Chapter 14- LT liabilities Flashcards
What is Long-Term Debt?
Long-term debt refers to financial obligations that are due more than one year from the date of the financial statement.
Examples include bonds, long-term notes, mortgages, and pension liabilities. These debts involve the sacrifice of future economic benefits, such as cash payments.
What do long-term debt agreements include?
Formal contracts outlining both the lender’s and borrower’s rights and obligations.
Interest Rate
Due dates for payments
Collateral pledged
Special Provisions (call options, early repayment
Sinking funds (funds set aside for future debt repayment)
What are restrictive covenants in debt agreements?
Restrictive covenants are conditions included in debt agreements to protect both parties.
include limits on working capital, restrictions on dividends, and caps on new debt to avoid increasing financial risk.
What are bonds?
LTD where companies borrow large sums from multiple investors. In return, companies promise to repay the face value of the bond at a future date (the maturity date) and make periodic interest payments (usually semi-annually).
What is a bond indenture?
A bond indenture is a legal contract that details the terms of a bond agreement. It includes information like the interest rate, payment schedules, maturity date, and the rights of both the issuer and the bondholder.
How can bonds be sold?
Firm commitment underwriting
Best efforts underwriting
Private placement:
Private placement:
Bonds are sold directly to large investors without an underwriter.
Best efforts underwriting:
The underwriter tries to sell as much as possible without guaranteeing the full sale.
Firm commitment underwriting:
Investment bankers guarantee the sale of the entire bond issue.
What are long-term notes?
Long-term notes are similar to bonds in that they have a fixed maturity date and interest rate. The main difference is their legal form, which may vary depending on the issuer and structure. They are treated similarly in accounting to bonds.
What is a registered bond?
A registered bond is issued in the name of the bondholder. The ownership is tracked by the issuer, and the bondholder must surrender the certificate to transfer ownership to another party.
What is a bearer bond?
A bearer bond is not registered in the name of a specific owner, making it easily transferable. Whoever physically holds the bond certificate is considered the owner.
What is secured debt?
Secured debt is backed by collateral, which serves as protection for the lender if the borrower defaults. Examples of secured debt include:
Mortgage bonds
Collateral trust bonds
Collateral trust bonds:
Secured by shares or bonds of other companies.
What is unsecured debt?
Unsecured debt is not backed by collateral and is based on the issuer’s creditworthiness.
The most common type of unsecured debt is debenture bonds, which rely on the issuer’s ability to repay based on their creditworthiness.
What are term bonds?
Term bonds are a type of bond that matures on a single date. At maturity, the full face value of the bond is repaid.
What are serial bonds?
Serial bonds are bonds that mature in installments over a period of time. This is commonly used by municipalities or schools, where portions of the debt are paid off at different maturity dates.
What are perpetual bonds?
Perpetual bonds have extremely long terms, sometimes lasting 100 years or more, or they may have no maturity date at all. These bonds are also called century or millennium bonds and do not require repayment of principal during the bondholder’s lifetime.
What are income bonds?
Income bonds pay interest only if the issuer is profitable. This makes them riskier for investors but more affordable for the issuer if they’re facing financial difficulties.
What are revenue bonds?
bonds where the interest payments are made from specific sources of revenue, tolls
taxes
other income generated by the issuing entity.
What are deep discount bonds?
Deep discount bonds, also known as zero-interest bonds, are sold at a significant discount to their face value and pay little to no interest. The investor’s return comes from the appreciation of the bond’s value as it approaches maturity.
What are commodity-backed bonds?
Commodity-backed bonds are redeemable in commodities, such as oil or precious metals, rather than in cash. These are also referred to as asset-linked debt.
What are callable bonds?
Callable bonds give the issuer the option to redeem the bonds before the maturity date. This is beneficial if interest rates decline, as the issuer can refinance the debt at a lower rate.
What are convertible bonds?
Convertible bonds can be converted into other types of securities, such as shares of stock, at the bondholder’s or issuer’s discretion. This provides the bondholder with potential upside if the company’s stock price rises.
What is a credit rating?
A credit rating is an assessment of a company’s ability to repay its debts. Ratings range from AAA (highest quality, low risk) to BBB or lower (indicating higher risk).
What is defeasance?
Defeasance is the process of paying off debt early by setting aside funds in a trust that will cover future debt payments. It is often used to avoid legal restrictions or penalties that come with early repayment.
What is the business model of companies using debt financing?
Companies often use debt financing to invest in income-generating assets. Debt increases liquidity, but also adds financial risk. Companies may also use equity issuance or internal funds for financing.
What is leverage?
Leverage refers to using borrowed funds to amplify returns on investment. It can increase potential profits but also heightens financial risk.
How are bonds valued at par?
Bonds are valued at their face value (par value) when the market interest rate equals the bond’s coupon rate. The value is based on the present value of future interest payments and the lump-sum face value repayment at maturity.
What is a bond issued at a discount?
When the market interest rate is higher than the bond’s stated interest rate, the bond will be sold at a discount (less than face value). This helps align the bond’s effective yield with the market rate.
What is a bond issued at a premium?
When the market interest rate is lower than the bond’s coupon rate, the bond sells for more than its face value (a premium). The premium is amortized over the life of the bond.
What is the effective interest method with a discount?
The effective interest method calculates interest expense based on the bond’s carrying value and the effective interest rate. The discount is amortized over time, resulting in a constant interest expense.
What is the fair value option for long-term debt?
The fair value option allows companies to measure long-term debt at its fair value instead of amortized cost. Changes in fair value are reflected in net income (ASPE) or other comprehensive income (IFRS).
What are substantial modifications to debt?
Substantial modifications to debt involve significant changes to the original debt agreement, such as reducing the interest rate or extending the maturity date. If the modification is deemed substantial, the old debt is extinguished and replaced with new debt.
