Flashcards in long term debt Deck (59)
What is the definition of a short term liability?
short-term notes payable generally have a term of at least 30 days and bear interest. Short-term notes are typically reported at face value, rather than at present value
What is the definition of a long term liability?
Long-term notes are a major source of significant debt financing, especially for smaller firms. Long-term borrowing with notes involves one or a small number of creditorsLong-term notes are reported at present value and are noncurrent liabilities if they meet that definition.
How do you treat a simple interest note?
Simple interest notes have a face value that is also the maturity amount, the amount the debtor pays when the note matures (end of note term). The stated interest rate and face value determine the annual interest to be paid
What is an installment note?
each payment includes principal and interest - have no maturity value because the last payment reduces the note payable balance to zero.
What is the stated rate on a note?
The stated rate is the rate stated in the note and determines the cash interest due on the note each period.
What is a yield or market rate for a note?
The yield rate for the note (also called effective or market rate) is the rate on notes of similar risk and term. If the note is to be reported at present value, the yield rate is used for that computation.
What happens when the yield rate exceeds the stated rate?
When the yield rate exceeds the stated rate at time of borrowing, the note is issued at a discount which is recorded in a contra account to the note
What happens when the yield rate is less than the stated rate?
When the yield rate is less than the stated rate, the note is issued at a premium and recorded in an adjunct account to the note
What happens with the discount or premium on a loan?
The discount or premium is amortized over the note term with the discount amortization increasing the net note liability and the premium amortization decreasing the net note liability
How do you account for noncurrent notes payable?
Noncurrent notes payable are issued for the present value of all future cash flows, including principal, and interest payments computed using the stated rate. The computation of present value uses the yield rate at the date of issuance.
What is the balance of a note payable account at balance sheet dates?
notes are reported at the present value of remaining payments, again using the yield rate at the date of issuance
How do you calculate periodic interest expense? (using the effective interest method)
the product of the yield rate at the date of issuance, and the beginning net note liability (present value). The difference between cash interest paid and interest expense recognized at each payment date is the amortization of discount or premium
Loan origination fees and points are amortized
How do you calculate periodic interest expense? (using the straight line interest method)
amortizes the discount or premium equally each period. This approach is allowed only if it results in interest expense amounts not materially different from the effective interest method.
What's the equation for present value of future cash flows
Value * (PV, N, I) + Interest amount *(PV of annuity, N, I)
What is a non-interest bearing notes payable?
A non-interest-bearing note payable is one in which the interest element is not explicitly stated but rather is included in the face amount of the note. These notes are recorded at the present value of future cash flows, using the market rate of interest as the discount rate
What is a bond?
A bond is a financial debt instrument that typically calls for the payment of periodic interest (although a zero coupon bond pays no interest), with the principal being due at some time in the future. The bondholder (creditor or investor) pays the issuing firm an amount based on the stated and market rates of interest and receives interest and the face amount in return, over the bond term
What are the 7 pieces of info that need to be known to account for a bond?
Face value, stated interest rate, interest payment dates, market interest rate, bond date, issuance date, maturity date
What is the face value of a bond?
The amount paid to the bondholder at maturity
What is the stated (coupon) interest rate for a bond?
The rate at which the bond pays cash interest
What is the market interest rate for a bond?
The rate equating the sum of the present values of the cash interest annuity and of the face value single payment, with the bond price.
What items are included in bond issue costs?
The cost of printing, registering, and marketing the bonds
What is a secured bond?
A secured bond issue has a claim to specific assets
What is an unsecured bond?
the bondholders are unsecured creditors and are grouped with other unsecured creditors
How do you determine the selling price of a bond? (initial book value)
The selling price of a bond is equal to the present value of future cash flows related to the bond financial instrument (principal and cash interest). The discount rate used for this calculation is the market rate of interest on the date the bonds are issued.
When will a bond issue yield a premium?
Stated Rate > Market Rate
When will a bond issue yield a discount?
Stated Rate < Market
How is the premium or discount on a bond issue treated?
Amortized over the bond term.
What two types of amortization can be used on a bond premium and discount?
effective interest rate and straight line amortization
How doe the effective interest method for bonds work?
This method first computes interest expense based on the beginning book value of the bond and the market rate at issuance. The difference between interest expense and the cash interest paid is the amortization of the discount or the premium. The market rate at issuance is always used. The rate is not changed after issuance because it represents the true interest rate over the bond term. The amortization of discount or premium is a "plug" figure.
How does the straight line method work for amortization of bond premium or discount?
This method recognizes a constant amount of amortization each month of the bond term. The straight-line method should not be used when (a) the term to maturity is quite long and there is more than a minor difference between the market and stated rates, or (b) when there is a very significant difference between the market and stated rates regardless of the length of the term.
What is a zero interest bond?
These bonds pay no interest (coupon rate is zero) but the accounting procedure remains the same except that no cash interest is paid during the term. The entire amount of interest is included in the face value, just like a noninterest-bearing note. Zero coupon bonds, and also "deep-discount" bonds with very low coupon rates, are issued at a large discount.
What happens when bonds are issued between interest dates?
When bonds are issued between interest dates, the total cash received by the company issuing the bonds will be equal to the selling price of the bonds plus interest accrued since the last interest date. This sum is called the proceeds. The accrued interest computation uses the stated rate.
What happens to bond issue costs?
These costs include legal costs, printing costs, and promotion costs. They are capitalized as a noncurrent deferred charge (asset account) and amortized to expense over the term of the bonds using the straight-line method.
What happens to bond issue costs when a bond is retired early
When bonds are retired early, any remaining unamortized bond issue costs increase the loss on retirement, or decrease the gain, because the asset no longer has any future benefit.
How are debt issue costs treated in IFRS?
Debt issue costs, called transaction costs under international accounting standards, are treated as a reduction in the proceeds from the debt.
The international treatment reduces any premium and increases any discount because proceeds are reduced
How much of the bond price is allocated to stock warrants under convertible bonds when issued?
None, the stock warrants do not have a value until the bonds are converted.
What two methods are allowed by GAAP for convertible bond conversions?
book value and market value
How does the book value method work for the conversion of convertible bonds?
Upon conversion, the remaining book value of the bonds (face value plus unamortized premium or less unamortized discount) is transferred to the capital stock account and contributed capital in excess of par account. No gain or loss is recorded.
1. If conversion occurs between interest dates, interest expense and amortization of discount or premium is recognized to the point of conversion, for both book value and market value methods.
How does the market value method work for the conversion of convertible bonds?
Upon conversion, the market value of the stock or bonds, whichever is more reliable, is allocated to the capital stock account and contributed capital in excess of par account. A gain or loss is recorded equal to the difference between the total market value recorded, and the remaining book value of the bonds.
What happens when additional consideration is given to help lead to conversion of bonds?
On conversion, the issuer recognizes an expense for the excess of the common stock and other consideration provided to the bondholder, over the fair value of the common stock that would have been issued under the original bond terms
How do you account for bonds with detachable stock warrants?
the issuing company is actually selling two securities in a single transaction. The bond price must be allocated between the bonds payable and the stock warrants based on their fair values. Any accrued interest is treated as with ordinary bonds. The portion of the bond price allocated to the bonds then determines if there is a discount or premium. The portion of the bond price allocated to the warrants is recorded in an owners' equity account. `
Fair Market Value of Bonds and Stock Warrants Can be Determined. If both fair market values are known, the proceeds are allocated based on the respective fair market values of the securities.
Fair Market Value of One Security Can be Determined. If the fair market value of only one security is known, proceeds equal to the fair market value are allocated to that security, and the incremental proceeds are allocated to the remaining security.
How do you account for bonds with nondetachable stock warrants?
there is no allocation of the bond price to the warrants.
How do you account for bonds with detachable stock warrants under IFRS?
For international reporting, the total price of the compound security must be allocated first to the debt component, with the remainder to the equity component as a residual (credit). In the case of a convertible bond (or bonds issued with warrants), the firm estimates the fair value of the bonds without the conversion feature or warrants by using the prevailing rate on similar bonds without such features to discount the future cash flows on the bond alone
What conditions must be met to classify current liabilites as noncurrent?
intent and ability
In order to have the ability to refinance, there are 3 ways to meet the requirement
Actually refinance the liability on a long-term basis. In this case, the firm replaces the current liability with a noncurrent liability.
Enter into a noncancelable refinancing agreement supported by a viable lender. The agreement must extend more than one year beyond the balance sheet date. The purpose of the agreement is to refinance the liability on a noncurrent basis.
Issue equity securities replacing the debt.
When must the liability be refinanced for international standards?
the debtor firm must exhibit its ability to refinance the current liability by taking action or having an agreement in-place before the balance sheet date. If the action is delayed until after the balance sheet date but before the financial statements are issued or available to be issued, the current liability is not reclassified
Is there a gain or loss recognized when debt is retired?
No, not when it is retired at maturity
If retired early, a gain or loss will be recognized
Does a firm recognize a gain or loss when interest rates have increased since a bond was issued?
Does a firm recognize a gain or loss when interest rates have decreased since a bond was issued?
How do you accound for the extinguishment of debt?
1. Record interest and amortization of discount or premium, and amortization of debt issue costs, to the date of extinguishment. Accrued interest from the most recent interest payment date will be included in the proceeds.
2. Remove the related debt accounts at their remaining amounts (face value, unamortized discount or premium, and any unamortized debt issue costs).
3. Record the gain or loss. Unless the gain or loss is both unusual and infrequent, it is classified as an ordinary gain or loss
Gain = debt book value - unamortized debt issue costs - cash paid
Loss = cash paid - debt book value + unamortized debt issue costs
Premium on B/P
Discount on B/P
Bond Issue Costs
What must happen for a restructuring to be considered a Troubled Debt Restructuring?
The creditor granted a concession;
The debtor is in financial difficulty, which means that without the concession, it is likely that the debtor will default.
What is a TDR?
Troubled Debt Restructuring.
A TDR is a formal restructure. A loan impairment is recorded by the creditor for TDRs and whenever the creditor believes it will receive less than under the original agreement.
How do you account for a TDR?
1. If the debt is settled, the market value of consideration transferred is less than the carrying value of the debt at date of restructure (creditor grants a concession);
2. If the debt is modified, the present value of the restructured cash flows is less than the carrying value of the debt at date of restructure (creditor grants a concession).
What is the concession for a TDR when the settlement is a restructure?
the concession is the acceptance of assets, or equity securities, with a market value less than the book value of the receivable from the debtor, in full payment of the debt
What is the concession for a TDR when the terms are modified?
the concession is the acceptance of revised debt terms that result in a new present value of remaining cash flows that is less than the book value of the receivable from the debtor.
How does the debtor record a TDR?
1. Records a gain equal to the book value of the debt, including any unpaid accrued interest, less the market value of consideration transferred in full settlement of the debt;
2. Records an ordinary gain or loss on the disposal of nonmonetary assets transferred in full settlement of the debt;
3. Removes the debt from the books;
4. Records any stock issued in settlement at the market value.
How does the creditor record a TDR?
1. Records an ordinary loss equal to the difference between the book value of the receivable and the market value of assets or stock of the debtor received;
2. Removes the receivable from the books;
3. Records assets received at market value.
How does a debtor report a modification of terms TDR?
1. In modification of terms restructures in which the nominal sum of the restructured flows is less than or equal to the book value of the debt plus accrued interest, the debtor:
a. Reduces the carrying value of the debt to the nominal sum of restructured cash flows;
b. Records a gain for the difference between the book value and the nominal sum of restructured cash flows;
c. Records no further interest; all future cash payments are returns of principal.
2. In modification of terms restructures in which the nominal sum of the restructured flows is greater than the book value of the debt plus accrued interest, the debtor:
a. Records no gain or loss and does not change the carrying value of the debt;
b. Computes the new rate of interest equating the present value of restructured cash flows and the book value of the debt;
c. Records interest expense based on the new rate for the remainder of the loan term.