Long-term debt
probable future sacrifices of economic benefits arising from present obligations that are not payable within a year or the operating cycle of the company, whichever is longer.
Examples of long-term liabilities
bonds payable
long-term notes payable
mortgages payable
pension liabilities
lease liabilities
Bond Indenture
contract from which a bond arises
Promise that a bond represents
promise to pay
(1) a sum of money at a designated maturity date
(2) periodic interest at a specified rate on a maturity amount (face value)
What is the main purpose of a bond?
Borrow for the long-term when the amount of capital needed is too large for one lender to supply.
Secured Bonds
bonds backed by a pledge of some sort of collateral
Unsecured Bonds
Bonds not backed by collateral (debenture bond)
What is a potential use for an unsecured bond?
finance leverage buyouts
Term Bonds
Bond issues that mature on a single date
Serial Bonds
Issues that mature in installments
Callable Bonds
gives the issues the right to call and redeem the bonds prior to maturity
Convertible Bonds
Bonds that are convertible into other securities of the corporation for a specified time after issuance
Commodity-Backed Bonds
Bonds redeemable in measures of a commodity, such as barrels of oil, tons of coal, or ounces of rare metal.
Deep-Discounted Bonds
Zero-interest debenture bonds--sold at a discount that provides the buyer's total interest payoff at maturity.
Registered Bonds
Bonds issued in the name of the owner and require the surrender of the certificate and issuance of a new certificate to complete a sale
Bear (Coupon) Bonds
Bond that is not recorded in the name of the owner and may be transferred from one owner to another by mere delivery.
Income Bonds
Bonds that pay no interest unless the issuing company in profitable
Revenue Bonds
Bonds upon which interest is paid from specific revenue sources.
Most frequently used by airports, school districts, counties, toll-road authorities, and governmental bodies.
Describe the process of issuing a bond
1. issuing company must arrange for underwritiers that will help market and sell the bonds
2. Must obtain the SEC's approval of the bond issue, undergo audits, and issue a prospectus
3. Company must have the bond certificates printed
What sets the selling price of a bond?
the sellign price of a bond issue is set by the supply and demand of buyers and sellers, relative risk, market conditions, and the state of the economy.
A bond is valued at:
the present value of its expected future cash flows
1. interest
2. principal
Stated, coupon, or nominal rate
the interest rate written in the terms of the bond indenture
Discount
Bonds sell for less than face value
-effective rate is lower than stated rate
Premium
Bonds sell for more than face value
-effective rate is higher than stated rate
Effective yield or market rate
the rate of interest actually earned by bondholders
When a company issues bonds on an interest payment date at par, does it accrue interest?
NO. No premium or discount exists
How does a company treat a discount on bonds?
Companies amortize the discount and charge it to interest expense over the period of time that the bonds are outstanding
Amortization of a discount ______ interest expense
increases
Amortization of a premium ______interest expense
decreases
What happens to interest when a bond is issued between interest dates?
Buyers of the bonds will pay the seller the interest accrued from the last interest payment date to the date of issue.
Under the effective-interest method, companies:
1. Compute the bond interest expense first by multiplying the carrying value of the bonds at the beginning of the period by the effective (actual) interest rate
2. Determine the bond discount or premium amortization next by comparing the bond interest exp
Costs of issuing bonds
engraving and printing costs
legal and accounting fees
commissions
promotion costs
**all charged to Unamortized Bond Issue Costs
IFRS requires that issue costs reduce the carrying amount of the bond, which increases the _____
effective-interest rate
Extinguishment of debt
Payment of debt
What are some similarities and differences between notes and bonds?
Similarities:
-fixed maturity dates
-carry stated or implicit interest rate
Differences:
-do not trade as readily
At what value is a note valued?
Present value of its future interest and principal cash flows. Company amortizes any discount or premium over the life of the note
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
Difference
How is a zero-interest bearing note's present value measured?
It measures the note's present value by the cash received for the note
Implicit interest rate
the rate that equates the cash received with the amounts to be paid in the future.
Mortgage note payable
promissory note secured by a document called a mortgage that pledges title to property as security for the loan.
Off-balance-sheet financing
an attempt to borrow monies in such a way to prevent recording the obligations
The covenants and other terms of the agreement between the issuer of bonds and the lender are set forth in the:
Bond indenture
The interest rate written in the terms of the bond indenture is known as the:
The coupon rate, nominal rate, or stated rate
A bond for which the issuer has the right to call and retire the bonds prior to maturity is a:
Callable Bonds
A bond issued in the name of the owner is a:
Registered Bond
When the effective rate of a bond is lower than the stated rate, the bond sells at a __________.
Premium
If a bond sold at 97, the market rate was:
greater than the stated rate
The effective interest calculates interest expense by:
multiplying the carrying value of the bonds by the market rate of interest
If bonds are initially sold at a discount and the straight-line method of amortization is used, interest expense in the earlier years will ________ what it would have been had the effective-interest method of amortization been used
EXCEED
Gains and losses on early extinguishment of debt are reported as other gains and losses on the ____________.
Income Statement
All of the following statements are true regarding IFRS treatment of reporting and recognition of liabilities except:
--IFRS allows the recognition of liabilities for future losses.
--For contingencies, IFRS requires insurance recoveries be "virtually cer
IFRS allowes the recognition of liabilities for future losses; Both GAAP and IFRS prohinit the recognition of liabilities for future losses.
If a company elects the fair value option for its long-term liabilities, a decrease in the fair value of a bond payable will result in an unrealized holding loss. T/F
False. When the fair value of a bond decreases, the cost to settle the debt at that point has decreased, resulting in an unrealized holding gain to the issuing company.
Are capital leases an example of "off-balance-sheet financing"?
Yes
Note disclosures for long-term debt generally include all of the following except:
--restrictions imposed by the creditor.
--names of specific creditors.
--call provisions and conversion privileges.
--assets pledged as security.
Names of specific creditors
T/F: The loss recorded by the creditor in a troubled debt restructuring is based on the expected future cash flows discounted at the current effective interest rate
FALSE: the loss recorded by the creditor in a troubled debt restructuring is based on the expected future cash flows discounted at the HISTORICAL effective interest rate
Franzia Co. prepares its financial statements using IFRS. The company has a loss contingency to accrue. The loss amount can only be reasonably estimated within a range of outcomes. No single amount within the range is a better estimate than any other amou
Mid-point of the range
The investment bank guarantees the proceeds of the bond issue will be a certain amount
Firm Underwriting
Bonds not recorded in the name of the bondholder are called:
Coupon Bonds
A Bond that matures in installments is called a:
serial bond
Bonds which do not pay interest unless the issuing company is profitable are called:
Income Bonds
The selling price of a bond is the sum of the present value of the principal and the periodic interest payments. The present values are determined by discounting using the:
Market rate;
the market rate is used to discount the cash flows in determining the selling price (proceeds) of a bond.
The printing costs and legal fees associated with the issuance of bonds should:
be accumulated in a deferred charge account and amortized over the life of the bonds
Stonehenge, Inc. issued bonds with a maturity amount of $5,000,000 and a maturity eight years from date of issue. If the bonds were issued at a premium, this indicates that:
The stated rate of interest exceeded the market rate; bonds will sell at a premium when the market rate is lower than the stated rate
Under the effective interest method, interest expense:
is the same total amount as straight-line interest expense over the term of the bonds
When bonds sell at a premium, the interest expense will be:
less than the bond interest payment;
Selling a bond at a premium results in interest expense being less than the interest payment because of the amortized premium
A debt instrument with no ready market is exchanged for property whose fair market value is currently indeterminable. When such a transaction takes place,
the present value of the debt instrument must be approximated using an imputed interest rate
When a note is exchanged for property in a bargained transaction, the stated interest rate is resumed to be fair unless:
--the stated face amount of the note is materially different from the current cash sales price for similar items.
--the stated interes
All of these options would challenge the presumption that the stated interest rate is fair
Are mortgage notes payable always reported as a long-term liabilities?
No. Mortgage notes payable in installments are reported as part current liabilities and part long-term liabilities.
T/F: Boomchickapop Company elects the fair value option for a long-term note payable. In 2014, the company reported an unrealized holding gains which was reported as a component of Other Comprehensive Income.
False: Unrealized holding gains and losses are included in net income if a company elects the fair value option.
What are some examples of off-balance-sheet financing?
Non-consolidated subsidiary
Operating lease
Special purpose entity
When a business enterprise enters into what is referred to as off-balance-sheet financing, the company
can enhance the quality of its financial position and perhaps permit credit to be obtained more readily and at less cost.
The times interest earned ratio is:
equal to income before interest and taxes divided by interest expense
T/F: When assets such as buildings and equipment are transferred in a troubled debt restructuring, the creditor should record a gain or loss for the difference between the fair value and the debtor's book value.
FALSE: Assets transferred to a creditor in connection with a troubled debt restructuring are recorded on the books of the creditor at fair value. Any gain or loss on the transfer would be recognized by the debtor.
Under IFRS, bond issuance costs, including the printing costs and legal fees associated with the issuance, should be:
recorded as a reduction in the carrying value of bonds payable.
Under IFRS, how are premiums and discounts recorded?
Bonds payable is recorded at the carrying value so no separate premium or discount account is needed. Under GAAP, bonds are recorded at the face value, and any premium or discount is recorded in a separate account
Under GAAP, how are bond issuance costs recorded?
they are recorded as an asset and amortized to expense over the terms of the bond
T/F: convertible bonds give the issuer the right to retire bonds prior to maturity
FALSE
Bond issuance costs are recorded as a:
Deferred Charge
The interest rate actually earned by bondholders is called the:
effective rate
The effective interest rate method is preferred when amortizing bond premiums and discounts: T/F
True
A long-term note is valued at its
present value
If a company elects the fair value option for a long-term notes payable, its net income will be increased ( decreased) by any unrealized holding gains (losses). T/F
True: unrealized holding gains and losses are included in net income if a company elects the fair value option
Are zero-interest bearing notes a means of accomplishing off-balance sheet financing?
No
Long-term debt that matures within one year and is to be converted into stock should be reported as:
non-current and accompanied with a note explaining the method to be used in its liquidation
When assets such as land are transferred in a troubled debt restructuring, the creditor should account for the transferred asset at:
FAIR VALUE
Under both GAAP and IFRS, bond issuance costs are recorded as deferred charges and amortized to expense over the term of the bond: T/F
FALSE
All of the following statements related to bonds are correct regarding bonds except:
--Bonds typically have a $1,000 face value.
--Bonds represent a promise to pay a sum of money plus periodic interest.
--Bonds arise from a contract known as a bond debent
Bonds usually pay interest annually
A debenture bond is an:
Unsecured bond
When bonds sell between interest payment dates, the purchaser will pay the seller:
the price of the bonds plus the accrued interest
T/F: The adjusting entry for bond premium amortization increases interest expense and decreases the balance in premium on bonds payable.
False: The adjusting entry for bond premium amortization decreases interest expense and decreases the balance in premium on bonds payable.
Both discounts on bonds payable and premium on bonds payable are:
Valuation Accounts:
Discount on bonds payable is a contra liability account and premium on bonds payable is an adjunct account.
The GAAP method of accounting for gains or losses from the early extinguishment of debt is to treat them as:
the difference between the reacquisition price and the net carrying amount of the debt which should be recognized in the period of redemption
T/F: the discount on a zero-interest-bearing note is amortized to interest expense in the period the note is issued
False: the discount on the note is amortized to interest expense over the term of the note
If a company elects the fair value option for its long-term liabilities, an increase in the fair value of a bond payable will result in an unrealized holding loss.
TRUE: When the fair value of a bond increases, the cost to settle the debt at that point has increased, resulting in an unrealized holding loss to the issuing corporation.
Is a consolidated subsidiary an example of off-balance sheet financing?
No
Which of the following is not a reason companies engage in off-balance sheet financing?
--Lower amounts of debt reported on the balance sheet offsets the lower book values reported for long-term assets.
--Higher levels of debt may violate debt covenants.
The rent expense rather than the interest and depreciation expenses reported for operating leases is not a reason companies engage in off-balance sheet financing
The numerator in the times interest earned ratio is:
Income before interest and taxes
T/F: The loss recorded by the creditor in a troubled debt restructuring is based on the expected future cash flows discounted at the current effective interest rate.
FALSE: The loss recorded by the creditor in a troubled debt restructuring is based on the expected future cash flows discounted at the historical effective interest rate.