Chapter 9 Debt Financing and Tax Flashcards
What are the advantages & disadvantages of both equity and debt financing
Equity Financing
- Advantages: No obligation to repay shareholders
- Disadvantages: Dilution of shares
Debt Financing
- Advantages: No dilution of shares
- Disadvantages: Solvency risk if unable to payback
What is the formula for debt to equity ratio and what does it tell you
Total Debt / Total Equity.
The ratio indicates the proportion of debt & equity used to finance the company. A higher ratio has greater implications on a company’s credit ratings and ability to repay borrowings
What is the ratio for times interest earned?
Ratio is: (Net income + Interest expense + Tax expense) / Interest Expense
This ratio indicates how many times net income can cover interest expense. The higher the ratio the more times it can cover interest expense
What is debt financing
Company obtains funds in exchange for an obligation to repay the borrowed funds in the future
What are liabilities?
Liabilities are present obligations arising from past events that the company expects an outflow of economic resources.
30 APRIL 20X1
ABC Ltd purchased a $100,000 machine on credit. What are the journal entries?
31st JULY 20X1
ABC pays in cash for the above
DR Machine 100K
CR Account Payable 100K
DR Account Payable 100K
CR Cash 100K
20 JAN 20X1
ABC Ltd collected $100 from its customer as a security deposit
23 FEB 20X1
When refund is made to customer
30 MAY 20X1
When deposit is forfeited
20 JAN 20X1
DR Cash
CR Security Deposit Refundable {Treat as liability / unearned rev}
23 FEB 20X1
DR Security Deposit Refundable {Treat as liability / unearned rev}
CR Cash
30 MAY 20X1
DR Security Deposit Refundable {Treat as liability / unearned rev}
CR Other Income
What are provisions, what are the criteria surrounding recognition provisions?
Provisions is a liability of UNCERTAIN TIMING AND AMOUNT
Criteria:
1) Present obligation arising from past event
2) Probable outflow of resources
3) Reliable estimates
ABC Ltd provides a one year warranty on its laptops. Based on past experience the expected repair expense under warranty is $100. The following cost is recorded at time of recognising revenue.
What are the journal entries and expected effect on balance sheet and profit and loss
DR Warranty Expense 100
CR Provision for warranty expense 100
On Balance Sheet
Current Liability
Provision for warranty expense
On P&L
Warranty Expense
ABC Ltd incurred $30 repairs on the warrantied product.
What are the journal entries?
DR Provision for warranty of expense
CR Cash
What is a contingent liability?
A contingent liability is
- A possible obligation which will be known upon the outcome of uncertain future events not within the company’s control; or
- A present obligation not recognised because of failure to meet the recognition criteria for liabilities. (eg. Not probable or amount cannot be measured reliably)
- Hence, contingent liabilities are never recognised, but may have to be disclosed (if not remote)
On 1st Jan X1, ABC Ltd issues a $100,000, 3 year, 5% bond at $105,657. Interest is payable on 31st December of each year. The company makes all payments when due. The effective interest rate is 3%
What are the journal entries?
1st Jan 20X1
DR Cash 105,657
CR Bond Payable 105,657
Balance Sheet
Current Liabilities
Bond Payable 105,657
31st Dec 20X1
DR Interest Expense (3% * 105,657) 3170
DR Bond Payable (cash - interest expense) 1830
CR Cash (5% * 100K) 5,000
How do you account for maturity of bond? What are the journal entries?
DR Bond Payable 100K [par value of issuing the bond]
CR Cash 100K
What are the two kinds of differences in taxes? explain them
1) permanent difference
- permanent difference arises from different treatment of income and expenses between accounting standards and tax rules. [mainly from legislation]
2) temporary difference
- temporary difference arises when income and expenses are recognized in different periods. This gives rise to the deferred tax asset and deferred tax liabilities
If tax payable > Tax Expense, is it considered a deferred tax asset or a deferred tax liability?
It is treated as a deferred tax asset because tax payable is like the amount you accounted for where as tax expense is the one you are required to pay. Hence in this scenario you have clearly prepared for more than you were supposed to pay.
