14 Debt (financial liabilities)

Question 1

What is the classification of a liability callable on demand if the debt covenant is violated and it is probable that the debtor will cure violation?

Answer 1

Noncurrent liability

Question 2

List some examples of specific attributes in a covenant.

Answer 2

Minimum current ratio
Maximum debt to equity ratio

Question 3

Give an example of a response by a creditor if the debt covenant is violated by the debtor.

Answer 3

Require the debtor to pay the debt or refinance the debt.

Question 4

Describe the post-restructure interest rate for a troubled debt restructure that modifies the terms of the original debt such that the sum of restructured cash flows is greater than the book value of the original debt.

Answer 4

Rate that equates the book value of the original debt with the present value of restructured cash flows

Question 5

What aspect of a debt restructuring must be present for the restructuring to be “troubled”?

Answer 5

Creditor makes a concession, and debtor must be in financial difficulty.

Question 6

What is the amount of interest to be recognized after a troubled debt restructure that modifies the terms of the original debt such that the sum of restructured cash flows is less than the book value of the original debt?

Answer 6

No interest is recognized; all payments are considered principal payments.

Question 7

What is the amount of interest to be recognized after a troubled debt restructure modifies the terms of the original debt such that the sum of restructured cash flows is greater than the book value of the original debt?

Answer 7

Difference between the sum of restructured cash flows and the book value of the original debt

Question 8

What is the subsequent accounting treatment for restructured cash flows in a troubled debt restructure that modifies the terms of the original debt such that the sum of restructured cash flows is less than the book value of the original debt?

Answer 8

They are all treated as principal payments.

Question 9

When bonds are sold at premiums, what will interest expense reflect?

Answer 9

It will reflect periodic amortization.

Question 10

Identify at least five financial liabilities.

Answer 10

1. Accounts payable
2. Notes and bonds payable
3. Option contracts (with unfavorable terms)
4. Futures and forward contracts (with unfavorable terms)
5. Swap contracts (with unfavorable terms)

Question 11

How is total interest expense for a bond issue using an effective interest bond amortization schedule (assume a premium) computed?

Answer 11

Sum of the cash interest column less sum of amortization of premium column

Question 12

The premium associated with an investment in a callable bonds is amortized over what period?

Answer 12

The premium is amortized to the earliest call date.

Question 13

How is interest expenses on the current line of an effective interest bond amortization schedule computed, assuming semiannual interest payments?

Answer 13

Multiply one-half the yield rate at date of issuance by the book value of the bond issue on the line above the current line.

Question 14

What is the length of a bond term when bonds are issued between interest dates?

Answer 14

Period of time from issuance date to maturity date

Question 15

How many months of interest are collected at issuance when bonds are issued between interest dates?

Answer 15

Number of months between the most recent interest payment date and the date of issuance

Question 16

How are bond issue costs accounted for?

Answer 16

The are treated as a direct reduction from the debt carrying value and amortized to interest expense over the term of the bonds.

Question 17

When are bonds sold at a premium?

Answer 17

When stated rate > market rate

Question 18

When are bonds sold at a discount?

Answer 18

When stated rate < market rate

Question 19

What method is used to amortize a premium or discount on a security?

Answer 19

The effective interest method or straight-line method if not materially different

Question 20

What method is required for premium/discount amortization?

Answer 20

Effective interest method

Question 21

What is the amount of interest recognized for a period on a note calling for a face amount due at maturity, issued with an effective interest rate not equal to the stated rate?

Answer 21

Product of the effective rate at date of issuing the note and the principal balance at the beginning of the period

Question 22

List the two different methods of amortizing a discount or premium on a note.

Answer 22

1. Effective interest method
   2 Straight-line method

Question 23

Define “interest-bearing note payable.”

Answer 23

A note in which the interest element is explicitly stated

Question 24

What is the distinction between notes payable and accounts payable?

Answer 24

Time period is usually extended.
Notes have an interest element.

Question 25

When is the straight-line method not allowed for notes payable accounting?

Answer 25

Installment notes, and when the yield and stated rates are greatly different

Question 26

How should a short-term note payable refinanced every six months on a continuous basis be classified?

Answer 26

The classification of this note is current.

Question 27

What do we call the (1) maker and (2) holder of a note?

Answer 27

The maker is the buyer or borrower.
The holder is the seller or lender.

Question 28

What is the principal amount of a noninterest-bearing note?

Answer 28

Present value of the face amount discounted at the yield rate on the note

Question 29

What is the total interest expense recognized on a non-interest-bearing note?

Answer 29

Total payments less amount borrowed

Question 30

What is the amount borrowed on an installment note issued at discount?

Answer 30

Product of the periodic payment and the annuity factor for the term of the note and the yield rate on the note

Question 31

What is the amount of interest recognized for a period on an installment note (one requiring equal periodic payments that include both principal and interest)?

Answer 31

Product of the effective rate at date of issuing the note and the principal balance at the beginning of the period

Question 32

What causes a discount on a note?

Answer 32

The yield rate is greater than the stated rate.

Question 33

Is a non-interest-bearing note issued at a premium or discount?

Answer 33

Discount

Question 34

When can refinancing current debt be classified as noncurrent?

Answer 34

When the following are issued:
Issue stock to extinguish the debt.
Refinance the current liability with a noncurrent liability.
Enter into an irrevocable agreement to refinance the current liability with a noncurrent liability.

Question 35

How does an entity show intent to refinance short-term obligations?

Answer 35

The intent must be proven, possibly in the form of board of directors’ meeting minutes.

Question 36

List the three ways to meet the “ability to refinance” requirement.

Answer 36

1. Actually refinance before issuance of the financial statements.
2. Enter into a noncancelable refinancing agreement supported by a viable lender.
3. Issue equity securities replacing the debt.

Question 37

List the criteria for reclassifying current liabilities to long term.

Answer 37

The intent to refinance the short-term obligation must be proven.
The firm must demonstrate the ability to refinance the obligation.

Question 38

When determining whether a debt extinguishment results in a gain or a loss, how is that calculated?

Answer 38

Gain/Loss = Reacquisition price - Net Carrying Amount

Question 39

How are gains/losses from extinguishment of debt reported on the income statement?

Answer 39

Recognized as components of income from continuing operations

Question 40

When determining whether a debt extinguishment results in a gain or a loss, what are the financial statement adjusting items?

Answer 40

Reacquisition items to be accounted for:
Debt issue costs
Any unamortized discount/premium
Difference between debt’s face value and reacquisition amount

Question 41

List the steps to retire debt on the books.

Answer 41

Record interest, amortization of discount/premium, issue costs to date of retirement.
Remove debt and related accounts.
Record gain or loss.

Question 42

Define “debt covenant compliance.”

Answer 42

Steps taken by a debtor to meet the restriction and reporting such compliance

Question 43

Define “debt covenant.”

Answer 43

Restriction on debtor and possible responses by creditor

Question 44

What is the classification of liabilities that are due on demand?

Answer 44

Current liability