Chapitre 10

Question 1

bond, note, bill definition

Answer 1

bond refers to a debt instrument with original maturity greater than 10 years; note is a debt instrument with original maturity greater than 1 year, less than or equal to 10 years; and bill is a debt instrument with original maturity less than 1 year.

Question 2

Issuer’s Accounting for debt at issuance and interest payment and repayment

Answer 2

1)entry is debit cash and credit bonds payable.

2)Debit interest expense, credit cash

3)Debit bonds payable and credit cash.

Question 3

Discount or premium on bonds. coupon rate vs Market rate. if Market rate smaller than coupon rate

Answer 3

If the coupon rate on the bonds is higher than the market rate when the bonds are issued, the market value of the bonds and thus the amount of cash the company receives will be higher than the face value of the bonds. In other words, the bonds will sell at a premium to face value because they are offering an attractive coupon rate compared with current market rates.

Question 4

If bond trades at a discount. Balance sheet effect?

Answer 4

The bond discount is shown with a negative sign because it is a contra-liability.
ie: : Debit cash ($928), debit discount on bonds payable ($72), credit bonds payable ($1,000).

Question 5

What is book value of bond

Answer 5

The book value (also known as carrying value) equals the face value minus the discount.

Question 6

Cash interest payment vs Interest expense ?

Answer 6

Cash interest payment = Principal x Coupon rate x Time = $1,000 × 10% × 1 year = $100

Interest expense = Carrying value × Effective rate × Time
Amortization of discount = Interest expense – Cash interest payment

Question 7

Amortization of the discount how does it work?

Answer 7

Each year, the amortization of the discount is calculated as Interest expense – cash interest payment.

Slide 16 example : For Year 2, the amount of discount amortized is $113 – $100 = $13

Question 8

IF bond trades at premium?

Answer 8

The bond premium account is an adjunct account. It increases the carrying value of the bonds payable.

ie Slide 18 : Issuer’s journal entry: Debit cash ($1080), credit bonds payable ($1,000), and credit premium on bonds payable ($80).

Question 9

Bond Prices Subsequent to Issuance effect on the issuers statments?

Answer 9

Changes in value subsequent to issuance do not affect the value of the bond on the issuer’s statement unless the issuer has chosen the fair value option (much less common).

Question 10

Gain or loss on bond repurchase formula

Answer 10

= Net bonds payable − Repurchase payment

Question 11

IFRS VS GAAP debt issuance linked with bonds

Answer 11

Under IFRS, debt issuance costs are included in the measurement of the liability and are thus part of its carrying amount.
Under U.S. GAAP, debt issuance costs are accounted for separately from bonds payable and are amortized over the life of the bonds. Any unamortized debt issuance costs must be written off at the time of redemption and included in the gain or loss on debt extinguishment.

Question 12

What is covenants and the types

Answer 12

Covenants protect creditors by restricting activities of the borrower.
Affirmative covenants restrict the borrower’s activities by requiring certain actions (e.g., may require that the borrower maintain certain financial ratios above a specified amount or perform regular maintenance on real assets used as collateral).
Negative covenants require that the borrower not take certain actions (e.g., may restrict the borrower’s ability to invest, pay dividends, or make other operating and strategic decisions that might adversely affect the company’s ability to pay interest and principal).

Question 13

If a borrower violates a debt covenant, lenders may?

Answer 13

choose to waive the covenant,
be entitled to a penalty payment or higher interest rate,
renegotiate, or
call for immediate repayment of the debt (liquidity issue!).

Question 14

Common covenants examples

Answer 14

Limitations on how borrowed monies can be used, maintenance of collateral pledged as security (if any), restrictions on future borrowings, and requirements to meet specific working capital requirements.

Question 15

What is leases and what is the benefits?

Answer 15

Rather than borrowing and buying the asset, a company arranges to lease the asset.

Advantages to leasing an asset compared with purchasing it:
Leases can provide less costly financing; usually require little, if any, down payment; and are often at fixed interest rates.
The negotiated lease contract may contain less restrictive provisions than other forms of borrowing.
Leasing can reduce the risks of obsolescence, residual value, and disposition to the lessee.

Question 16

Old leases rules vs the new one

Answer 16

There were two main classifications of leases under the old accounting standards in IFRS and US GAAP: finance (or capital) and operating leases. The economic substance of a finance (or capital) lease was very different from an operating lease, as were the implications of each for the financial statements of the lessee and lessor. In substance, a finance (capital) lease is equivalent to the purchase of some asset (lease to own) by the buyer (lessee) that is directly financed by the seller (lessor) and this is a similar treatment under the new rules for lessees. Under the new rules, leases can only be treated as operating in very limited circumstances (e.g. if the lease is 12 months or less or, under IFRS, if the leased asset is of low value). “Finance lease” is IFRS terminology, and “capital lease” is U.S. GAAP terminology.

Question 17

New Leases rules explain IFRS VS GAAP differences. Long and indepth answer given.

Answer 17

Under the revised rules under IFRS and US GAAP, a lessee must recognize an asset and a lease liability at inception of each of its leases (with an exception for short-term leases).
The lessee reports a ‘right-of-use’ (ROU) asset and a lease liability, calculated essentially as the present value of fixed lease payments, on its balance sheet.
After the lease inception, a lessee’s treatment of leases differs for IFRS and US GAAP.
Under IFRS, after inception, the lessee records depreciation expense on the right-of-use asset, recognizes interest expense on the lease liability, and reduces the balance of the lease liability for the portion of the lease payment that represents repayment of the lease liability. In effect, the lease treatment is similar to having purchased a long-term asset, financed by a long-term interest-bearing liability.
Under US GAAP, lessee accounting after inception depends whether the lessee categorizes a lease as a finance lease or an operating lease. A finance lease is similar to purchasing an asset while an operating lease is similar to renting an asset. Criteria for categorizing a lease as a finance lease include indicators that the benefits and risks of owning the leased asset have been transferred to the lessee. (Note that this categorization does not affect the requirement for recognition of the asset and lease liability at inception).
A lessee’s accounting for a finance lease under US GAAP is the same as described above for leases under IFRS: after inception, the lessee records depreciation expense on the right-of-use asset, recognizes interest expense on the lease liability, and reduces the balance of the lease liability for the portion of the lease payment that represents repayment of the lease liability. For an operating lease after inception, under US GAAP, the lessee recognizes a single lease expense which is a straight-line allocation of the cost of the lease over its term.
Exceptions exist for short-term leases (those with a lease term less than one year) and, under IFRS, for leases where the leased asset is low in value. When these exceptions apply, the lessee is not required to recognize an asset and liability and instead records lease payments as an expense when paid (similar to the old operating lease accounting treatment).

Question 18

Lease term less than 1 year (or low value under IFRS) (lessee’s perspective)

Answer 18

Reports rent expense.
Rent payment is an operating cash outflow.

Question 19

Finance Lease under IFRS (capital lease under U.S. GAAP) (lessee’s perspective)

Answer 19

Recognizes leased asset and lease liability.
Reports depreciation expense on leased asset.
Reports interest expense on lease liability.
Reduction of lease liability is a financing cash outflow.
Interest portion of lease payment is either an operating or financing cash outflow under IFRS and an operating cash outflow under U.S. GAAP.

Question 20

Operating Lease (Leases from lessor’s perspective)

Answer 20

Retains asset on balance sheet.
Reports rent income
and depreciation expense on leased asset.
Rent payments received are an operating cash inflow.

Question 21

Finance Lease: When present value of lease payments equals the carrying amount of the leased asset (called a “direct financing lease” in U.S. GAAP) (from lessor’s perspective)

Answer 21

Removes asset from balance sheet.
Recognizes lease receivable.
Reports interest revenue on lease receivable
Interest portion of lease payment received is either an operating or investing cash inflow under IFRS and an operating cash inflow under U.S. GAAP.
Receipt of lease principal is an investing cash inflow.

Question 22

Finance Lease: When present value of lease payments exceeds the carrying amount of the leased asset (called a “sales-type lease” in U.S. GAAP) (lessor’s perspective)

Answer 22

Removes asset.
Recognizes lease receivable.
Reports profit on sale.
Reports interest revenue on lease receivable.
Interest portion of lease payment received is either an operating or investing cash inflow under IFRS and an operating cash inflow under U.S. GAAP.
Receipt of lease principal is an investing cash inflow.

Question 23

Assuming both companies enter into an identical long-term contract to lease a similar asset, which metric is most likely to differ due to differences in accounting standards?
Total assets?
Total liabilities?
Operating cash flows?

Answer 23

Answer = Operating cash flows.

Question 24

Defined Contribution pension plan

Answer 24

Amount of Future Benefit to Employee: Depends on investment performance of plan assets
Contribution from Employer: Amount (if any) is defined in each period

Question 25

Defined benefit pension plan

Answer 25

Amount of Future Benefit to Employee: Defined based on plan’s formula

Contribution from Employer: Depends on current period estimate and investment performance of plan assets

Question 26

Defined contribution Financial statement effects

Answer 26

Balance sheet: There is typically no liability (“None”); however, if some portion of the agreed-upon amount has not been paid by fiscal year-end, a liability would be recognized on the balance sheet. The only other impact on the balance sheet is a decrease in cash.
Income statement: The agreed-upon company contribution is the pension expense.
The amount paid (contributed to the plan) is treated as an operating cash outflow.
Footnote disclosure is minimal.

Question 27

Defined benefit Financial Statements effects

Answer 27

Balance sheet: The net funded position (with adjustments in some circumstances) is shown on the balance sheet. The net funded position is the net of estimated future pension obligation minus pension fund assets.
Income statement: The pension expense reflects the increase in the estimated future pension obligation, net of earnings on the pension assets.
Footnote disclosure is extensive, including information on pension fund asset allocation, breakdown of periodic pension expense, assumptions used in estimating future pension obligation, and so on.

Question 28

Solvency definition and common ratio used

Answer 28

Company’s ability to meet its long-term debt obligations.
Two types of commonly used solvency ratios:
Leverage ratios:
Focus on the balance sheet.
Measure relative amount of debt in the company’s capital structure.
Coverage ratios:
Focus on the income statement and cash flows.
Measure the ability of a company to cover its debt-related payments.

Question 29

Common leverage and Coverage ratios

Answer 29

Leverage Ratios

Debt-to-assets: Total debt / Total assets
Debt-to-capital: Total debt / (Total debt + Shareholders’ equity)
Debt-to-equity: Total debt / Shareholders’ equity
Financial leverage: Avg. total assets / Avg. shareholders’ equity
Coverage Ratios

Interest coverage: EBIT / Interest payments
Fixed charge coverage: (EBIT + Lease payments) / (Interest + Lease payments)