FAR 2H LT Debt

Question 1

What is compared to the carrying amount of the debt in a troubled debt restructuring involving a modification of terms?

Answer 1

The total future cash payments under the modified terms are compared to the carrying amount of the debt. If the future payments are less than the carrying amount, the debtor may report a gain.

Debtor owes money. Needs to pay back
Creditor lends money. Expects repayment

Question 2

How does a debtor determine if a gain is reported in a troubled debt restructuring?

Answer 2

A gain is recognized if the total future cash payments (including principal and interest) under the modified terms are less than the carrying amount of the debt before restructuring.

(principle of conservatism)

Question 3

Who are the debtor and creditor in a loan agreement?

Answer 3

The debtor is the entity that owes money and is obligated to repay the loan. The creditor is the party that lends money and expects repayment from the debtor, typically with interest.

Question 4

How does a bond discount affect the carrying amount of the bond over time?

Answer 4

A bond discount occurs when the bond is issued for less than face value. The carrying amount of the bond increases over time as the discount is amortized until it reaches the face value at maturity.

Question 5

How does a bond premium affect the carrying amount of the bond over time?

Answer 5

A bond premium occurs when the bond is issued for more than face value. The carrying amount of the bond decreases over time as the premium is amortized, reducing it to the face value at maturity.

Question 6

How do you calculate interest expense on a bond issued at a discount or premium?

Answer 6

Interest expense is calculated by multiplying the carrying amount of the bond at the beginning of the period by the effective interest rate (market rate at issuance). This amount reflects the actual cost of borrowing.

Question 7

How is the amortization of a bond premium or discount calculated?

Answer 7

The amortization of the premium or discount is the difference between the interest expense (calculated using the effective interest rate) and the cash interest paid (based on the bond’s stated coupon rate).

• Premium amortization reduces the carrying amount.
• Discount amortization increases the carrying amount.

Question 8

How to set up a bond amortization table?

Answer 8

Column 1: Date of payments
Column 2: Cash Payment
Column 3: Interest expense
Column 4: Premium/Discount amortized
Column 5: Carrying value

Question 9

What is the unamortized premium or discount on a bond?

Answer 9

The unamortized premium or discount is the remaining balance of the bond’s premium or discount that has not yet been amortized. For a premium, it reduces the bond’s carrying amount over time; for a discount, it increases the carrying amount until the bond reaches its face value at maturity.

Question 10

What are the key criteria for a Modification of Terms (TDR) under U.S. GAAP?

Answer 10

1) Debtor’s financial difficulty.
2) Creditor grants a concession (e.g., reduced interest, extended payment terms).
3) Compare total future cash payments with the carrying amount to determine if a gain is recognized. The debt is not derecognized.

Question 11

When is debt considered extinguished under U.S. GAAP?

Answer 11

1) There is a substantial modification of terms, often measured by the 10% test.
2) The old debt is fully repaid or replaced by new debt.
3) The old debt is removed, and any gain or loss is recognized.

Question 11

What is the 10% test for debt extinguishment?

Answer 11

The 10% test compares the PV of modified cash flows to the original cash flows using the original interest rate. If the difference is 10% or more, the debt is extinguished and derecognized.

Question 12

What are the criteria for a Troubled Debt Restructuring (TDR)?

Answer 12

1) The debtor is experiencing financial difficulties.
2) The creditor grants a concession (e.g., reduced interest rate, extended terms, forgiveness of principal).
3) The restructuring must provide relief to the debtor, and the terms wouldn’t have been offered if the debtor were not in financial trouble.

Question 13

How is the total amount received from a bond issuance calculated?

Answer 13

The total amount received from a bond issuance is calculated by adding the proceeds from the sale of the bonds at the issue price (percentage of face value) to the accrued interest paid by the buyer. This includes the face value multiplied by the issue rate plus any interest accumulated between the last interest payment date and the sale date.

Question 14

How to calculate the discount/premium of a bond that includese a warrent?

Answer 14

1) calculate cash amount
2) calculate bond face value
3) calculate number of warrents and then calculate value warrents with that
4) Residual is discount/premium

e.g. 1) debit cash 1090 2) credit face bond payable 1000 3) debit APIC warrents 200 4) calculate residual and debit discount

Question 15

What should the issuer/investor record when warrents are non-detachable?

Answer 15

Issuer: Ignore the warrent
Investor: Record investment in Bonds and Investment in Warrents separately

Question 16

How do you calculate the total issue price of a bond sold at a discount?

Answer 16

1) Determine the present value of the bond’s principal using the present value factor for a single payment at the end of the bond’s term, matching the bond’s yield rate.
2) Determine the present value of the annuity of interest payments using the annuity present value factor for semi-annual interest payments, also at the bond’s yield rate.
3) Add the present values of the principal and the interest payments to get the total issue price.

Question 17

What present value factors are used for calculating the issue price of bonds with semi-annual interest payments?

Answer 17

1) Present value of $1 for the number of periods till maturity at the bond’s yield rate for the bond’s principal.
2) Present value of an annuity of $1 for the same number of periods at the same yield rate for the bond’s semi-annual interest payments. These factors reflect the time value of money based on the bond’s yield, allowing for the adjustment of future cash flows to their present value at the bond’s effective interest rate.

Question 18

How should a note payable be recorded when the interest rate is not explicitly stated?

Answer 18

When the interest rate is not stated or is unreasonable, a note payable should be recorded at the fair value of the property, goods, or services exchanged or the market value of the note, whichever is more clearly determinable. If neither is clear, the note is recorded at its present value by discounting future payments using an imputed interest rate reflecting the debtor’s credit standing and market conditions.

Question 19

How is the discount on a note payable treated in financial statements?

Answer 19

The discount on a note payable is the difference between the face amount and the present value calculated using the imputed interest rate. This discount is amortized over the life of the note, increasing the carrying amount to the face value by maturity and is recognized as interest expense in the financial statements.

Question 20

What is a Debenture bond?

Answer 20

A Debenture is an unsecured bond, meaning it does not have specific assets pledged as collateral for the bond’s repayment.

Question 21

What are Serial bonds?

Answer 21

Serial bonds are issued with various maturity dates scheduled at regular intervals until the entire issue is retired. This means different portions of the bond issue mature at different times, providing a way for issuers to manage debt repayment gradually over time. Interest payments may decrease over the life of the issue as portions of the principal are paid off

Question entails e.g. “bonds mature annually beginning in Year XY”

Question 22

Debtor is in financial difficulties when any of the following occur…?

Answer 22

1. It is in default on any of its debt.
2. It has filed, or is in the process of filing, for bankruptcy.
3. It cannot obtain funds from other sources.
4. The creditor projects the debtor cannot service its debt.
5. There is substantial doubt about whether it can continue to be a going concern.
6. The debtor has securities that have, or are being, delisted from an exchange

Question 23

Terms of the debt agreement are modified to include:

Answer 23

1. A provision for outright foreclosure without a court filing
2. A reduction in the applicable interest rate
3. An extension of the loan repayment period at an interest rate less than the current rate
4. An acceptance of interest‐only payments for a specified period
5. Forgiveness of a part of the principal and/or accrued interest

Question 24

What are a) Income bonds and b) revenue bonds?

Answer 24

a) Income bonds pay no interest unless the issuer is profitable.
b) Revenue bonds pay interest from specific revenue sources

Question 25

Serial vs term bonds repayment structure?

Answer 25

Unlike term bonds, which repay the entire principal at maturity, serial bonds are structured so that the principal is paid back in increments over the life of the bonds.

For $10 million in serial bonds structured to be fully repaid over 10 years, the issuer might repay $1 million each year as part of the principal. This repayment schedule reduces the total outstanding principal gradually.

Question 26

What includes Bonds payable?

Answer 26

Face value of bond + Bond premium/- bond discount

Interest payable is separate