Long Term Debt pg 356-401

Question 1

Types of Notes Payable

Answer 1

1. Simple Interest Notes: maturity value, interest pd annually and face value pd @ maturity date
2. Installment Notes: Each pmt has principle & interest so no maturity date bc last pmt reduces note to zero (used to purchase plant assets - mortgage note is example)

Question 2

Interest Rates on Notes

Answer 2

> > Both types NP have two interest rates. Interest pd is called stated rate..Yield/Effective/Market rate is rate of notes w/ similar risk & term this is rate used if need to report to PV

• -Yield rate >stated rate @ time of borrowing note is issued @ discount (recorded in contra acct to note)
• -Yield rate>Premium/Discount is amortized

Question 3

Noncurrent NP

Answer 3

• -Issued @ PV future cash flows
• -Effective Interest Method: (required by GAAP) Periodic interest exp is computed as product of yield rate at date of issuance and beg net note liability (PV)..Diff b/w cash interest pd and interest exp is amortization of premium/discount
• -Straight-line Method: Only allowed if results in interest exp amts not materially different from EIM– Not ok for non-interest bearing notes
• -Gross Method: Separates FV & discount/premium in diff accts
• -Net Method: Uses one combine net acct which is PV and net note liability under EIM
• Fair Value Method: Described in Bond lesson

Question 4

Non interest bearing note

Answer 4

• -Interest Rate is included in face value of the note

- -Recorded at PV future cash flows

Question 5

Zero Coupon Bonds

Answer 5

Just like non-interest bearing notes

Question 6

Bonds Issued between Interest Dates

Calculation of Proceeds

Answer 6

Total cash received by company issuing bonds = selling price plus interest accrued since last interest date.

Used stated rate for accrued interest computation

Question 7

Bond Issue Costs

Answer 7

• Legal Costs, Printing Costs, Promotion Costs

- Capitalized as noncurrect deferred change and amortized to expense over term of bond using straight line

Question 8

Types of Bonds

Answer 8

1. Secured vs Unsecured: Secured bond issue has claim to specific assets. If not secured then creditor grouped w/ other unsecured creditors-debentures (backed only by credit rating of issuing firm)
2. Serial vs Single Maturity Term: Serial bond matures at regular or staggered intervals. Principal is pd gradually instead of all at once (just like single maturity or term bond)
3. Callable vs Redeemable: An issuer can retire callable bonds before maturity at specified price. Bondholder can require redeemable bond to be retired early.
4. Convertible vs. Nonconvertible: Convertible bond can be converted into capital stock by bondholder (nonconvertible cannot)

Question 9

Selling Price

Answer 9

equal to present value future cash flows related to bond financial instrument (principal and cash interest) Use market rate on dates bonds are issued for discount rate.

Question 10

Effective Interest Method

Answer 10

First computes interest expense based on beginning book value and market rate. Difference b/w interest expense and cash interest paid (uses Face value of bond and stated/coupon rate) is premium/discount on bond

Question 11

Straight-line

Answer 11

• Do not use when 1) term to maturity is quite long and 2)Major difference b/w market and stated rates (such as zero coupon bonds)
• Calculations: total discount on bond–( Face value -book value)–/total number months to maturity in entire bond * number months since last interest pmt

Question 12

Total interest cost to the firm

Answer 12

Premium: Total cash interest less total premium
Discount: Total cash interest less discount

Question 13

Fair Value option on Bonds

Answer 13

-Unrealized gain/loss recorded in income yr occur
-Must make decision on date of issuance and is irrevocable
-Can be applied to all or subset of debt instruments even w/in same type
- If chosen accting continues as would w/out FV option, but in addition firm increases/decreases resulting book liability to Fair Value
-If no market rate on security use current market rate of interest on similar debt to estimate FV
-Fair Value adj is unrealized gain/loss and included in income from continuing operations
> Adjustment has increased firm has loss–adjustment decrease firm has a gain

Question 14

Convertible bonds

Answer 14

• Purchase single debt security may be converted to equity security.
• When issued entire proceeds are treated as selling price of bond

Question 15

Convertible bond methods

Answer 15

1. Book Value: No gain or loss all transferred to capital stock and contributed capital in excess of par
2. Market Value: Market value of stock or bond (whichever more reliable) allocated to capital stock account and contributed capital in excess of par. GAIN/LOSS IS recognized equal to diff b/w total market value recorded and remaining book value of bonds

• -If conversion b/w interest dates interest exp and amortization of discount/premium is recognized to pt of conversion for both methods
• -Is possible firms may offer incentives to have bonds converted–if happens issuer recognizes expense for excess Common stock that would have been issued under bondholder over fair value of common stock would have been issued under original bond terms

Question 16

Bonds w Detachable Warrants

Answer 16

Used to increase marketability. Means holder can purchase stock @ fixed price for limited time

Question 17

Recording Issuance of Bonds w/ detachable warrants

Answer 17

-Allocated on Fair Value.
-Accrued interest treated just like ordinary bonds–as a separate liability
-Price is allocated to bonds then determine if a discount or premium. Price allocated to warrant is recorded in owners equity acct.
-May sell for price over 100, but after allocating portion of proceeds to warrants amt less than Face Value may be allocated to bonds resulting in discount (meaning just bc price over 100 doesn’t mean premium happened)
-Subsequent accounting for bonds is unaffected by warrants…Discount/Premium amortized as before, if warrants exercised cash is debited @ exercise price and detachable stock warrant is debited (closed) CS and contributed capital in excess of par are credited.
>If warrants expire and no exercise balance of detachable stock warrants is debited to contributed capital from expiration of stock warrants

Question 18

Criteria for Reclassifying CL to Non CL

Answer 18

1. Intent: intent to refinance must be proven
2. Ability: Must be able demo ability before issuance of FS. Must occur b/w BS date and date FS are issued or available to be issued
   > Actually refinance liability on LT basis.
   > Enter into noncancelable refinancing agreement supported by viable lender
   > Issue equity securities replacing debt

Question 19

Retiring Debt

Answer 19

• Most Gains/Losses from retirement of debt are included in income from continuing operations
• Interest rates and debt price are inversely related–If interest rates go up debt price goes down and gain recognized

Question 20

When is Debt considered extinguished (2 conditions)

Answer 20

1. Debtor pays creditor & is relieved of any obligation related to debt.
2. Debtor is legally released from being primary obligor of liability. (may be done by creditor or by courts) (ex. release from mortgage note upon sale of related property)

Question 21

Accounting for Extinguishment

Answer 21

1. Record interest & amortization of discount/premium, and amortization of of debt issue costs to date of extinguishment–Accrued interest from most recent interest pmt date will be included in proceeds
2. Remove related debt accts @ remaining amts
3. Record gain/loss-classified as ordinary g/l unless both unusual and infrequent
   >Gain = debt book value - unamortized debt issue costs-cash paid
   >Loss=cash paid-debt book value+unamoritized debt issue costs

Question 22

Concession/Troubled Debt Restructuring

Answer 22

-Concession: When crditor agrees to terms that are less favorable than under original debt agreement.
-When Concession happens Troubled Debt Restructuring happens IF
> Creditor granted concession
> Debtor is in financial difficulty and w/o concession likely debtor will default

Question 23

Two was to restructure TDR (troubled debt restructuring)

Answer 23

1. Settled: Market Value of consideration transferred is less than CV of debt @ date of restructure.
   > concession is acceptance of assets/equity securities w/ market value less than book value of receivables from debtor in full pmt of debt
2. Modified: Present value of restructured cash flow is less than CV of debt @ date of restructure
   > concession is acceptance of revised debt terms result in present value of remaining cash flows less than book value of receivable from debtor

Question 24

Settlement of Troubled Debt Restructures Accounting for Debtor & Creditor–look @ table on pg 396

Answer 24

Debtor:
1. Records gain = to BV of debt, including unpaid accrued interest, less market value of consideration transferred in full settlement of debt
2. Records ordinary gain/loss on disposal of nonmonetary assets transferred in full settlement debt
3. Removes debt from books
4. Records stock issued in settlement @ market value
Creditor:
1. Records ordinary loss = diff b/w BV of receivable & market value of assets or stock of debtor received
2. Removes receivable from books
3. Records assets received @ market value

Question 25

Modification of Troubled Debt Restructures Accounting for Debtor--look @ table on pg 396

Answer 25

A. Modification when nominal sum of restructured flows is LESS THAN or EQUAL TO book value plus accrued interest. Debtor: 1. Reduces CV of debt to nominal sum 2. Records gain for diff b/w BV and nominal sum 3. Record no further interest all future pmts are principle B. Modification terms when nominal sum is GREATER THAN BV of debt plus accrued Interest: 1. Records no Gain/Loss & doesn't change CV 2. Computes new rate of interest equating PV of restructured cash flows and BV of debt 3. Records interest expense based on new rate for remainder of loan term

Question 26

Page 399 Learn how to find IRR (internal rate of return) on spreadsheet

Answer 26

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Question 27

Debt Covenant Compliance

Answer 27

- Part of larger contract underlying debt instrument. - Covenant (aka restriction) is section of contract that describes responses available to creditor if certain events/conditions occur- may allow creditor to call debt and collect pmt immediately - Description of covenant is disclosed in notes to debtors FS

Question 28

Attributes used in Covenants

Answer 28

If debtor violates min/max covenant can come into effect: 1. Current ratio: (CA/CL) measure of liquidity-drops below 2.0 for example 2. Working Capital: (CA-CL), Min level specified 3. Income Measures (income before tax, net income, income from continuing oper, EBITDA) Min level 4. Interest coverage ratio: (EBITDA/interest exp) Min level 5. Retained Earnings/Total owners equity balance: Min level 6. Debt to equity ratio: Max level 7. Total Debt: Max level 8. Interest Exp: Max level 9. Total assets/net assets: Min level