FAR 5-3: Long-Term Liabilities & Bonds Payable Flashcards
When is a bond issued at a discount? A premium?
A bond is issued at a discount when the bond interest rate is less than the market rate of interest.
A bond is issued at a premium when the bond interest rate is greater than the market rate of interest.
How is the bond selling price computed?
The price is the sum of the PV of the future principal pymt plus the PV of the periodic interest pymts discounted using the market rate on the date the bonds are issued.
Name 2 methods of amortizing bond premium (discount).
*Straight-Line Method:
>Premium (Discount) / # of periods outstanding
*Interest (Effective Rate) Method (GAAP/IFRS):
>Premium (Discount) amortized = (Carrying value X Effective rate) - (Face value X Stated rate)
>Interest expense = (Face value X Stated rate) + Discount amortized - Premium amortized = Carrying value X Effective rate
NOTE: The straight-line method is permitted under GAAP if not materially different than the effective interest method. It is prohibited under IFRS.
What is the preferred method of accounting for bond issue costs under GAAP & IFRS?
*GAAP:
Capitalized as a deferred charge (asset) & amortized to expense over the period the bond is outstanding using SL method.
*IFRS:
Deducted from the carrying value amt of the liability & amortized using the effective interest method.
How are convertible bonds accounted for when issued under IFRS & GAAP?
*GAAP:
Like non-convertible bonds. No separate recognition of the conversion feature.
IFRS:
Both a liability (bond at FV) & equity (difference between proceeds & FV) recognized.
Describe the 2 methods of accounting for the conversion of convertible bonds.
*Book Value Method (GAAP):
No G/L is recognized.
*Market Value Method (not GAAP):
G/L is recognized for the difference between market value of stock & book value of bond.
Define stock warrants.
Option contracts that are issued with, & are usually detachable from, bonds & notes. Gives the bondholder the right to buy stock at a fixed price within a specific time period.
Describe the 2 methods of accounting for bonds with detachable stock purchase warrants.
*Warrants Only Method:
Warrants are valued at FV in SHE. Residual of bond proceeds is assigned to the bonds.
*Market Value Method:
Bond proceeds are allocated to the bonds & warrants according to their relative FVs.
When is a liability considered extinguished?
If either 1 of the following conditions is met:
- If the debtor pays the creditor & is relieved of its obligations for the liability.
- If the debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor.
Define in-substance defeasance.
An arrangement where a company places purchased securities into an irrevocable trust & pledges them for the future principal & interest pymts on its L/T debt.
The company remains the primary obligor; therefore, liability is not considered extinguished.
How is the gain or loss on early extinguishment of debt treated?
Ordinary gain or loss on the I/S, shown as a separate line item, if material, in income from continuing operations, unless it meets the criteria of unusual in nature & infrequent in occurrence, in which case it is treated as an extraordinary item & reported net of taxes.
The gain or loss is the difference between net carrying value (including unamortized bond issue costs asset (GAAP only) & premium or discount) & the reacquisition price of the debt.
What are the major disclosures for long-term debt?
- Maturity dates
- Interest rates
- Call & conversion privileges
- Assets pledged as security
- Future sinking fund pymts
- Maturities for each of the next 5 years
List some examples of current liabilities.
- Trade accounts & N/P
- Current portion of L/T debt
- Cash dividends payable
- Accrued liabilities
- Payroll liabilities
- Taxes payable
- Customer advances (deferred revenue)
