Exam 1 Flashcards
Liabilities
- Are probable, future sacrifices of economic benefits.
- Arise from present obligations (to transfer goods or provide services) to other entities.
- Result from past transactions or events.
current liabilities
- obligations payable within one year or within
the firm’s operating cycle, whichever is longer. - expected to be satisfied with
current assets or by the creation of other current liabilities
Classifying liabilities as either current or long term helps investors and creditors assess
relative risk of a business’s liabilities.
How are Current liabilities ordinarily reported
at their maturity amounts
The most common obligations reported as current liabilities
accounts payable, notes payable,
commercial paper, income tax liability, dividends payable, and accrued liabilities
Amounts reported on the face of the balance sheet seldom are sufficient to adequately describe
current liabilities
Additional descriptions are provided in disclosure notes.
Accounts payable
obligations to suppliers of merchandise or of services purchased on open
account.
Trade notes payable
differ from accounts payable in that they are formally recognized by a written
promissory note. Often these are of a somewhat longer term than open accounts and bear interest
noncommitted
line of credit
an informal agreement that permits a company to borrow up to a prearranged limit
without having to follow formal loan procedures and paperwork
committed line of credit
a more formal agreement that usually requires the firm to pay a
commitment fee to the bank.
Calculate Interest
Face Amt x Interest x Time to maturity as a fraction
noninterest-bearing note
interest is deducted (or discounted) from the face amount to determine the cash proceeds made
available to the borrower at the outset
Journal entry for interest bearing note
Cash, Notes payable at issuance and Interest Expense, Notes payable, cash with maturity
Journal entry for noninterest-bearing note
cash, discount, n/p at issuance and interest expense, discount, n/p, cash with maturity
effective interest rate
result of noninterest-bearing note to yield a higher interest rate than the stated rate. calculated by interest divided by amt borrowed
SECURED LOANS
a specified asset of the
borrower is pledged as collateral or security for the loan.
what are normally pledged for short-term loans
Inventory or accounts receivable
factoring receivables.
the receivables actually are sold outright to a finance company as a means of
short-term financing
Commercial paper
unsecured notes sold in
minimum denominations of $25,000 with maturities ranging from 30 to 270 days
the cash a company receives from using short-term notes to borrow
funds as well as the cash it uses to repay the notes are reported among cash flows from
financing
activities.
the cash a company receives from accounts payable, interest
payable, and bonuses payable, are reported among cash flows from
operating activities (are integrally related to a company’s primary operations)
Accrued liabilities
expenses already incurred but not yet paid (accrued expenses)
sick pay
quite often meets the conditions for accrual, but accrual is not mandatory
because future absence depends on future illness, which usually is not a certainty
The reason is that in most settings outsiders (like banks, bondholders, and shareholders)
consider debt that is payable currently to be riskier than debt that need not be paid for some time,
because the current payable requires the company to be able to access the necessary cash relatively
soon.
The currently maturing portion of a long-term debt must be reported as
current liability
Short-term obligations (including the callable obligations we discussed in the previous section) that
are expected to be refinanced on a long-term basis can be reported as noncurrent, rather than current,
liabilities only if two conditions are met:
- (1) the firm must intend to refinance on a long-term basis, and
- (2) the firm must actually have demonstrated the ability to refinance on a long-term basis
Long-term obligations (bonds, notes, lease liabilities, deferred tax liabilities) usually are reclassified
and reported as current liabilities when
they become payable within the upcoming year (or operating
cycle, if longer than a year).
Obligations Callable by the Creditor classified as?
current liabilities
Classification of Liabilities to be Refinanced. Under U.S. GAAP
classified as long-term liabilities if refinancing is completed before the date of
issuance of the financial statements
Classification of Liabilities to be Refinanced Under IFRS
refinancing must be completed before the balance
sheet date
loss contingency
an existing uncertainty as to whether a loss really exists, where the
uncertainty will be resolved only when some future event occurs
GAAP definition of loss contingencies
- Probable - Confirming event is likely to occur.
- Reasonably possible - The chance the confirming event will occur is more than remote but less than
likely. - Remote - The chance the confirming event will occur is slight.
GAAP Accounting Treatment of Loss Contingencies
- Probable and known or easily estimated - accrue for loss contingency
- Probable yet not easily estimated - disclosure note
- Reasonably possible - disclosure note
- Remote - no disclosure or accrual needed
accounting for warranties
The costs of satisfying guarantees should be recorded as expenses in the same accounting period
the products are sold.
1. Record sales for the year (Cash/AR and Sales Rev)
2. Estimate the Warranty Liability over the life of the warranty (Warranty Exp and Estimated War. Liability)
3. Cost incurred to satisfy any claims (Estimated War. Liability and cash/wages payable/supplies)
accounting for extended warranties
- record sale (cash/AR and unearned sales rev)
2. Record earned rev over life of warranty (unearned rev and revenue)
Gain Contingencies
an uncertain situation that might result in a gain
GAAP gain contingency reporting
- conservatism - never accrued
2. material gains are reported in disclosure notes when future realization is probable
IFRS Gain Contingencies reporting
- accrued if their future realization is “virtually certain” to occur
- material gains are reported in disclosure notes when future realization is “more likely than not” (greater than 50 percent)
Periodic interest
stated percentage of face amount (variously referred to as the stated rate, coupon rate, or nominal
rate)
Bonds
obligate the issuing corporation to repay a stated amount (variously referred to as the
principal, par value, face amount, or maturity value) at a specified maturity date and periodic interest between issue date and maturity date.
bond indenture
describes the specific promises made to bondholders
debenture bond
secured only by the “full faith and
credit” of the issuing corporation. No specific assets are pledged as security.
mortgage bond,
backed by a lien on specified real estate owned by the issuer. typically will command a lower
interest rate
coupon bonds
(sometimes called bearer bonds). The name of the owner of a coupon
bond was not registered. Instead, to collect interest on a coupon bond the holder actually clipped an
attached coupon and redeemed it in accordance with instructions in the indenture.
registered bonds
Today most corporate bonds. Interest checks are mailed directly to the owner of
the bond, whose name is registered with the issuing company
Serial bonds
provide a more structured (and less popular) way to retire bonds on a piecemeal basis.
Serial bonds are retired in installments during all or part of the life of the issue
Convertible bonds
are retired as a consequence of bondholders choosing to convert them into shares
of stock.
Recording a Bond
- issuance (face amt of bond) (issuer - cash and bond payable) and (investor - investment in bonds and cash)
- UNLESS there is a variance in market rate to state rate, then determine the present value of the bond and record a discount or premium. (issuer - DR Cash and discount then CR Bond Payble) (investor - DR Investment in bonds and CR discount and cash) opposite for premium
bond premium
may sell for more than face
amount due to a more favorable stated rate to the market or effective rate
bond discount
may sell for less than face amount
amount due to a unfavorable stated rate to the market or effective rate
the effective interest method
the market rate of interest multiplied by the outstanding balance of the debt.
debt issue costs
Costs of issuing debt securities are recorded as a debit to an asset account, “debt issue costs,”
and amortized to expense over the term to maturity.
cash flow impact of loans
Borrowing is a financing activity; lending is an investing activity. Paying or receiving interest is an operating activity.
The debt to equity ratio
indicates the extent of trading on the equity, or financial leverage. (total liabilities/shareholder equity)
When Apex classifies its liabilities as either current or long-term, it helps creditors assess Apex’s:
Relative risk of not meeting its obligations
Other things being equal, most managers would prefer to report liabilities as noncurrent rather than current. The logic behind this preference is that the long-term classification permits the company to report:
A more favorable Current ratio
Accumulated Other Comprehensive Income reflects changes in the fair value of which type of securities?
Securities accounted for as Available for sale securities
For long-term bonds, “Interest Expense” is usually computed as
The effective interest rate times the carrying amount of the debt outstanding during the interest period
zero-coupon bonds
These bonds are especially suitable for tax-deferred or tax-exempt purposes
Issuers of these bonds must record semi-annual or annual interest expense
These bonds are sold at a deep-discount
When callable bonds are retired prior to their maturity date
The issuing company will usually report a non-operating gain or loss
The interest rate that is attached to the specific bond issue in the bond indenture may be referred to as
Nominal rate or
Stated rate or
Coupon rate
Jesse “owns” a home with a 30-year mortgage and makes a monthly mortgage payment. The agreement under which this occurs is most likely a/an
Installment note
The rate of interest that is typically used to compute the debit to INTEREST EXPENSE on a long-term bond, and that is based on the market rate of interest when the bond is sold, is called the
Effective rate
