3.10 non-current long term liabilities Flashcards
Non-current liabilities
represent a payment that will likely be made more than one year in the future.
Common types include long-term debt, finance leases, pension liabilities, and deferred tax liabilities.
The effective interest rate
defined as the relevant market rate at issuance.
Accounting for Bond Amortization, Interest Expense, and Interest Payments
Discounts or premiums arising from differences between the coupon rate and the effective interest rate are amortized over the life of a bond.
This amortization will decrease the interest expense for a bond issued at a premium and increase it for a bond issued at a discount.
Then the bond is reported at amortized cost, which will equal the face value at maturity. Companies could choose to report at fair value instead.
Amortization of a bond can be done with which methods?
the effective interest rate method or the straight-line method
the effective interest rate method
required under IFRS
Under this method, the market rate at issue is multiplied by the carrying amount to determine the interest expense.
The difference between the interest expense and the interest payment is the amortization.
Derecognition of Debt
A company may choose to retire its bonds by exercising its call option (if applicable) or simply by repurchasing the securities on the open market.
The gain or loss on extinguishment is the difference between the carrying value and the cash required to redeem the bond.
Any material extinguishment gain or loss is disclosed in a separate line on the income statement.
Debt Covenants
Covenants protect the creditors by limiting a borrower’s actions
Affirmative covenants
require actions for the borrowers
negative covenants
restricts actions for the borrowers
a lease contract must:
Identify a specific underlying asset
Allow the lessee the right to obtain most of the economic benefits from the asset over the contract term
Give the lessee control over the usage of the asset
Leasing offers several advantages compared to purchasing the asset, including:
Less costly financing with little or no down payment
Higher cost effectiveness as the effective interest rate for a lease is typically lower than that of a loan
Lower risk of obsolescence
A finance lease
effectively the purchase of an asset by the lessee with the financing provided by the seller (the lessor).
An operating lease
renting
A lease is a finance lease if any of the following conditions are met:
Ownership of the leased asset is transferred to the lessee
The lessee has the option to purchase the asset and will most likely do so
The lease term covers most of the asset’s expected useful life
The present value of lease payments at inception is close to the fair value of the asset
The leased asset is so specialized that it has no alternative use to the lessor
Under US GAAP, different accounting models are used for operating leases and finance leases.
explain how it works for a finance lease
the lease liability is reduced by the periodic lease payments using the effective interest method.
Each lease payment consists of interest expense and principal repayment, which is the difference between the lease payment and the interest expense.
The Right-Of-Use asset is amortized on a straight-line basis over the lease term
Under US GAAP, different accounting models are used for operating leases and finance leases.
explain how it works for an operating lease
the amortization expense of the ROU asset is the lease payment minus the interest expense
Thus, the total expense reported on the income statement, which is the sum of the interest expense and the amortization expense, will always equal the lease payment
The carrying values of the lease liability and the ROU asset will always equal each other.
Under IRFS, the lessee accounting model for both operating and finance leases are the same as the lessee accounting model for finance leases under US GAAP.
true or nah
tru
defined-contribution (DC)) Plan
the sponsoring company simply makes contributions, so the pension expense is easy to calculate
defined-benefit (DB) plan
the sponsor has an obligation to provide specific payments to retired employees, so accounting for pension expenses is more complicated.
The present value of future benefits is calculated by estimating the amount and timing of expected payments and applying an appropriate discount rate.
typically use a separate entity, called a pension trust fund, to administer post-retirement benefits for retired employees.
–> A pension plan will be in surplus if its assets exceed the present value of estimated future payments.
–> A pension plan’s surplus or deficit position is reflected on its sponsor’s balance sheet.
Under IFRS, the change in the net pension asset or liability is split into three components:
employees’ service cost (pension expense)
net interest expense (pension expense)
remeasurements (including actuarial gains and losses) (other comprehensive income)
Solvency
refers to the ability of a company to meet its long-term debt obligations
the two key types of solvency ratios
leverage and coverage ratios
leverage ratios
focus on the balance sheet
coverage ratios
focus on the income statement.
examples of leverage ratios
Debt-to-assets
Debt-to-capital
Debt-to-equity
Financial leverage ratio
Debt-to-assets
total debt / total assets
Debt-to-capital
total debt / (total debt + total shareholders’ equity)
debt-to-equity
total debt / total shareholders’ equity
Financial leverage ratio
average total assets / average shareholders’ equity
examples of coverage ratios
interest coverage ratio
fixed charge coverage ratio
interest coverage ratio
EBIT / Interest payments
Fixed Charge coverage ratio
(EBIT + Lease payments) / (Interest payments + Lease payments)
