Chapter 14: Long Term Liabilities Flashcards
Classification of Discount and Premium
Liability valuation accounts
Discount = contra account, reduces the face value of the liability
Premium = adjunct account, addition to face value of liability
Effective-interest rate amortization amount
Interest expense - Interest paid = amortization amount
Carrying value of bonds x effective rate
less face value of bonds x stated rate
= amortization amount
Treatment of bond issue costs
Recorded as a reduction to carrying value of the bond and then amortized to expense over the life of the bond
arguably should be expensed, as not technically an asset
Recording accruing interest
If financial statements do not align with interest payment dates then you need to accrue prorated amortization but ensure not to double count
Recording discount on bond or note
Demanded interest rate > stated rate
Sales price < face value of note
amortized over life of note
face value - cash received = discount
Discount on bond/ note: contra account that decreases value of note or bond
Recording premium on bond or note
Demanded interest rate < stated rate
Sales price > face value of note
amortized over life of the note
Cash received - face value = premium
premium on bond or note: adjacent account - increases the value of note or bond
Effective-interest method
AKA present value amortization
Preferred method for amortizing a discount or premium on a bond payable
carrying value x effective interest rate = interest expense
less face amount of bond x stated rate = amortization amount
produces a periodic interest expense equal to a constant percentage of the carrying value
CONSTANT RATE OF INTEREST
straight line amortization is okay but only if not materially different from this method
Recording loss on settlement of troubled debt
charged to allowance for doubtful accounts
Troubled debt restructuring
When for economic or legal reasons related to a debtor’s financial difficulties a creditor grants a concession to the debtor it would not otherwise consider
- settlement of debt at less than carrying amount
- continuation of debt with modification of terms
Troubled debt steps
1) loan origination
2) creditor recognizes loss on impairment of loans
3) loan terms modified or settled (unfavorable to creditor)
4) bankruptcy (highest possible collection amount)
Times interest earned
Ability to meet interest payments as they come due
= (net income + interest expense + income tax expense) / Interest expense
Debt to assets ratio
Percentage of total assets provided by creditors
= total liabilities / total assets
higher % of total liabilities to assets = higher rate
Long-term liabilities on balance sheet
One line on balance sheet supported by comments and schedules in the notes
report as current if maturing in one year or operating cycle UNLESS using non-current assets for redemption
Disclose liquidation methods
Fair value option
Non current liabilities reported at fair value
+ recognize unrealized holding gain or loss
- general interest rate change: reported in net income
- creditworthiness change: reported in “other comprehensive income” - any credit risk portion of gains or losses
Reporting non-current liabilities
generally at amortized amounts (face value, less payments, adjustment for premium or discounts)
BUT have the option to record fair value as it may be more relevant
Mortgage Note payable
Promissory note secured by a document that pledges the title to a property as security for a lon
“point” = 1% of face value of the note: decreases the amount the borrower receives
may be fixed rate or variable (floating rate) which is tied to the market rate
Effective interest rate
Sales price < face value = sold at a discount = demanded interest rate > stated rate
Sale price > face value = sold at premium = demanded interest rate < stated rate
Recording Bonds issued at par (face value)
Entry at sale
Debit cash
Credit bond payable
Paying interest
Debit interest expense (or interest payable if already accrued)
Credit cash
To accrue interest
Debit Interest expense
Credit interest payable
Recording bond issued at Discount
% of par (stated value usually given
Debit Cash (amount received)
Debit Discount on Bond Payable (Face value - purchase price)
Credit Bond Payable (Face value0
Accrue interest
Debit interest expense
Credit discount on bonds payable
Credit cash
Recording Bonds issued at premium
Debit Cash (amount received)
Credit premium on bonds payable
Credit bonds payable
Interest:
Debit Interest Expense
Debit Premium on bonds payable (decreases interest expense)
Credit cash
Recording amortization discount or premium on bonds payable
Discount or premium is amortized to interest expense over the life of the bond
Discount adds to total interest expense
Premium decreases total interest expense
Discount/premium on bonds payable
Recording amortization on callable bonds
Must amortize premium/ discount over the life of the bond to maturity because early redemption is not certain
Recording bonds issued between interest dates (issued at par)
Buyers pay seller the interest accrued from last payment date to date of issue
then on next payment date purchases receives full siz month interest payment
Purchase:
Debit Cash
Credit Bonds Payable
Credit Interest Expense (or interest payable)
Recording bonds issued between interest dates at a discount or premium
Debit Cash (premium amount + interest advance)
Credit Bonds payable
Credit premium on bonds payable
Credit interest expense
then amortize from date of sale
