3.10 non-current long term liabilities

Question 1

Non-current liabilities

Answer 1

represent a payment that will likely be made more than one year in the future.

Common types include long-term debt, finance leases, pension liabilities, and deferred tax liabilities.

Question 2

The effective interest rate

Answer 2

defined as the relevant market rate at issuance.

Question 3

Accounting for Bond Amortization, Interest Expense, and Interest Payments

Answer 3

Discounts or premiums arising from differences between the coupon rate and the effective interest rate are amortized over the life of a bond.

This amortization will decrease the interest expense for a bond issued at a premium and increase it for a bond issued at a discount.

Then the bond is reported at amortized cost, which will equal the face value at maturity. Companies could choose to report at fair value instead.

Question 4

Amortization of a bond can be done with which methods?

Answer 4

the effective interest rate method or the straight-line method

Question 5

the effective interest rate method

Answer 5

required under IFRS

Under this method, the market rate at issue is multiplied by the carrying amount to determine the interest expense.

The difference between the interest expense and the interest payment is the amortization.

Question 6

Derecognition of Debt

Answer 6

A company may choose to retire its bonds by exercising its call option (if applicable) or simply by repurchasing the securities on the open market.

The gain or loss on extinguishment is the difference between the carrying value and the cash required to redeem the bond.

Any material extinguishment gain or loss is disclosed in a separate line on the income statement.

Question 7

Debt Covenants

Answer 7

Covenants protect the creditors by limiting a borrower’s actions

Question 8

Affirmative covenants

Answer 8

require actions for the borrowers

Question 9

negative covenants

Answer 9

restricts actions for the borrowers

Question 10

a lease contract must:

Answer 10

Identify a specific underlying asset

Allow the lessee the right to obtain most of the economic benefits from the asset over the contract term

Give the lessee control over the usage of the asset

Question 11

Leasing offers several advantages compared to purchasing the asset, including:

Answer 11

Less costly financing with little or no down payment

Higher cost effectiveness as the effective interest rate for a lease is typically lower than that of a loan

Lower risk of obsolescence

Question 12

A finance lease

Answer 12

effectively the purchase of an asset by the lessee with the financing provided by the seller (the lessor).

Question 13

An operating lease

Answer 13

renting

Question 14

A lease is a finance lease if any of the following conditions are met:

Answer 14

Ownership of the leased asset is transferred to the lessee

The lessee has the option to purchase the asset and will most likely do so

The lease term covers most of the asset’s expected useful life

The present value of lease payments at inception is close to the fair value of the asset

The leased asset is so specialized that it has no alternative use to the lessor

Question 15

Under US GAAP, different accounting models are used for operating leases and finance leases.

explain how it works for a finance lease

Answer 15

the lease liability is reduced by the periodic lease payments using the effective interest method.

Each lease payment consists of interest expense and principal repayment, which is the difference between the lease payment and the interest expense.

The Right-Of-Use asset is amortized on a straight-line basis over the lease term

Question 16

Under US GAAP, different accounting models are used for operating leases and finance leases.

explain how it works for an operating lease

Answer 16

the amortization expense of the ROU asset is the lease payment minus the interest expense

Thus, the total expense reported on the income statement, which is the sum of the interest expense and the amortization expense, will always equal the lease payment

The carrying values of the lease liability and the ROU asset will always equal each other.

Question 17

Under IRFS, the lessee accounting model for both operating and finance leases are the same as the lessee accounting model for finance leases under US GAAP.

true or nah

Answer 17

tru

Question 18

defined-contribution (DC)) Plan

Answer 18

the sponsoring company simply makes contributions, so the pension expense is easy to calculate

Question 19

defined-benefit (DB) plan

Answer 19

the sponsor has an obligation to provide specific payments to retired employees, so accounting for pension expenses is more complicated.

The present value of future benefits is calculated by estimating the amount and timing of expected payments and applying an appropriate discount rate.

typically use a separate entity, called a pension trust fund, to administer post-retirement benefits for retired employees.

–> A pension plan will be in surplus if its assets exceed the present value of estimated future payments.

–> A pension plan’s surplus or deficit position is reflected on its sponsor’s balance sheet.

Question 20

Under IFRS, the change in the net pension asset or liability is split into three components:

Answer 20

employees’ service cost (pension expense)

net interest expense (pension expense)

remeasurements (including actuarial gains and losses) (other comprehensive income)

Question 21

Solvency

Answer 21

refers to the ability of a company to meet its long-term debt obligations

Question 22

the two key types of solvency ratios

Answer 22

leverage and coverage ratios

Question 23

leverage ratios

Answer 23

focus on the balance sheet

Question 24

coverage ratios

Answer 24

focus on the income statement.

Question 25

examples of leverage ratios

Answer 25

Debt-to-assets

Debt-to-capital

Debt-to-equity

Financial leverage ratio

Question 26

Debt-to-assets

Answer 26

total debt / total assets

Question 27

Debt-to-capital

Answer 27

total debt / (total debt + total shareholders’ equity)

Question 28

debt-to-equity

Answer 28

total debt / total shareholders’ equity

Question 29

Financial leverage ratio

Answer 29

average total assets / average shareholders’ equity

Question 30

examples of coverage ratios

Answer 30

interest coverage ratio

fixed charge coverage ratio

Question 31

interest coverage ratio

Answer 31

EBIT / Interest payments

Question 32

Fixed Charge coverage ratio

Answer 32

(EBIT + Lease payments) / (Interest payments + Lease payments)