Ch 14 Flashcards
(134 cards)
1
Q
Long term debt
A
Consists of probable future sacrifices of economic benefits arising from present obligations that are not payable within a year or the operating cycle of company whichever is longer
2
Q
Example of long term liabilities
A
Bond payable
Long term notes payable
Mortgages payable
Pension liabilities
Lease liabilities
3
Q
The by laws of the corporation, it requires approval by whom before bonds or notes can be issued?
A
Board of directors and stockholders
4
Q
Does long term debt have various covenants or restrictions to protect both lenders and borrowers?
A
Yes
5
Q
Bond indenture
A
A bond arises from the contract known as bond indenture
6
Q
A bond represents a promise to pay
A
1) sum of money at a designated maturity date plus
2) periodic interest at a specified rate on maturity amount (face value)
7
Q
How are individual bonds evidenced? & what is their typical face value?
A
Evidenced by paper certificate and typically have $1000 face value
8
Q
What is the main purpose of bonds?
A
Is to borrow for the long term when the amount of capital needed is too large for one lender to supply
9
Q
A company may sell an entire bond issue to the investment bank which can act as a ?
A
Selling agent in the process of marketing the bonds.
10
Q
Investment banks may do what with the bond issue?
A
- Underwrite the entire issues by guaranteeing a certain sum to the company this taking the risk of selling bonds for whatever price they can get.
Or
- Sell the bond issue for a commission on the proceeds of the sale
11
Q
The issuing company may sell bonds to who?
A
Directly to a large institution, financial or otherwise without the aid of an underwriter
12
Q
Secured bonds
A
Are backed by a pledge of some sort of collateral
Ex: mortgage bonds are secured by a claim on real estate
13
Q
Collateral trust bonds are secured by what?
A
Stocks and bonds of other corporations
14
Q
Debenture bond
A
Is unsecured.
Ex: junk bond is unsecured and very risky so it pays a high interest rate.
15
Q
When are debenture bonds used?
A
To finance leveraged buyouts
16
Q
Term bonds
A
Bond issues that mature on a single date
17
Q
Serial bonds
A
Issues that mature in installments
Serially bonds used by school or sanitary districts, municipality or other local taxing bodies that receive money through a special levy
18
Q
Callable bonds
A
Gives the issuer the right to call and redeem bonds prior to maturity
19
Q
Convertible bonds
A
If bonds are convertible into other securities of the corporation for a specified time after issuance
20
Q
What are the two types of bonds that have been developed in an attempt to attract capital in a tight money market?
A
Commodity backed bonds and
Deep discount bonds
21
Q
Commodity backed bonds also called (asset linked bonds)
A
Are redeemable in measures of s commodity such as barrels of oil, tons of coal or ounces of rare metal.
22
Q
deep discount bonds also known as (zero interest debenture bonds)
A
Are sold at a discount that provides the buyers total interest payoff at maturity
23
Q
Registered bonds
A
Bonds issued in the name of owner &I require surrender of the certificate and issuance of a new certificate to complete the sale
24
Q
Bearer or coupon bond
A
Is not recorded in the name of the owner and may be transferred from one owner to another by mere delivery
25
Income bonds
Pays no interest unless the issuing company is profitable
26
Revenue bonds
So called bc the interest on them is paid from specified revenue sources, are most frequently issued by airports, school districts, counties, toll road authorities and governmental bodies
27
The issuance and marketing of bonds to the public takes
Weeks or even months
28
Before the company can issue and market bonds, they have to do what?
1. Issuing company must arrange for underwriters that will help market & sell bonds
2. It must obtain SEC approval of the bond issue, undergo audits & issue a prospectus
3. The company must generally have the bonds certificate printed
29
The company frequently establishes the term of bond indenture when?
In advance of sale of bonds
30
The selling price of a bond issue is generally set by?
The supply and demand of buyers & sellers, relative risk, market conditions and the state of the economy
31
The investment community values a bond at
Present value of its expected future cash flows which consists of
1. Interest
2. Principal
32
What is the rate used to compute present value of cash flows?
Interest rate that provides an acceptable return on investment commensurate with the issuers risk characteristics
33
Stated, coupon or nominal rate
Is the interest rate written in the terms of bond indenture
34
Who sets sets the stated, coupon ,nominal rate ?
The issuer of the bond
35
Face value (par value, principal amount or maturity value)
The stated rate is expressed as a percentage of the face value of bonds
36
If the rate employed by investment community (buyers) differs from the stated rate, the pv of bonds computed by buyers will differ from the
Face value of bonds
37
The difference between face value and the present value of bonds determines what?
Actual price that buyers pay for the bonds
38
Discount
If the bonds sell for less than face value
39
Premium
If the bonds sell for more than face value
40
Effective yield or market rate
Rate of interest actually earned by bond holders
41
If the bonds sell at discount the effective yield exceeds
Stated rate
42
If bonds sell at premium the effective yield is
Lower than the stated rate
43
The price at which bonds sell is typically stated as a
% of the face or par value of the bonds
44
When bonds sell at less than face value it means that investors demand a rate of interest
Higher than the state rate
45
When investors demand a date of interest higher than the stated rate, this usually occurs because
Investors can earn a greater rate on alternative investments of equal risk
46
Investor can not change stated rate so they refuse to pay
Face value for bonds
47
The investors receive interest at the stated rate computed on the face value but they can actually earn what?
An effective rate that exceeds the stated rate because they paid less than face value of bonds
48
When a company issues bonds on interest payment date at par (face value , it accrues no what?
Interest
49
Companies amortize discount and charge it to what?
Interest expense of the period of time that the bonds are outstanding
50
Straight line method
Amortizes a constant amount each period
51
Amortization of a discount increases
Interest expense
52
Amortization of a premium decrease
Interest expense
53
Can issuers call some bonds at state price after a certain date?
Yes
54
The call feature gives the issuing corporation the opportunity to do what?
To reduce its bonded indebtedness or take advantage of lower interest rates
55
Whether callable or not, what must a company do?
Must amortize any premium or discount over the bonds life maturity bc early redemption (call of bond) is not a certainty
56
When do companies usually make bond interest payments?
Semiannually on dates specified in the bond indenture
57
When companies issue bonds on other than interest payment dates, the buyer of bonds will do what?
Pay the seller the interest accrued from the last interest payment date to the date of issue.
58
What is the preferred procedure for amortization of discount or premium?
Effective interest method ( also called present value amortization)
59
The effective interest method produces a periodic interest expense equal to the
Constant % of the carrying value of the bonds
60
The effective interest method provides a more relevant measure of interest than what method?
Straight line method
61
Both the effective interest and straight line methods will result in the same what?
Total amount of interest expense over the term of the bonds
62
When the annual amounts are materially different between straight line and effect interest rate, GAAP requires the use of which one?
Effective interest method
63
Discounts on bonds payable is not an?
Asset because it does not provide any future economic benefit .
64
What does a bond discount mean?
That the company borrowed less than the face of maturity value of the bond. So it faces an actual (effective) interest rate higher than the stated (nominal) rate
65
Discount on bonds payable is a liability valuation account which means
It reduces the face or maturity amount of the related liability which is referred as a contra account
66
Premium on bonds payable is a liability valuation account which means
It adds to the face or maturity amount of the related liability and this is referred as a adjunct account
67
If the company holds bonds ( or any other form of debt security) to maturity, the company does not compute any what?
Gain or losses
68
When company does not compute any gains or losses, it will have fully amortized any what?
Premium or discount at the date the bonds mature.
Which as a result, the carrying amount will = the maturity face value of the bond
69
When maturity or face value will also equal the bonds fair value at that time, no what exists?
Gains or losses
70
In some cases, companies can do what to debt before maturity date?
Extinguish debt
71
Reacquisition price
The amount paid on extinguishment or redemption before maturity including any call premium and expense reacquisition
72
Gain from extinguishment
Is any excess of net carrying amount over the reacquisition price
73
Loss from extinguishment
Excess of the reacquisition price over the net carrying amount
74
St the time of reacquisition
The unamortized premium or discount and any costs of issue applicable to bonds must be amortized to the reacquisition date
75
It is advantageous for the issuer to acquire the entire outstanding bond issue and replace it with what?
A new bond issue bearing a lower rate of interest
76
Refunding
The replacement of an existing issuance with a new one
77
a company should recognize the difference (gain or loss) between the reacquisition price and the net carrying amount of redeemed bonds in income of the period of redemption
True
78
Short term note spayable
Expect to pay within a year or operating Cycle which ever is longer
79
Long term notes is similar in substance to bonds in that they both have
Fixed maturity dates and Carry either a stated or implicit interest rate
80
Accounting for notes and bond is quite similar
True
81
Like a bond, a note is valued at what?
Present value of its future interest and principal cash flows
82
If a company issues a zero interest bearing (non interest bearing more) solely for cash, the what must be measured?
The notes present value by the cash received
83
Implicit interest rate is
Rate that equates the cash recieved with the amounts to be paid in future
84
The issuing company records the difference between face Amount and present value as what?
A discount and amortizes that amount to interest expense over the life of the note
85
When exchanging the debt instrument for property, goods or services in a bargained transaction entered into arms length, the stated interest rate is presumed to be fair unless
1. No interest rate is stated or
2. The stated interest rate is unreasonable or
3. The stated face amount of debt instrument is materially different from the current fair value of the debt instrument
86
Company measures the present value of the debt instrument by what?
Fair value of property, goods, or services or by an amount that reasonably approximates fair value of note
87
If there is no stated rate of interest, the amount of interest is the difference between the
Face amount of the note and the fair value of the property
88
When a company cannot determine the fair value of property, and if note has no ready market. The determination of PV of note is difficult
So how do you estimate the present value of note under such circumstances ? (Imputation)
A company must approximate an applicable interest rate that may differ from the stated interest rate
89
Imputation
Process of interest rate approximation
90
Imputed interest rate
Resulting interest rate is called an imputed interest rate
91
What affects the choice of a rate?
The prevailing rates for similar instruments of issuers with similar credit ratings
Other factors include: restrictive covenants, collateral, payment schedule and the existing prime interest rate
92
Mortgage note payable
Is a promissory note secured by a document called a mortgage that pledged title to property as a security for the loan
93
Who uses mortgage notes payable more frequently?
Individuals, proprietorships, and partnerships
94
What is most common form of long term notes payable?
Mortgage note payable
95
What does the borrow usually receive for the face amount of mortgage note?
Cash
96
The amount total recieved by borrower is less than the
Face amount of the note
97
If the mortgage payable is payable at maturity , it should be reported as
Long term liability on balance sheet until such time as the approaching maturity date warrants showing it as a current liability
98
Most lenders offer variable rate mortgages
Featuring interest rates tied to changes in the fluctuating market rate
99
Why does FASB believe that fair value provides more relevant & understandable info than amortizes cost?
Bc of reflects the current cash equivalent value of financial instruments
100
If the companies choose fair value option then non current liabilities such as
Bonds and notes payable are reported at fair value
101
Companies report unrealized holding gains or losses as part of
Net income or in other comprehensive income
102
What is a unrealized holding gain or loss?
It is the net change in the fair value of the liability from on period to another exclusive of interest expense recognized
103
When the value of bonds decline what does the decline lead to?
Reduction in the bond liability and resulting unrealized holding gain which is reported as part of net income
104
The decline in value of bonds was due to market interest rate increase but the decline may have occurred because
The bonds become more likely to default
105
If the creditworthiness declines than the value of its debt also
Declines
106
FASB require that credit risk portion of gains or losses on a financial liability are reported in other
Comprehensive income
107
As indicated unrealized gains or losses due to credit risk will not affect what?
Income
108
Off balance sheet financing
Is an attempt to borrow monies in such way to prevent recording the obligations
109
Off balance sheet financing take many different forms such as
1. Non consolidated subsidiary
2. Special purpose entity (SPE)
3. Operating leases
110
Under GAAP, a parent company does not have to consolidate a subsidiary company that is what % owned?
And does the parent report assets and liabilities? If not , what is reported instead on balance sheet?
50% owned
No, it only reports investment in subsidiary
111
Special purpose entity
Is to perform a special project . To build the plant which it financed and builds he plant
112
What is another way that companies keep debt off the balance sheet?
Leasing
113
What is the major reason that companies engage in off balance sheet financing?
Many believe that removing debt enchanted the quality of the balance sheet and permits credit to be obtained more readily and at less cost
114
Loan covenants often limit the amount of debt a company can have so the company use off balance sheet financing bc
These type of commitments might not be considered in computing debt limitation
115
Many argue that the asset side of the b/s is what?
Severely understated
116
If companies report assets @ fair values then there would be less what!
Pressure would exist for off balance sheet financing arrangements
117
In response to the odd balance sheet financing arrangements, FASB has done what?
Increased disclosure (note requirements)
118
Companies must disclose what?
1. All contractual obligations in tabular format
| 2. Contingent liabilities and commitments in either textual or tabular format
119
If the company plans to refinance debt, convert it into stock or retire it from a bond retirement fund , the debt should be reported as
Non current
120
Debts to asset ratio
Measures the % of the total assets provided by creditors
121
Time interest earned
Indicates the companies ability to meet interest payments as the come due
122
Troubled debt restructuring
Occurs when a creditor for economic or legal reasons related to the debtors financial difficulties grants a confession to the debtor that it would or otherwise consider
123
A troubled debt restructuring involves one of two basis types of transactions
1. Settlement of debt at less than its carrying amount
| 2. Continuation of debt with a modification of terms
124
Settling a debt obligation can involve
Transfer of non cash assets
Issuance of the debtors stock
Cash
125
The debtor must determine the excess of the carrying amount of payable over the fair value of assets or equity transferred gain
True
126
The creditor mist detentions the excess o f the receivable over the fair value of those same assets or equity interest transferred (loss)
True
127
When does the debtor recognize a gain?
Equal to the amount of excess
128
The creditor normally charges the excess (loss) to
Allowance for doubtful accounts
129
Debtor recognizes gain or loss on disposition of assets to the extent that fair value of those assets differ from?
Carrying amount (book value)2
130
In some cases, a debtors serious short run cash flow problems will lead it to request one or a combination of the following:
1. Reduction of a stated interest rate
2. Extension of the maturity date of the face amount of the debt
3. Reduction of the face amount of debt
4. Reduction or deferral of any accrued interest
131
Creditors loss is based on what
Expected cash flows discounted st the historical effective rate of the loan
132
Debtor calculates its gains based on what?
Undiscounted amounts
133
The gain that is recorded by debtor will not equal to the loss recorded by the creditor under many circumstances
True
134
2 examples demonstrate the accounting for troubled debt restructuring by debtors and creditors
1. Debtor does not record a gain
2. The debtor does record a gain
In both instances the creditor has a loss
