10. Long-term liabilities

Question 1

Long-term liability

Answer 1

An obligation that will not be satisfied within one year or the current operating cycle.

Question 2

Debenture bonds

Answer 2

Bonds that are not backed by specific collateral. Normally the bond certificate indicates the collateral on the loan.

Question 3

Serial bonds

Answer 3

Bonds that do not all have the same due date; a portion of the bonds comes due each time period.

Question 4

Callable bonds

Answer 4

Bonds that may be redeemed or retired before their specified due date.

Question 5

Face value

Answer 5

The principal amount of the bond as stated on the bond certificate.

Question 6

Face rate of interest

Answer 6

The rate of interest on the bond certificate.

Question 7

Market rate of interest

Answer 7

The rate that investors could obtain by investing in other bonds that are similar to the issuing firm’s bonds.

Question 8

Bond issue price

Answer 8

The present value of the annuity of interest payments plus the present value of the principal.

Question 9

Premium

Answer 9

The excess of the issue price over the face value of the bonds.

Question 10

Discount

Answer 10

The excess of the face value of bonds over the issue price.

Question 11

Carrying value

Answer 11

The face value of a bond plus the amount of unamortized premium or minus the amount of unamortized discount.
It is equal to the issue price of the bond in the first year. The next year the carrying value will increase/decrease by the amount of amortized discount/premium, i.e. the difference between the interest of the bond and the interest one could get by investing in similar bonds on the market.

Question 12

Effective interest method of amortization

Answer 12

The process of transferring a portion of the premium or discount to interest expense; this method results in a constant effective interest rate. The effective rate is equal to annual interest expense divided by the carrying value.

Question 13

Redemption of bonds

Answer 13

The retirement of a bond by repaying the principal amount.

Question 14

Gain or loss on redemption

Answer 14

The difference between the carrying value and the redemption price
at the time bonds are redeemed.

Question 15

Capital lease

Answer 15

A lease that is recorded as an asset by the lessee. For this to be the case it has to meet one or more of the following criteria:

1. The lease transfers ownership of the property to the lessee at the end of the lease term.
2. The lease contains a bargain-purchase option to purchase the asset at an amount lower than its fair market value.
3. The lease term is 75% or more of the property’s economic life.
4. The present value of the minimum lease payments is 90% or more of the fair market value of the property at the inception of the lease.

Question 16

Operating lease

Answer 16

A lease that does not meet any of the four criteria for capital lease and is not recorded as an asset by the lessee.

Question 17

Dept-to-Equity Ratio

Answer 17

total liabilities divided by total stockholders’ equity.

Question 18

Times Interest Earned Ratio

Answer 18

income before interest and tax divided by interest expense