Topic 11: Non-current liabilities Flashcards Preview

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Flashcards in Topic 11: Non-current liabilities Deck (25)
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1
Q

Reporting liabilities on the balance sheet:

Economic consequences

A

Shareholders are affected by liabilities through:

① Seniority of interest payments over dividend payments.
② Debt covenants that influence investing, financing, and operating
activities that a company may undertake.
③ Seniority of creditors’ claims on assets over shareholders’ claims in the event of liquidation.

Creditors are concerned with:
① The seniority of liabilities.
② The presence of sufficient assets to cover liabilities.
③ The protection of their investments through debt covenants.

Managers:
① Liabilities are an important source of capital for operating, investing, and financing activities.
② Debt covenants may restrict investing, financing, and operating decisions that the managers may make.
③ Credit raitng is affected by the amount of debt a company has and the ability to manage this debt. Improved credit ratings can lead to lower borrowing costs.
④ Management has strong incentive to manage the balance sheet by using “off-balance-sheet financing”

Auditors are concerned with ascertaining that liabilities are not materially understated.
-Materially understated liabili7es could result in the auditor being sued.

2
Q

Loan conventants specify mutual expectatinos of the borrowe and lender by speciying actions the borrower will and will not take.

A

① Require certain action
② Preclude certain action
③ Require maintenance of certain financial ratios

3
Q

Types of collaterals

A
  • Receivables: Trade receivable are the most desirable form of security because they are the msot liquid
  • Inventory: The desirability of inventory as security varies widely. Bank typically lend up to 60% on raw materials, 50% on finished goods and 20% on work in process.
  • Machinery and equipment: Less desirable as collateral (used, stored, insured and marketed). Banks typically will lend up to 50% of the estimated value.
  • Real estate: The value of real estate as collateral varies considerably. Banks will often lend up to 80% of the appraised value readily saleable real estate.
4
Q

How Long-Term Notes Payable differs and are similar to Bonds?

A

Similar to bonds: valued at the present value of its future interest and principal cash flows. Fixed maturity
Differ from bonds: Not traded in public security markets

5
Q

Mortgage Payable and how they differ from notes payable

A

Most common form of long-term notes payable
Payable in full at maturity or in installments

Differs from notes payable:

  • Secure with specific assets = Backed with a security interest in specific property
  • Legal title of assets will be transferred if the mortgage isn’t paid on schedule.
6
Q

Bonds Payable

A

Large companies need large amounts of money to finance operations:

  • borrow long-term from banks
  • issue bonds payable to multiple lenders to raise the money
7
Q

What show the bond certificate?

A
  • the name of the company that borrowed the money
  • the principal of face value
  • the maturity date
  • stated interest rate
8
Q

Types of bonds

A

§ Term bonds: Mature on a single date
§ Serial bonds: Mature in installments at regular intervals
§ Callable bonds: Issuer has the right to call and rezire the bonds prior to maturity

§ Secured bonds: Backed by assets if company fails to pay
§ Debenture: Unsecured; not backed by company’s assets

§ Convertible: Bonds convertible into other securities of the company

§ Income bonds: pay no interest unless the issuing company is profitable
§ Revenue bonds: the interest is paid from specific revenue sources

9
Q

Steps for issuance of bonds

A

company must:

  • Arrange for underwritters
  • Obtain regulatory approval of the bond issue, undergo audits, and issue prospectus
  • Have bond certificates
10
Q

A company can sell the bond to:

A

i) An investment bank that act as selling agent
1) Firm underwritting: Investment bank underwrites the entires issu and guarantees a certain sum to the company
2) Best-Effort underwritting: Investment bank sells the bond issue taking a commission on the proceeds of the sale.

ii) Financial institution ( private placement)

11
Q

Categories of bond prices

A

Face value: price = face value

Discount price: price < face value => contra account: discount on bond payable

Premium price: price > face value => contra account: premium on bond payable

12
Q

Difference between Stated interest rate and Market interest rate

A

Stated Interest rate:
-Rate used to calculate interest the borrower pays each year

Market interest rate:
-Rate that provides an acceptable retur commensurate with the issuer’s risk

13
Q

Steps for Journal entry of bonds

A

① Issue of bonds
② Payment of semiannual interest and amortized discount/premium
③ Payoff of bonds at maturity

14
Q

Bonds Payable at Face Value

Smart Touch has $100,000 of 9% bonds payable that mature in 5 years. Smart Touch issues these bonds at maturity (par) value on January 1, 2013.

A

① Issue of bonds

② Interest payments: semi-annually (every 6 months)

③ Maturity date: the principal is paid back

15
Q

What causes a bond to priced:
• At maturity (face or par) value?
• A discount
• A premium

A
  • At maturity: The stated interest rate on the bond = the market interest rate
  • A discount : The stated interest rate on the bond < interest rate
  • A premium : The stated interest rate on the bond > interest rate
16
Q

Characteristic of discount on bond payable

A
  • Contra account to bond payable
    => decreases carrying amount (book value) of bonds
    => is additional interest expense (added to interest expense over the life of bonds)

Interest expense = stated interest + amortization of discount

17
Q

Characteristic of premium on bond payable

A

-Adjunct account to Bonds Payable
=> increases carrying amount (book value) of Bonds
=> reduces interest expense over the life of bonds

Interest expense = stated interest - amortization of discount

18
Q

What happens to the bonds’ carrying amount when bonds payable are issued at
• At maturity (face or par) value?
• A discount
• A premium

A
  • At maturity: Carrying amount stays at maturity (face or par) value
  • A discount : Carrying amount decreases gradually to maturity value
  • A premium : Carrying amount increases gradually to maturity value
19
Q

What is off-balance-sheet financing?

A

Arrangements to finance assest and create obligation that do not appear on the balance sheet.

20
Q

Forms of off-balance-sheet financing

A

• Non-Consolidated Subsidiary
=> IFRS: a parent company does no have to consolidate subsidiary that is less than 50% owned.

• Special Purpose Entity (SPE)

• Operating Leases:
=>Instead of buying the assets, companies lease them

21
Q

Benefits of Leasing

A
Flexibility
Avoid obsolescence
Improves Cash flow
Tax advantages
Off-balance-sheet financing
Used equipment
22
Q

Situations that normally lead to a lease being classified as a finance lease

A
  • Transfer of ownership of the asset to the lessee by the end of the lease term
  • The lesses has the option to purchase the asset at a price that is lower than the fair value at the date the option becomes exercisable (bargain purchase option)
  • The lease term is for the major part of the economic life of the asset even if title is not transferred
  • Asset is specialized to lesses’s needs, costly to modify for other use

-At the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all the fair value of the leased asset

23
Q

Other factors influencing leasing decisons?

A

Off balancing financing

Tax advantages

Flexible payment option

24
Q

How shall lesses recognise finance leases

A

As assets and liabilities in their balance sheet at amounts equal to :

  • The fair value of the leased property
  • If it is lower, the present value of the minimum lease payments
25
Q

Disclosure fo Lease

A
  • Future minimum lease payments in the aggragate and for period to 1 year, from over 1 up to 5 years and over 5 years.
  • Total of future minimum sublease paymenst expected to be received
  • Lease and sublease payments recognised as an expense in the period
  • General description of the lesses’s lease arrangements