Chapter 14 (Financing Liabilites) Flashcards
What are the labels of all the columns included in an effective interest amortization table (discount/premium)?
From left to right:
- Date
- Stated Interest (Cash Payment)
- Market Rate (Interest Expense)
- Discount or Premium Amortization
- Carrying Value
How to Calculate Cash Interest Payment?
Face Value x Stated Rate x Time
I=PRT
Adjusting Entry for Accrued Interest
Dr Interest Expense
Cr Interest Payable
What does every adjusting entry include?
One income statement account and one balance sheet account
Accounts Payable
No interest, regular notes to vendors/supplies, typically short term
Notes Payable
Interest, underlying legal document (promissory note), typically long term
Current Liabilities
Debt expected to be extinguished in the operating cycle or year, whichever is longer; can be extinguished with current assets or by creating liabilities
Noncurrent Note Payable
- Term Loan: payment of interest periodically, principal is paid at a specific due date (maturity)
- Installment Loan: each payment consists of interest plus the principal (car, education, mortgage)
Things to Identify When Reading a Question
- Stated Interest Rate
- Market Rate of Interest
- Issuance Debt
- Interest Payment Date
- Year/End Date
- Date Financial Statements are Issued (Quarterly, Annually)
The ______ is initially reported as a debit. It is a ________ on the balance sheet. It is ________ each interest period. ________ increases the cost of borrowing.
Discount Account
Contra Liability
ALWAYS
Discounting
Entry for Issuance of Bonds (Par Value)
Dr Cash
Cr Bonds Payable
Entry for Issuance of Bonds (Discount)
Dr Cash
Dr Discount
Cr Bonds Payable
- **increases the cost of borrowing
- **recognized as interest expense when interest is paid or accrued
Entry for Issuance of Bonds (Premium)
Dr Cash
Cr Bonds Payable
Cr Premium
- **reduces the cost of borrowing
- **recognized as interest expense as a reduction when interest is paid or accrued
Stated Rate = Market Rate
Par
Stated Rate < Market Rate
Discount
Stated Rate > Market Rate
Premium
Effective Interest Expense Calculation
Market Rate x Carrying Value of the Bond at the Beginning of the Period
Discount/Premium Amortization Calculation
Effective Interest Expense - Cash Interest Paid
Zero Coupon Bonds
Issuer does not have to pay periodic interest expense
Will record interest expense, but not to Cash; Stated rate is zero, no cash interest
Difference between issue price and face value represents interest expense over the life of the bond
Typically issues at significant discounts, market rate is always higher than zero coupon bond
Will be recording a discount at issuance
When a bond is issued between dates, you MUST
Pay interest accrued up to the point of issuance (GAAP)
Early Retirement of Bonds
Always have to calculate gain/loss on retirement (extinguishment)
**Gain occurs if the cash paid is less than the CV of bonds at retirement
***Loss occurs if the cash paid is greater than the CV of bonds at retirement
Convertible Bonds
Option of surrendering bonds and converting to shares
***How many bonds are issued, conversion ratio
Warrant
Long-term options to acquire a stated number of shares at a specific price
***HAVE to pay warrant price
Detachable Warrants
Removed by holder and sold separate on the secondary market
Non Detachable Warrants
Can not be separated
***No allocation between debt and equity
Proportional Method
Allocation of Cost
Cr Bonds Payable
Cr APIC
Incremental Method
Allocation of proceeds to instrument with fair value that is determinable, allocate residual value to the other instrument
Zero Coupon Bond Entries
Issuance:
Dr Cash
Dr Discount on Bonds Payable
Cr Bonds Payable
Interest:
Dr Interest Expense
Cr Discount on Bonds Payable
Maturity:
Dr Bonds Payable
Cr Cash
- **Interest Payments are never a credit to cash
- **ALWAYS a discount
Short Term Debt Expected to be Refinanced
- Demonstrate ability to reclassify liability
2. Satisfy or pay off Current Liabilities with issued debt
Why would corporations refinance short term debt?
To improve liquidity ratios (current ratio, quick ratio, etc.)
Fair Value Option
OPTION— NOT required
Restate financial assets and financial liabilities to fair market value using new account which is fair value adjustment account
