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FA3 financial liabilities > Chapter 13 > Flashcards

Chapter 13 Flashcards

1
Q

What is Long term debt for companies

A

a significant source of financing for many companies

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2
Q

what do you need to report for long term debt

A
  1. issuance
  2. retirement
    - measure of annual interest cost is critical (capitalize or expensed)
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3
Q

What are the common forms of short term financing

A

From Creditors (1. trade credit - interest free and 2. Promissory notes)

From Lenders (1. Operating line of credit, and 2. commercial paper)

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4
Q

for business short term loans is usually what

A

a line of credit

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5
Q

operating line of credits are what

A

due on demand therefore they are considered short term

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6
Q

what is another type of short term financing

A

sale or assignment of company’s receivables to a financial institution

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7
Q

what are the different types of long-term financing from

A
  1. lenders, 2. other, 3. Financial markets
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8
Q

what is long term financing form lenders include

A
  1. leases (long term),
  2. term loans (medium 1-5 years),
  3. Commercial mortgages
  4. Term loans (long term) more than 5 years
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9
Q

What are common long term bank financing

A
  1. term loans

2. commercial mortgages

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10
Q

What are term loans

A

are usually medium term loans

  • usually for 1 1/2 to 5 years
  • repayment terms can be structured as
    1. blended payments (each payment includes some principal and interest)
    2. designated monthly principal payments plus accrued interest
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11
Q

for accounting purposes, how is interest accrued

A

as time passes

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12
Q

what are promissory notes

A

– obligate company to pay a supplier at or before a given date – may bear interest or be non-interest bearing

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13
Q

what are short term bank loans (describe the characteristics)

A
  1. operating lines of credit (finance working capital; secured by charge on receivables and inventory)
    - variable rates
    - limit set by percentage of collateral base
    - due on demand
    - may be drawn as an “overdraft”
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14
Q

what are commercial papers

A
  • short term promissory notes sold in the open market

- issued by large companies

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15
Q

what are some types of long term financing

A
  1. bank loans
  2. notes payable
  3. mortgages
  4. other asset backed loans
  5. publicly issued bonds
  6. long-term leases
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16
Q

what are the types of long-term bank financing

A
  1. can be term loans or

2. commercial mortgages

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17
Q

what are term loans

A

usually characterized as medium term loans (usually 1 1/2 to 5 years)

  • repayment terms can be blended payments or designated monthly principal payments and accrued interest
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18
Q

what are bonds or debentures payable

A
  • is a deb t security issued by corporations or governments
  • to secure large amounts of capital on a long-term basis
  • a bond is a formal promise to pay by issuing organization to pay interest and principal in return for the capital invested
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19
Q

what is a bond indenture

A

a formal bond agreement

- specifies the terms, rights and duties of both the issuer and bondholder

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20
Q

what are debt agreements

A

debt agreements often restrict the operations and financial structure of the borrower to reduce the risk of default.

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21
Q

what are debt covenants

A

are restrictions placed on a corporation’s activities and conditions of maintaining the loan
- if the covenants are broken the lender has the right to call the loan

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22
Q

why are long term loans appealing

A
  1. short term financing may not be available and cost may be higher than the long-term at the time
  2. cause s no dilution of voting control or ownership
  3. interest expense is tax deductible
  4. leverage used successfully can result in returns on borrowed funds being higher than the cost of interest
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23
Q

why is leverage risky

A
  1. interest must be paid even if sales and profits are declining
  2. business failure may result if debt levels too high
  3. if financial difficulty, will have to restructure debt maturity dates or interest rates
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24
Q

why is debt attractive for lenders

A
  1. provides legally enforceable debt payments
  2. principal is returned at maturity
  3. priority claim if corporation restructures debt or goes into receivership or bankruptcy
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25
Q

what are the forms of long-term debt

A
  1. bank loans
  2. notes payable
  3. mortgages
  4. other asset backed loans
  5. publicly issued bonds, secured or unsecured
  6. long-term leases
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26
Q

what are term loans

A
  • medium loans
  • period of 1.5 to 5 years
  • requires collateral (equipment, land, buildings)
  • secured on these tangible assets
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27
Q

what are blended payments

A

interest rate is fixed and regular equal annuity payments are made including principle and interest

  • principal portion of each payment reduces loan balance
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28
Q

what are designated monthly principal payments plus interest on the outstanding balance

A
  • interest may be fixed or float - and paid at end of each month based on outstanding balance
  • payment terms for principal may be monthly, quarterly, annually or lump sum “balloon payment”
29
Q

what are term loans

A
  • interest is accrued as time passes and is paid when due
  • shown as long-term on SFP
  • current portion is amount of principal due in the next 12 months
30
Q

what are long-term bank financing loans

A
  • repayment terms more than 5 years
  • include;
    1. commercial mortgages and
    2. asset -backed financing
31
Q

what are commercial mortgages

A
  • secured on land and building
  • regular blended payments (designated to repay loan over the initial amortization period
  • amortization period may be 25 years; but term is usually 5 years or less
  • fixed interest rate for the term; and is reset each new term
  • may also have floating rate
32
Q

what are some other sources of long-term financing

A
  1. insurance companies or
  2. pension funds
  • may provide financing to larger companies
33
Q

what are bonds payable also called

A

debenture

34
Q

what are bonds payable used for

A

to raise large amounts of capital on a long-term basis

35
Q

what is a bond

A

a formal agreement (bond indenture) to pay principal and interest

36
Q

what is a bond indenture

A

specifies term, rights and duties of issuer and bondholder

37
Q

what are the restrictions on the issuer of a bond indenture

A
  1. dollar amount authorized for issuance
  2. interest rate
  3. payment dates (for interest)
  4. maturity date
  5. any conversion or call privileges
38
Q

what are debt covenants

A

-restrictions on corporations’ activities

39
Q

what happens if covenants are broken

A

lender can demand repayment

40
Q

what are the accounting based covenants (maintenance tests)

A
  1. maximum debt to equity ratio (or debt to asset ratio)
  2. minimum current ratio
  3. minimum interest coverage ratio
41
Q

what are some debt covenant behavioural restrictions (6)

A
  1. issuance of additional debt without permission
  2. dividend payments
  3. redemption or retirement of shares
  4. ability to pledge assets as security
  5. current management must remain in place
  6. transfer of control
42
Q

what are bonds payable classified as?

A

other financial liabilities

43
Q

how are bonds payable recorded

A
  1. initially at fair value (cash received less transaction costs - based on present value model)
  2. subsequently, amortized cost is used over its term
44
Q

how do you value a bond

A

fair value - present value of all future cash flows using effective interest rate (market yield rate)

45
Q

for bonds, when effective rate - nominal rate

A

bonds is issued at par or maturity amount

46
Q

for bonds, when effective rate is greater than nominal rate

A

bond is issued at a discount

47
Q

for bonds, when effective rate is less than nominal rate

A

bond value is at a premium

48
Q

for bonds payable, when interest rates are different from year end dates

A
  1. accrue interest form last interest payment date and
  2. bring discount discount/ premium amortization up to date
  3. when bonds issued between interest dates, accrued interest is added to the price
49
Q

bond amortization

A
  1. the premium or discount can be unwound using - results in a constant dollar interest expense each year
  • acceptable under ASPE
  • acceptable under IFRS if not materially different from the effective interest rate method
50
Q

bonds have a face value and stated interest rate. the stated interest rate is also called

A

nominal interest rate

51
Q

what is the fair value of the bond

A

the present value of all future cash payemtns discounted using the effective interest rate

52
Q

what is the effective interest rate for a bond also called

A
  1. market yield rate

2. incremental borrowing rate

53
Q

what are the bond interest payment dates

A

the dates the periodic interest payments are due

54
Q

what is the bond date and what is it also called

A

also called the amortization date

- is the earliest date the bond can be issued and represents the planned issue date of the bond

55
Q

is it rare that a bond’s market value will be the same as its face value or carrying value

A

yes

56
Q

the premium or discount on bonds is the

A

difference between the face value and the present value of bonds

57
Q

premium or discount recognition, what do you do

A

the premium or discount must be completely recognized (amortized) over the bond term using effective-interest method

  • so that the net book value equals face value at maturity.
  • amortized premium reduces periodic interest expense and amortized discount increases interest expense
58
Q

for a bond, what does amortizing the premium do

A

reduces periodic interest expense

59
Q

for a bond, what does amortizing the discount do

A

increases interest expense

60
Q

if interest payments dates (for bonds) are different from statement dates what do you do

A

when the accounting period ends between interest dates, it is necessary to accrue interest since the last interest date to the end of the accounting period and to bring the bond discount/ premium amortization up to date

61
Q

what do you do when bonds are issued between interest dates

A

bonds sold between interest dates are sold at the appropriate market price plus accrued interest

62
Q

what happens to accrued interest for a bond

A

accrued interest is added to the price because the holder of the bonds on any interest date receives the full amount of interest since the last interest date, even if the investor bought the bonds only the week before

63
Q

Debt issuance costs include and what happens with them

A
  1. upfront fees
  2. legal
  3. accounting
  4. underwriting
  5. commission,
  6. engraving
  7. printing
  8. registration
  9. promotion costs
  • they are paid by the issuer and reduce the net proceeds form the bond issue , increasing the effective cost for the issuer
  • amortize as part of effective interest expense
64
Q

what is bond amortization based on

A

historical interest rate at time of issuance, does not reflect changes in the market interest rate

65
Q

for bonds, the effective interest method is the method required by accounting standards because

A

it best reflects the underlying basis of valuation for long–term debt

  • it provides a measure of interest expense that reflects the present value process
  • it also achieves a constant rate of interest expense over the life of the bond
66
Q

debt issue costs for bonds - how do you account for them

A

recorded and amortized separately on an effective interest method, reducing the net proceeds of the debt issue

67
Q

what are up-front fees with regards to bonds

A

or administrative fees are often charged by lenders when granting loan

68
Q

how do you account for upfront fees

A

reduces the net cash proceeds and increases the loan’s effective interest rate

  • a the inception of the loan debit up-front costs as a deferred financing cost
  • as interest is recognized using the effective interest, credit the deferred financing cost

FA3 financial liabilities (6 decks)

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