debt and liabilities Flashcards
how are provisions estimates usually done?
similar to the BS method for bad debt expense. each year you estimate the required ending balance and compute expense as a plug number.
how are contingent liabilities reported?
Contingent losses are only recognized as liabilities if they are reasonably estimable and their occurrence is probable (US GAAP) or ‘more likely than not’ (IFRS).
Otherwise, they are disclosed in a footnote (if the contingency is reasonably possible) or not at all (if the probability is remote).
what are the main entries affecting the balance of contingent liabilities?
-payments
-additions
-releases (when you decrease the balance without a need for cash to exit, for example, losses related to a suit were lower than expected and so you reverse part of the loss you recognized previously)
For large companies, notes/bonds tend to be the predominant form of debt financing. (Why?)
banks cannot afford high exposures to individual clients such as large companies.
how is the book value for a debt issue determined?
by discounting future payments at current interest rate (which is the price paid by investors)
how do you register actual interest expense on a bond which is not recorded at par? what is the journal entry?
by multiplying the carrying value of debt by the market yield that we used to discount payments when computing debt liability. in case the debt is recorded at discount, the actual interest expense will be higher than the cash payment we have to make for the coupon, in order to balance the transaction we amortize the discount pushing carrying value of debt up. by the end the carrying value of debt will equal exactly face value by construction.
how do you treat issuance costs when computing debt entries?
it is subtracted from the initial debt amount at time of registration, at that point the actual borrowing yield will be a little higher than the market one used for discounting. we will need to use that different rate to compute each period’s interest rate for the final balance at end date to equal face value.
what if the note is repurchased before the final date? how is fair value treated under GAAP and IFRS?
the company carries it on the BS at present value based on the initial yield used for discounting. market price is going to fluctuate. in case of repurchase the company has to recognize a loss/gain on the repurchase to balance. fair value must always be reported in the notes for this purpose.
what is fair value option?
to option to always recognize your financial liabilities at fair value on your BS.
