Skip to content

CFA Level I · CFA Level I Exam

Topics in Long-Term Liabilities and Equity for CFA Level I

This chapter covers how companies account for long-term financing under IFRS: bonds and the effective interest rate method, derecognition and covenants, leases, defined benefit pensions and share-based compensation. To solve questions, identify the item, apply the measurement rule, then trace the effect on the balance sheet, income statement and cash flow.

What this chapter covers

This chapter sits in Financial Statement Analysis. It looks at obligations that last longer than a year and at equity-linked pay. You learn how a company records a bond, a lease, a pension promise or a stock option grant. You also learn how these choices change reported debt, profit and cash flow.

The topics share one idea: a future cash obligation is turned into a present value today, then unwound over time. Bonds use the effective interest rate set at issue, which is the market rate when there are no issuance costs. Leases use the rate implicit in the lease or the incremental borrowing rate. Pensions use a discount rate on the benefit obligation. Share-based pay uses grant-date fair value spread over the vesting period. Once you see this pattern, the chapter feels like one idea in six forms.

The chapter links to other parts of the paper. Time value of money from Quantitative Methods drives every bond and lease calculation. Solvency ratios in financial analysis change when leases and pension deficits are added to debt. Corporate Finance covers capital structure and covenants from a decision angle. Fixed Income uses the same bond maths from the investor side. Questions are standalone three-option MCQs, so you must be quick at both the concept and the arithmetic.

Financial Statement Analysis carries 11-14% of the Level I exam, and this chapter feeds directly into the liability and analyst-adjustment questions in it. The questions are often concept checks with one short calculation, which makes them good marks if you know the direction of each effect. There is no penalty for wrong answers and no minimum score per topic, so a solid grip here lifts your total even if other areas are weaker. The same logic also helps with solvency ratios and with questions that compare companies.

Topics in Long-Term Liabilities and Equity: topics in the order to study them

  1. 1Bond Issuance and Accounting for BondsIt sets the base: issue at par, discount or premium, and how issue costs and carrying amount are recorded.
  2. 2Effective Interest Rate Method and AmortizationIt builds directly on issuance and gives you the interest expense, carrying amount and cash flow effects used in later topics.
  3. 3Derecognition, Fair Value Option and Debt CovenantsOnce you can track a carrying amount, you can compute gains or losses on redemption and see why covenants matter.
  4. 4Leases: Lessee and Lessor AccountingIt reuses the present value and effective interest logic, applied to right-of-use assets and lease liabilities.
  5. 5Pensions and Defined Benefit PlansIt is the heaviest concept topic, so study it after the debt-style mechanics are comfortable.
  6. 6Share-Based CompensationIt is the most self-contained topic, so it works well last as a short fresh finish.

How to prepare Topics in Long-Term Liabilities and Equity

Aim to understand the mechanics first, then drill short questions until the direction of each effect is automatic.

  1. Refresh present value and annuity calculations on your TI BA II Plus or HP 12C, using N, I/Y, PMT, FV and CPT PV. Check that your calculator is set to one payment per period.
  2. Work one bond from issue to maturity by hand. Record carrying amount, interest expense (opening carrying amount × effective interest rate, which equals the market rate at issue when there are no issuance costs) and cash coupon each period.
  3. Make a one-page table for each topic showing effects on assets, liabilities, equity, profit and operating, investing and financing cash flows.
  4. For leases, learn the lessee model under IFRS first: a single model with depreciation on the right-of-use asset plus interest expense on the lease liability. Then note the US GAAP lessee difference, where leases are classified as finance or operating and operating leases show a single straight-line lease expense. Finally note the lessor difference, finance versus operating classification.
  5. For pensions, learn the components of the net defined benefit liability or asset and which parts go to profit or loss and which to other comprehensive income.
  6. For share-based pay, practise grant-date fair value, vesting period expense and the effect on equity. Know why options expense is not a cash cost.
  7. Finish with timed sets at about 90 seconds per question. Review each miss by naming the rule you missed, not just the right answer.

Common mistakes in Topics in Long-Term Liabilities and Equity

  • Using the coupon rate instead of the effective interest rate to compute interest expense.

    Fix: Interest expense uses the effective interest rate set at issue, applied to the opening carrying amount. It equals the market rate at issue when there are no issuance costs. The coupon only sets the cash payment.

  • Getting the direction of discount and premium amortization wrong.

    Fix: Ask where the carrying amount must end up: at face value at maturity. A discount rises to it and a premium falls to it.

  • Calculating a redemption gain or loss from face value.

    Fix: Always compare the redemption price with the carrying amount at the redemption date.

  • Mixing up IFRS and US GAAP lease treatment for lessees.

    Fix: Unless the question says US GAAP, apply IFRS. IFRS uses a single lessee model: depreciation on the right-of-use asset plus interest expense on the lease liability. US GAAP classifies lessee leases as finance or operating, and operating leases show a single straight-line lease expense.

  • Treating share-based pay as a cash expense or ignoring the vesting period.

    Fix: Remember it is non-cash and spread over vesting, with the credit going to equity.

  • Forgetting to adjust debt when comparing companies.

    Fix: Practise adding lease liabilities and pension deficits to debt and see the effect on ratios.

Last-day revision: Topics in Long-Term Liabilities and Equity

  • Bond issued at a discount means the market rate is above the coupon rate; at a premium means the market rate is below it.
  • Interest expense = opening carrying amount × effective interest rate set at issue. The effective rate equals the market rate at issue when there are no issuance costs and is higher than the market rate once costs are included. It is not the coupon rate.
  • Cash coupon = face value × coupon rate, and it does not change under the effective interest method.
  • A discount amortizes upward toward face value; a premium amortizes downward toward face value.
  • Debt issuance costs under IFRS reduce the initial carrying amount and raise the effective rate.
  • On early redemption, gain or loss = carrying amount minus the amount paid to redeem.
  • Covenants restrict actions or require ratios; a breach can make debt payable on demand.
  • Under IFRS a lessee records a right-of-use asset and a lease liability for most leases.
  • A lessor classifies a lease as finance or operating based on whether risks and rewards of ownership transfer.
  • Defined benefit plan: funded status = fair value of plan assets minus the benefit obligation.
  • Share-based pay is expensed over the vesting period at grant-date fair value.
  • Higher leases and pension deficits raise adjusted debt, so solvency ratios look weaker.

Topics in Long-Term Liabilities and Equity practice questions

Topics in Long-Term Liabilities and Equity in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Topics in Long-Term Liabilities and Equity: frequently asked questions

Is this chapter more theory or calculation?

It is a mix. Most questions test the direction of an effect or the right treatment, with a few short calculations such as carrying amount, interest expense or a redemption gain. Practise both.

Do I need to learn both IFRS and US GAAP?

Level I financial reporting questions use IFRS unless the question says US GAAP. Learn IFRS first and note the US GAAP differences the curriculum highlights.

Which topic should I spend the most time on?

Pensions usually take the longest because there are many components. Bond amortization and leases are quicker once you are fluent in present value.

Which calculator functions do I need here?

You need the time value keys on the TI BA II Plus or HP 12C: N, I/Y, PV, PMT and FV. You may also use the amortization worksheet on the BA II Plus if you practise it before exam day.