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Acct 302 > Ch 14 > Flashcards

Ch 14 Flashcards

1
Q

Long term debt

A

Consists of probable future sacrifices of economic benefits arising from present obligations that are not payable within a year or the operating cycle of company whichever is longer

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2
Q

Example of long term liabilities

A

Bond payable

Long term notes payable

Mortgages payable

Pension liabilities

Lease liabilities

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3
Q

The by laws of the corporation, it requires approval by whom before bonds or notes can be issued?

A

Board of directors and stockholders

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4
Q

Does long term debt have various covenants or restrictions to protect both lenders and borrowers?

A

Yes

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5
Q

Bond indenture

A

A bond arises from the contract known as bond indenture

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6
Q

A bond represents a promise to pay

A

1) sum of money at a designated maturity date plus

2) periodic interest at a specified rate on maturity amount (face value)

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7
Q

How are individual bonds evidenced? & what is their typical face value?

A

Evidenced by paper certificate and typically have $1000 face value

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8
Q

What is the main purpose of bonds?

A

Is to borrow for the long term when the amount of capital needed is too large for one lender to supply

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9
Q

A company may sell an entire bond issue to the investment bank which can act as a ?

A

Selling agent in the process of marketing the bonds.

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10
Q

Investment banks may do what with the bond issue?

A
  1. Underwrite the entire issues by guaranteeing a certain sum to the company this taking the risk of selling bonds for whatever price they can get.

Or

  1. Sell the bond issue for a commission on the proceeds of the sale
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11
Q

The issuing company may sell bonds to who?

A

Directly to a large institution, financial or otherwise without the aid of an underwriter

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12
Q

Secured bonds

A

Are backed by a pledge of some sort of collateral

Ex: mortgage bonds are secured by a claim on real estate

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13
Q

Collateral trust bonds are secured by what?

A

Stocks and bonds of other corporations

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14
Q

Debenture bond

A

Is unsecured.

Ex: junk bond is unsecured and very risky so it pays a high interest rate.

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15
Q

When are debenture bonds used?

A

To finance leveraged buyouts

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16
Q

Term bonds

A

Bond issues that mature on a single date

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17
Q

Serial bonds

A

Issues that mature in installments

Serially bonds used by school or sanitary districts, municipality or other local taxing bodies that receive money through a special levy

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18
Q

Callable bonds

A

Gives the issuer the right to call and redeem bonds prior to maturity

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19
Q

Convertible bonds

A

If bonds are convertible into other securities of the corporation for a specified time after issuance

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20
Q

What are the two types of bonds that have been developed in an attempt to attract capital in a tight money market?

A

Commodity backed bonds and

Deep discount bonds

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21
Q

Commodity backed bonds also called (asset linked bonds)

A

Are redeemable in measures of s commodity such as barrels of oil, tons of coal or ounces of rare metal.

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22
Q

deep discount bonds also known as (zero interest debenture bonds)

A

Are sold at a discount that provides the buyers total interest payoff at maturity

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23
Q

Registered bonds

A

Bonds issued in the name of owner &I require surrender of the certificate and issuance of a new certificate to complete the sale

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24
Q

Bearer or coupon bond

A

Is not recorded in the name of the owner and may be transferred from one owner to another by mere delivery

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25
Q

Income bonds

A

Pays no interest unless the issuing company is profitable

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26
Q

Revenue bonds

A

So called bc the interest on them is paid from specified revenue sources, are most frequently issued by airports, school districts, counties, toll road authorities and governmental bodies

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27
Q

The issuance and marketing of bonds to the public takes

A

Weeks or even months

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28
Q

Before the company can issue and market bonds, they have to do what?

A
  1. Issuing company must arrange for underwriters that will help market & sell bonds
  2. It must obtain SEC approval of the bond issue, undergo audits & issue a prospectus
  3. The company must generally have the bonds certificate printed
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29
Q

The company frequently establishes the term of bond indenture when?

A

In advance of sale of bonds

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30
Q

The selling price of a bond issue is generally set by?

A

The supply and demand of buyers & sellers, relative risk, market conditions and the state of the economy

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31
Q

The investment community values a bond at

A

Present value of its expected future cash flows which consists of

  1. Interest
  2. Principal
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32
Q

What is the rate used to compute present value of cash flows?

A

Interest rate that provides an acceptable return on investment commensurate with the issuers risk characteristics

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33
Q

Stated, coupon or nominal rate

A

Is the interest rate written in the terms of bond indenture

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34
Q

Who sets sets the stated, coupon ,nominal rate ?

A

The issuer of the bond

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35
Q

Face value (par value, principal amount or maturity value)

A

The stated rate is expressed as a percentage of the face value of bonds

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36
Q

If the rate employed by investment community (buyers) differs from the stated rate, the pv of bonds computed by buyers will differ from the

A

Face value of bonds

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37
Q

The difference between face value and the present value of bonds determines what?

A

Actual price that buyers pay for the bonds

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38
Q

Discount

A

If the bonds sell for less than face value

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39
Q

Premium

A

If the bonds sell for more than face value

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40
Q

Effective yield or market rate

A

Rate of interest actually earned by bond holders

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41
Q

If the bonds sell at discount the effective yield exceeds

A

Stated rate

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42
Q

If bonds sell at premium the effective yield is

A

Lower than the stated rate

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43
Q

The price at which bonds sell is typically stated as a

A

% of the face or par value of the bonds

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44
Q

When bonds sell at less than face value it means that investors demand a rate of interest

A

Higher than the state rate

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45
Q

When investors demand a date of interest higher than the stated rate, this usually occurs because

A

Investors can earn a greater rate on alternative investments of equal risk

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46
Q

Investor can not change stated rate so they refuse to pay

A

Face value for bonds

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47
Q

The investors receive interest at the stated rate computed on the face value but they can actually earn what?

A

An effective rate that exceeds the stated rate because they paid less than face value of bonds

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48
Q

When a company issues bonds on interest payment date at par (face value , it accrues no what?

A

Interest

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49
Q

Companies amortize discount and charge it to what?

A

Interest expense of the period of time that the bonds are outstanding

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50
Q

Straight line method

A

Amortizes a constant amount each period

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51
Q

Amortization of a discount increases

A

Interest expense

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52
Q

Amortization of a premium decrease

A

Interest expense

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53
Q

Can issuers call some bonds at state price after a certain date?

A

Yes

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54
Q

The call feature gives the issuing corporation the opportunity to do what?

A

To reduce its bonded indebtedness or take advantage of lower interest rates

55
Q

Whether callable or not, what must a company do?

A

Must amortize any premium or discount over the bonds life maturity bc early redemption (call of bond) is not a certainty

56
Q

When do companies usually make bond interest payments?

A

Semiannually on dates specified in the bond indenture

57
Q

When companies issue bonds on other than interest payment dates, the buyer of bonds will do what?

A

Pay the seller the interest accrued from the last interest payment date to the date of issue.

58
Q

What is the preferred procedure for amortization of discount or premium?

A

Effective interest method ( also called present value amortization)

59
Q

The effective interest method produces a periodic interest expense equal to the

A

Constant % of the carrying value of the bonds

60
Q

The effective interest method provides a more relevant measure of interest than what method?

A

Straight line method

61
Q

Both the effective interest and straight line methods will result in the same what?

A

Total amount of interest expense over the term of the bonds

62
Q

When the annual amounts are materially different between straight line and effect interest rate, GAAP requires the use of which one?

A

Effective interest method

63
Q

Discounts on bonds payable is not an?

A

Asset because it does not provide any future economic benefit .

64
Q

What does a bond discount mean?

A

That the company borrowed less than the face of maturity value of the bond. So it faces an actual (effective) interest rate higher than the stated (nominal) rate

65
Q

Discount on bonds payable is a liability valuation account which means

A

It reduces the face or maturity amount of the related liability which is referred as a contra account

66
Q

Premium on bonds payable is a liability valuation account which means

A

It adds to the face or maturity amount of the related liability and this is referred as a adjunct account

67
Q

If the company holds bonds ( or any other form of debt security) to maturity, the company does not compute any what?

A

Gain or losses

68
Q

When company does not compute any gains or losses, it will have fully amortized any what?

A

Premium or discount at the date the bonds mature.

Which as a result, the carrying amount will = the maturity face value of the bond

69
Q

When maturity or face value will also equal the bonds fair value at that time, no what exists?

A

Gains or losses

70
Q

In some cases, companies can do what to debt before maturity date?

A

Extinguish debt

71
Q

Reacquisition price

A

The amount paid on extinguishment or redemption before maturity including any call premium and expense reacquisition

72
Q

Gain from extinguishment

A

Is any excess of net carrying amount over the reacquisition price

73
Q

Loss from extinguishment

A

Excess of the reacquisition price over the net carrying amount

74
Q

St the time of reacquisition

A

The unamortized premium or discount and any costs of issue applicable to bonds must be amortized to the reacquisition date

75
Q

It is advantageous for the issuer to acquire the entire outstanding bond issue and replace it with what?

A

A new bond issue bearing a lower rate of interest

76
Q

Refunding

A

The replacement of an existing issuance with a new one

77
Q

a company should recognize the difference (gain or loss) between the reacquisition price and the net carrying amount of redeemed bonds in income of the period of redemption

A

True

78
Q

Short term note spayable

A

Expect to pay within a year or operating Cycle which ever is longer

79
Q

Long term notes is similar in substance to bonds in that they both have

A

Fixed maturity dates and Carry either a stated or implicit interest rate

80
Q

Accounting for notes and bond is quite similar

A

True

81
Q

Like a bond, a note is valued at what?

A

Present value of its future interest and principal cash flows

82
Q

If a company issues a zero interest bearing (non interest bearing more) solely for cash, the what must be measured?

A

The notes present value by the cash received

83
Q

Implicit interest rate is

A

Rate that equates the cash recieved with the amounts to be paid in future

84
Q

The issuing company records the difference between face Amount and present value as what?

A

A discount and amortizes that amount to interest expense over the life of the note

85
Q

When exchanging the debt instrument for property, goods or services in a bargained transaction entered into arms length, the stated interest rate is presumed to be fair unless

A
  1. No interest rate is stated or
  2. The stated interest rate is unreasonable or
  3. The stated face amount of debt instrument is materially different from the current fair value of the debt instrument
86
Q

Company measures the present value of the debt instrument by what?

A

Fair value of property, goods, or services or by an amount that reasonably approximates fair value of note

87
Q

If there is no stated rate of interest, the amount of interest is the difference between the

A

Face amount of the note and the fair value of the property

88
Q

When a company cannot determine the fair value of property, and if note has no ready market. The determination of PV of note is difficult

So how do you estimate the present value of note under such circumstances ? (Imputation)

A

A company must approximate an applicable interest rate that may differ from the stated interest rate

89
Q

Imputation

A

Process of interest rate approximation

90
Q

Imputed interest rate

A

Resulting interest rate is called an imputed interest rate

91
Q

What affects the choice of a rate?

A

The prevailing rates for similar instruments of issuers with similar credit ratings

Other factors include: restrictive covenants, collateral, payment schedule and the existing prime interest rate

92
Q

Mortgage note payable

A

Is a promissory note secured by a document called a mortgage that pledged title to property as a security for the loan

93
Q

Who uses mortgage notes payable more frequently?

A

Individuals, proprietorships, and partnerships

94
Q

What is most common form of long term notes payable?

A

Mortgage note payable

95
Q

What does the borrow usually receive for the face amount of mortgage note?

A

Cash

96
Q

The amount total recieved by borrower is less than the

A

Face amount of the note

97
Q

If the mortgage payable is payable at maturity , it should be reported as

A

Long term liability on balance sheet until such time as the approaching maturity date warrants showing it as a current liability

98
Q

Most lenders offer variable rate mortgages

A

Featuring interest rates tied to changes in the fluctuating market rate

99
Q

Why does FASB believe that fair value provides more relevant & understandable info than amortizes cost?

A

Bc of reflects the current cash equivalent value of financial instruments

100
Q

If the companies choose fair value option then non current liabilities such as

A

Bonds and notes payable are reported at fair value

101
Q

Companies report unrealized holding gains or losses as part of

A

Net income or in other comprehensive income

102
Q

What is a unrealized holding gain or loss?

A

It is the net change in the fair value of the liability from on period to another exclusive of interest expense recognized

103
Q

When the value of bonds decline what does the decline lead to?

A

Reduction in the bond liability and resulting unrealized holding gain which is reported as part of net income

104
Q

The decline in value of bonds was due to market interest rate increase but the decline may have occurred because

A

The bonds become more likely to default

105
Q

If the creditworthiness declines than the value of its debt also

A

Declines

106
Q

FASB require that credit risk portion of gains or losses on a financial liability are reported in other

A

Comprehensive income

107
Q

As indicated unrealized gains or losses due to credit risk will not affect what?

A

Income

108
Q

Off balance sheet financing

A

Is an attempt to borrow monies in such way to prevent recording the obligations

109
Q

Off balance sheet financing take many different forms such as

A
  1. Non consolidated subsidiary
  2. Special purpose entity (SPE)
  3. Operating leases
110
Q

Under GAAP, a parent company does not have to consolidate a subsidiary company that is what % owned?

And does the parent report assets and liabilities? If not , what is reported instead on balance sheet?

A

50% owned

No, it only reports investment in subsidiary

111
Q

Special purpose entity

A

Is to perform a special project . To build the plant which it financed and builds he plant

112
Q

What is another way that companies keep debt off the balance sheet?

A

Leasing

113
Q

What is the major reason that companies engage in off balance sheet financing?

A

Many believe that removing debt enchanted the quality of the balance sheet and permits credit to be obtained more readily and at less cost

114
Q

Loan covenants often limit the amount of debt a company can have so the company use off balance sheet financing bc

A

These type of commitments might not be considered in computing debt limitation

115
Q

Many argue that the asset side of the b/s is what?

A

Severely understated

116
Q

If companies report assets @ fair values then there would be less what!

A

Pressure would exist for off balance sheet financing arrangements

117
Q

In response to the odd balance sheet financing arrangements, FASB has done what?

A

Increased disclosure (note requirements)

118
Q

Companies must disclose what?

A
  1. All contractual obligations in tabular format

2. Contingent liabilities and commitments in either textual or tabular format

119
Q

If the company plans to refinance debt, convert it into stock or retire it from a bond retirement fund , the debt should be reported as

A

Non current

120
Q

Debts to asset ratio

A

Measures the % of the total assets provided by creditors

121
Q

Time interest earned

A

Indicates the companies ability to meet interest payments as the come due

122
Q

Troubled debt restructuring

A

Occurs when a creditor for economic or legal reasons related to the debtors financial difficulties grants a confession to the debtor that it would or otherwise consider

123
Q

A troubled debt restructuring involves one of two basis types of transactions

A
  1. Settlement of debt at less than its carrying amount

2. Continuation of debt with a modification of terms

124
Q

Settling a debt obligation can involve

A

Transfer of non cash assets

Issuance of the debtors stock

Cash

125
Q

The debtor must determine the excess of the carrying amount of payable over the fair value of assets or equity transferred gain

A

True

126
Q

The creditor mist detentions the excess o f the receivable over the fair value of those same assets or equity interest transferred (loss)

A

True

127
Q

When does the debtor recognize a gain?

A

Equal to the amount of excess

128
Q

The creditor normally charges the excess (loss) to

A

Allowance for doubtful accounts

129
Q

Debtor recognizes gain or loss on disposition of assets to the extent that fair value of those assets differ from?

A

Carrying amount (book value)2

130
Q

In some cases, a debtors serious short run cash flow problems will lead it to request one or a combination of the following:

A
  1. Reduction of a stated interest rate
  2. Extension of the maturity date of the face amount of the debt
  3. Reduction of the face amount of debt
  4. Reduction or deferral of any accrued interest
131
Q

Creditors loss is based on what

A

Expected cash flows discounted st the historical effective rate of the loan

132
Q

Debtor calculates its gains based on what?

A

Undiscounted amounts

133
Q

The gain that is recorded by debtor will not equal to the loss recorded by the creditor under many circumstances

A

True

134
Q

2 examples demonstrate the accounting for troubled debt restructuring by debtors and creditors

A
  1. Debtor does not record a gain
  2. The debtor does record a gain

In both instances the creditor has a loss

Acct 302 (7 decks)

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