest + principal). ROU asset amortized separately, typically straight-line — so liability and asset diverge over time even though they start equal.
Finance lease: identical to the IFRS model above. Operating lease: ROU amortization = lease payment − interest expense, so total expense (interest + amortization) always equals the lease payment, and liability = ROU asset throughout the lease term. Reported as one line, "lease expense."
WORKED EXAMPLE — PROTON ENTERPRISES (5-YR LEASE, EUR100,000/YR, 10% RATE, PV = EUR379,079)
Year | Lease Payment | Interest (10%) | Principal Repay. | Liability, End |
|---|---|---|---|---|
1 | 100,000 | 37,908 | 62,092 | 316,987 |
2 | 100,000 | 31,699 | 68,301 | 248,685 |
3 | 100,000 | 24,869 | 75,131 | 173,554 |
5 (final) | 100,000 | 9,091 | 90,909 | 0 |
Using an operating lease instead of a finance lease, all else equal:
EBITDA margin: Lower — lease expense is operating, not split into interest + amortization (which would sit below EBITDA)
Asset turnover: Lower — ROU asset amortizes more slowly in years 1–3, keeping total assets higher
Cash flow per share: Lower — entire payment hits operating CF, vs only the interest portion under a finance lease
Total expense is higher for a finance lease in years 1–3 but lower in years 4–5 (front-loaded interest vs level lease expense)
Lessor accounting is nearly identical under IFRS and US GAAP. Finance lease: derecognize the asset, recognize a lease receivable at PV of payments (discounted at the rate implicit in the lease), recognize interest income via the effective interest method, and the entire cash receipt flows through operating activities. Operating lease: lessor keeps the asset on its books, continues depreciating it, and recognizes lease revenue straight-line — no interest income, since it isn't treated as a financing. (US GAAP further splits finance leases into "sales-type" and "direct financing" — immaterial distinction for analysts.) Proton example: with asset carrying value EUR350,000, a finance lease would show a EUR316,987 lease receivable in Year 1 vs. EUR280,000 net PP&E under an operating lease — a materially different balance sheet.
Lease accounting exemptions for lessees only (not available to lessors): terms ≤12 months (IFRS and US GAAP), or "low-value" assets up to USD5,000 (IFRS only) — these can simply be expensed straight-line.
Cash flow statement, IFRS lessee: principal repayment = financing outflow; interest expense = operating or financing per the company's policy. US GAAP operating lease: the entire payment is one operating outflow — no separate interest/principal split.
Beginning fiscal year 2019, lessees report a ROU asset and lease liability on the balance sheet for virtually all leases over one year — a major shift from the old "off-balance-sheet" treatment of operating leases.
2 · Postemployment and Share-Based Compensation Plans
Employee compensation packages balance liquidity needs, retention, and performance incentives. Salary, bonuses, and most non-monetary benefits vest immediately or shortly after grant — straightforward accounting. Deferred compensation (pensions, share-based pay) vests over time and is more complex to measure.
Company pays a defined (agreed-upon) amount into the plan — e.g., matching 50% of employee's 5% contribution. Employee bears investment & actuarial risk. Company's contribution = pension expense = operating cash outflow. No further obligation once paid — simple accounting; only a decrease in cash (plus any accrued unpaid liability).
Company promises a defined future benefit (e.g., 70% of final salary). Employer bears investment & actuarial risk.Requires actuarial assumptions (salary growth, mortality) and discounting at a high-quality corporate bond yield. Net pension asset if plan assets > obligation; net pension liabilityif obligation > plan assets.
1. Service cost (incl. past service cost) → P&L
2. Net interest expense/income (net pension asset/liability × discount rate) → P&L
3. Remeasurements (actuarial gains/losses + actual return less amount in net interest) → OCI, never amortized into P&L
Recognized in P&L immediately: service cost, interest expense on beginning obligation, expected return on plan assets (reduces expense)
Recognized in OCI then amortized into P&L over time: past service costs, actuarial gains/losses ("smoothing") — though immediate P&L recognition of actuarial G/L is also permitted
EXHIBIT — BT GROUP PLC (IFRS, GBP MILLIONS)
Item | Mar 2018 | Mar 2017 | Mar 2016 |
|---|---|---|---|
Present value of liabilities | 57,327 | 60,200 | 50,350 |
Fair value of plan assets | 50,956 | 51,112 | 43,968 |
Retirement benefit obligation | 6,371 | 9,088 | 6,382 |
% of total non-current liabilities | 29% | 39% | 30% |
Share-based compensation aligns employee and shareholder interests and needs no current-period cash outlay — but it is a real expense (reduces earnings) and can dilute EPS. Risk side-effects cut both ways: increased ownership can make managers risk-averse (fearing wealth loss from a price decline), while the skewed payoff of stock options (capped downside at zero, unlimited upside) can encourage excessive risk-taking.
Compensation expense = fair value (usually market value) at the grant date — known with certainty. Allocated over the employee service/vesting period. Includes outright grants, restricted stock (RSUs), and performance shares (vesting tied to accounting metrics like ROA, not stock price). Retains value as long as share price > 0.
Compensation expense = fair value estimated via a pricing model (Black–Scholes, binomial) — market prices of traded options can't be used directly since employee options have different features. Key inputs: exercise price, volatility, expected life, forfeiture rate, dividend yield, risk-free rate. Can expire worthless if price never exceeds the exercise price.
↑ Higher volatility → ↑ fair value
↑ Longer estimated life → ↑ fair value
↑ Higher risk-free rate → ↑ fair value
↑ Higher assumed dividend yield → ↓ fair value
USD335 million unrecognized cost on nonvested awards, to be recognized over 1.9 years
2022 expense ≈ 335 / 1.9 = USD176 million
2023 expense ≈ 335 − 176 = USD159 million (new grants would add to this)
Grant date = measurement date (when both share count and price are known) for both stock grants and options. Post-grant stock price changes do not affect the reported expense — only the original grant-date fair value matters.
Exercising an option: cash increases by the exercise price paid; common stock increases by par value; additional paid-in capital absorbs the difference. Recognizing option expense has no net effect on total equity — it shifts retained earnings down and paid-in capital up by the same amount.
Cash-settled alternatives — stock appreciation rights (SARs) and phantom stock — compensate based on share-price changes withoutrequiring employees to hold shares. Advantages: limited downside (no risk-aversion problem) and no shareholder dilution. Phantom stock can even be used by private/illiquid companies, since it tracks a hypothetical share price rather than a real traded one.
Apple's 2021 RSU program: RSUs generally vest over 4 years; balance fell from 368.6M (2018) to 240.4M units (2021) even as weighted-average grant-date fair value rose from $33.65 to $75.16 — reflecting both vesting/cancellation activity and Apple's rising share price baked into newer grants.
3 · Presentation and Disclosure
Disclosure objectives across leases, pensions, and share-based compensation share a common thread: enabling users to assess the amount, timing, and uncertainty of related future cash flows. Most of this detail lives in the notes to the financial statements rather than on the face of the statements themselves.
Disclosure Area | Required Lessee/Issuer Disclosures (IFRS 16 / IAS 19 / IFRS 2) |
|---|---|
Lessee (leases) | ROU asset carrying amount by class; total cash outflow for leases; interest expense on lease liabilities; depreciation by asset class; additions to ROU assets; maturity analysis of lease liabilities (separate from bond/loan maturities) |
Lessor — finance leases | Selling profit/loss; finance income on net investment; maturity analysis of lease payments receivable (first 5 years individually, remainder in total) |
Lessor — operating leases | Disaggregated PP&E subject to operating leases; lease income (with variable-payment income separated); maturity analysis of payments to be received |
Defined benefit pension (IAS 19) | Plan characteristics & risks; full reconciliation of opening→closing net asset/liability; sensitivity analysis on key assumptions (e.g., discount rate); plan asset composition by category; cash flow effect indications |
Defined contribution pension | Simply the amount recognized as expense on the income statement during the period |
Share-based compensation (IFRS 2) | Terms/conditions of each plan type; option roll-forward (outstanding, granted, forfeited, exercised, expired, ending, exercisable); weighted-average exercise prices; fair value & measurement basis for non-option equity instruments |
EXHIBIT — APPLE INC. 2021 LEASE DISCLOSURE (USD MILLIONS)
Lease-Related Item | 2021 | 2020 |
|---|---|---|
ROU assets — operating leases | 10,087 | 8,570 |
ROU assets — finance leases | 861 | 629 |
Total lease liabilities | 11,803 | 9,482 |
Weighted-avg remaining lease term | 10.8 yrs | 10.3 yrs |
Discount rate used | 2.0% | 2.0% |
Apple's operating-lease fixed-payment costs were $1.7 billion in 2021 versus $1.5 billion in 2020, while variable lease costs (tied largely to retail/output volumes) were far larger — $12.9 billion in 2021 versus $9.3 billion in 2020 — showing how much of Apple's real estate cost structure is volume-linked rather than fixed.
Funded plans: Fair value of plan assets 18,817− Defined benefit obligation 17,609 = Over-funding of 1,208 (pension plans only)
Unfunded plans: Defined benefit obligation of 5,211 reported entirely as a liability
Combined net recognized liability across pension + other postemployment plans: CHF(4,605) million
Apple's 2021 RSU disclosure shows $13.6 billion of total unrecognized compensation cost (RSUs + options), to be recognized over a weighted-average 2.5 years — giving analysts a direct forward estimate of near-term compensation expense.
Why some companies skip discrete lease line items: depending on materiality, leases may be folded into "Other assets" / "Other liabilities" rather than shown as standalone balance sheet captions — always check the notes, not just the face of the balance sheet.
Regulatory layering: beyond IFRS/US GAAP minimums, regulators can require more — e.g., the US SEC requires a separate Form 11-K annual report (with audited plan financials) for certain employee benefit plans.