FAR - Financial Statement Acct - Long-Term Debt Flashcards
2 methods to record a note discount/premium
Gross and net
1) market/yield/effective rate > stated/coupon rate =
2) stated/coupon rate > mkt/yield/effective rate =
3) mkt/yield/effective rate = stated/coupon rate =
1) discount
2) premium
3) face value
non-interest bearing note?
zero interest paid for during period, interest included in amount paid at maturity date, deeply discounted note.
total interest expense related to non-interest bearing note?
total payments - amount borrowed
market rate = ?
stated rate = ?
difference = ?
market rate = interest expense
stated rate = interest payment
difference = discount/premium
2 methods to amortize a note premium/discount?
1) Straight-line
2) Effective Interest
amount borrowed on an installment note issued at discount?
Product of the periodic payment and the annuity factor for the term of the note and the yield rate
amount of interest recognized for a period on a note calling for a face amount due at maturity, issued with an effective interest rate not equal to the stated rate?
Product of effective rate at date of issuing the note and the principal balance at the beginning
principal amount of a noninterest-bearing note?
Present value of the face amount discounted at the yield rate
When is the straight-line method not allowed for notes payable accounting?
Installment notes, and when the yield and stated rates are materially different.
“interest-bearing note payable.”?
note with explicit interest element
reported amount of a note calling for a face amount due at maturity, issued with an effective interest rate not equal to the stated rate?
Present value of remaining cash flows discounted at the effective rate.
distinction between notes payable and accounts
payable?
1) time length is extended
2) explicit interest element
net note balance for a note issued at a discount?
Face value - unamort discount
amount of interest recognized for a period on an installment note (one requiring equal periodic payments that include both principal and interest)?
Product of effective rate at date of issuing the note and the principal balance at the beginning
amount of the periodic payment for an installment note issued at discount?
Face value divided by the annuity factor for the term of the note and the stated rate
amount of noninterest revenue recognized over the term
Define “discount on note” for a note exchanged for cash and other privileges.
true/false
Must use market rate of original issuance regardless of the fluctuation of the market rate
True
true/false
If the stated and market rates of interest are different, the market rate is used to compute the book value of the debt.
true
true/false
interest expense reflect mkt rate*
and note face value should be valued at PV**
interest payable reflects stated rate*****
true
Annuity due?
payment required at the beginning of the period
true/false
Bankruptcy law specifies that secured creditors are to be satisfied before any assets are paid to unsecured creditors
true
effective interest rate for the year (only amortization of interest method)
total interest paid / net amount loaned (less fees)
true/false
interest must be deducted from periodic payments to result in reduction in principal figure, the more the payments, the less the interest, and bigger the principal amount
Reduce note payable balance with the following figure = payment - interest = principal
accrue interest only on the periodic payment made, not entire balance
true
true/false
use market rate to assess the present value of loans
true
Pension cost interest is a component of pension expense. It is not separately reported as interest expense. It is the growth in the projected benefit obligation for the period.
true
Postretirement healthcare benefits interest is a component of postretirement benefit expense. It is not separately reported as interest expense. It is the growth in the accumulated postretirement benefit obligation for the period.
Interest incurred to finance construction of machinery for own use is capitalized interest and becomes part of the machinery under construction. The cost is never reported as interest. Instead, the cost is included in depreciation on the asset during its useful life.
noninterest-bearing note actually causes interest to be paid by the maker. The term noninterest-bearing means that the note carries no stated rate of interest. The face value of the note includes interest however, and exceeds the principal amount of the note (the amount borrowed).
true
define bond
Define “serial bonds.”
Define “issuance date.”
Define “bond date.”
secured bonds
method is required for premium/discount amortization?
financial debt instrument requires periodic interest payment and the principal will be due in the future
bonds that mature at regular or staggered intervals.
issuance date of bond
1st possible issuance date
claims to specific assets
effective interest
three general aspects about the valuation of all long-term liabilities.
- Initially recorded at the present value of future cash flows;
- Interest and amortization are recognized at the market interest rate the date the liability was established;
- Interest expense equals the liability balance at the beginning of the period times the market rate of interest the date the liability was recorded.
bond carrying value - bond face value =
bond premium amort = interest exp - interest paid
interest exp = yield rate X bond carrying value
premium
true/false
The discount increases the total interest over the term. The discount is additional interest because it represents the difference between face value and amount borrowed. The firm borrowed an amount less than the amount required to be paid at the end of the term.
true
true/false
always record bonds payable at face value, if discount/premium present, add additional account into entry and plug with cash
true
cash interest paid =
interest expense =
stated rate X face value
market rate X carrying value
Serial bonds mature at regular intervals rather than on one single date. Debenture bonds are not secured but rather are backed only by the general credit of the issuing firm. Debenture bonds can be serial bonds. Therefore, the total amount of debenture bonds equals the total of the unsecured bond issues
true
future value of $1 is the reciprocal of the present value of $1.
true
Both the registered debentures and collateral trust bonds are term bonds. A term bond matures on a single date. Although the bonds may be called or converted, these events may not occur, in which case they would be retired all on one date.
The subordinated debentures are serial bonds that mature in $30,000 amounts beginning 1997. They do not all mature on the same date.
true
SL method recognizes the average amount of discount amortization every period, which must be larger than under the effective interest method early in the bond term. Thus, interest expense under the SL method results in higher interest expense, lower retained earnings, and higher bond carrying value because more discount is amortized early in the bond term than under the effective interest method.
true
convertible bond
callable bond
redeemable bond
serial bond
single maturity (term) bond
secured bond (debenture)
unsecured bond (debenture)
sinking bond
- can be converted into capital
- issuer can retire callable bonds before maturity at a specified price
- bondholder can require a redeemable to retire early, pay off at call value to end the bond with interest
- serial bond matures serially/regular or staggerly, DOESNT mature at 1 date
- principal paid gradually, mature at 1 date
- secured bond issue has claim to specific assets, unsecured creditor, mature at 1 date
- only backed by credit rating of the issuing, mature at 1 date
- issuing firm is required to invest cash each year into a restricted fund for the purpose of retiring the bonds, mature on one date
amortized discount increases the bond carrying value while the amortized premium decreases the bond carrying value
true
Accrued interest is reported separately from the net bond liability.
true
Serial bonds mature serially according to a schedule set in the bond contract. At each date, a portion of the bond issue is paid off (matures) until the entire face value of the issue is retired. Each portion is a percentage of the total face value of the issue. Serial bonds are designed to reduce the risk, to the bondholder, of default by the issuing firm.
True, therefore serial bonds are like installments
if semi-annual, divide years in half and percentage in half to make sure to get the accurate PV formula to calculate the correct selling price of the bond
NOTE
issuance between interest dates -> accrued interest payable, between bond date and bond issuance date
bond proceeds
true
sum of bond price + accrued interest
issuance between dates:
1) bond price excludes interest
2) premium/discount unaffected
3) bond term is lesser than b4 by time period of accrued interest
affects overall time period -> change S/L formula
true
use stated rate to calculate accrued interest
Bond issue costs
acct, legal, printing, underwriting fees, promotion costs, costs to issue bonds
capitalized to deferred charge (asset) account/amortized as expense over bond term using the straight line method
How many months of interest are collected at issuance when bonds are issued between interest dates?’
length of a bond term when bonds are issued between interest dates?
Number of months between the most recent interest payment date and the date of issuance.
Period of time from issuance date to maturity date.
When bonds are sold between interest dates rather than on the bond date, the straight-line method will use a smaller number of months to amortize the discount or premium.
true
price at which bonds sell is calculated as the present value of the principal amount plus the present value of the bond interest payments; both are discounted using the market rate of interest appropriate for the bonds. (The market rate of interest is also the effective rate or the interest rate the bonds will yield.) The bond issue cost will be deducted from the gross proceeds to determine the net amount to be received by the issuer.
true
The bond issue costs are separately reported as a deferred charge.
true
they are reported as bond issue costs
The net cash receipts from the bond issue equals the total bond price plus accrued interest between the bond date and the issue date less the bond issue costs.
When bonds are issued between interest dates, the cash interest since the most recent past interest payment date must be collected from the bondholders because a full six months’ interest is paid on the following interest date.
true
if there are months dated back (different interest dates) these additional months must be subtracted from the bond term
AFFECTS AMORTIZATION!
true
income statement effect of the fair value option applied to financial liabilities?
balance sheet effect of the fair value option applied to financial liabilities?
Recognize gain or loss for the change in the fair value adjustment of the liability during the period.
Liability reported at FV
Bond FVO is irrevocable and may be applied to one/all bonds
increase in FV = unrealized loss
decrease in FV = unrealized gain
true
total interest expense for a bond issue using an effective interest bond amortization schedule (assume a premium) computed?
Sum of the cash interest column less sum of amortization of premium column.
GAAP and IFRS Bond Differences
debt issue costs (transaction costs) reduce proceeds from the debt. FVO is limited to assets/liab managed and evaluated as a group on a FV basis.
IFRS provides that financial instruments with characteristics of both debt and equity are compound instruments and must be separated into its respective components. The liability is valued at the fair value at the date of issuance and the residual value is assigned to the equity component.
true
IFRS provides that financial liabilities may be reported at amortized cost or at the fair value through profit or loss (FVTPL).
true
fair value of the bond and the principal obligation value must be disclosed
true
Discount on notes payable is a liability valuation account. It should be reported as a direct reduction from the face amount of the note (contra account). A premium on notes payable would be reported as an addition to the face amount of the note. Thus, a discount on notes payable should be reported on the balance sheet as a direct reduction from the face amount of the note.
true
book value method of recording converted debt?
Remaining book value of the bonds is transferred to the capital stock account and contributed capital in excess of par account. No gain or loss is recorded.
convertible bond is issued, how are the proceeds treated?
same as a nonconvertible bond. Nothing allocated to the conversion feature.
accounting treatment for convertible bonds with a beneficial conversion feature?
excess of fair value of the stock to be issued upon conversion (measured at the date of issuance) over the face value of the bonds, is allocated to owners’ equity.
market value method of recorded converted debt?
more reliable of market value of the stock or bonds is allocated to the capital stock account and contributed capital in excess of par account. A gain or loss is recorded equal to the difference between the total market value recorded and the remaining book value of the bonds.
amount is allocated to owners’ equity on issuance of convertible bonds that can be settled in cash?
Issuance price less the present value of the bonds using the prevailing rate on similar bonds.
accounting treatment by the issuer for additional consideration paid to induce conversion of convertible bonds?
Bonds are unaffected by conversion feature until what point in time?
Recognize expense for the fair value of the additional consideration (increase number of shares, issue warrants/cash)
Until conversion takes place.
convertible bond is a long term liability that can be converted into preferred/common stock NOT REEDEMABLE!
(2 methods BV or MKT value)
true
bonds convertible to stock are recorded the same way as nonconvertible bonds. The conversion feature is not separable at the issue date; there is no known market value for the conversion feature. Therefore, no value is assigned to the conversion feature at issuance.
true
Investors of convertible debt receive the security of debt (guaranteed principal and interest) plus the option of converting to stock if the value of the stock has appreciated. This conversion feature entices investors to accept a lower interest rate than would be given with a non-convertible debt issue
true
When bonds are converted to stock and accounted for by the book value method, the owners’ equity is increased by the book value of the bonds.
There is no gain or loss because the book value of the bonds is simply transferred to the stock accounts. Common stock, and additional paid in capital are increased if necessary. If the total par of common stock issued exceeds the book value of the bonds, then retained earnings is decreased. Retained earnings can never be increased on conversion.
true
How should the exercise of detachable warrants be accounted for?
bonds with detachable warrants be accounted for after issuance?
DR: Cash (exercise price
DR: Detachable warrants
CR: C.S.
CR: APIC
unaffected by warrants, amortize disc/prem
issuance of bonds with detachable warrants be recorded when the market value of both are known?
issuance of bonds with detachable warrants be recorded when only one market value is known?
Proceeds are allocated to each issue based on the respective fair market values of the securities.
Proceeds equal to the fair market value are allocated to that security, and the incremental proceeds are allocated to the remaining security.
purpose of detachable stock warrants?
allocation of bond price to stock warrant is owner’s equity acct?
increase marketability of bond issue.
yes.
total proceeds must first be allocated to both securities based on their relative market values. The difference between the portion of the proceeds allocated to the bonds, and the face value, is the discount to be recorded.
true
When only one of the two securities (warrants and bonds) has a known market value, the allocation of the proceeds to that security is its total market value. Thus, the warrants are recorded at fair value. The remaining proceeds (total proceeds less warrant fair value) are allocated to the bonds.
Let W = fair value and recorded value of the warrants, F = total face value of the bond, and P = total proceeds. W is allocated to the warrants and P - W is the allocation to the bonds.
W + F > P is according to the information in the question.
Therefore,
F > P - W face value exceeds proceeds less warrant fair value, and therefore also exceeds the allocation to the bonds.
Thus, the allocation of the proceeds to the bonds is less than face value. The bonds therefore are recorded at a discount.
way to figure out the discount
detachable stock warrants > par value and mkt value of preferred stock, effect on OE?
When the warrants are exercised, this account, which holds the carrying value of the warrants, is closed.
Cash is increased, and common stock (and possibly contributed capital in excess of par) also is increased to account for the issuance of stock. The net effect on owners’ equity of the exercise is, therefore, the amount of cash received.
short-term refinancing obligations
2 conditions for refinancing CL -> NCL
1) intent: BOD minutes/bank documentation
2) ability: 1 of 3 actions after B/S date, but before financials issuance
3 actions to refinance CL -> NCL
- Actually refinance before issuance of the financial statements;
- Enter into a noncancelable refinancing agreement supported by a viable lender;
- Issue equity securities replacing the debt.
IFRS requires for ST loan refinancing that the agreement or ability be done before the balance sheet date?
true
the noncancelable refinancing agreement has a limit to reclassify CL to the extent of the max amount in this agreement
true
FAS 47 requires the disclosure of the aggregate amount of maturities and sinking fund requirements for all long-term debt for each of the five years following the balance sheet date. The detail for each year is disclosed by the amount of both the sinking fund requirement and the maturity.
true
when CL reclassified as NCL -> details of the refinancing must be disclosed in the notes
true
The portion of the note paid between the balance sheet date and the date of issuing the financial statements is classified as current because current assets were used to retire that part of the note. (prepaid CL = CL paid for that year)
true
conditions that must exist for debt to be extinguished.
- Debtor pays creditor and is relieved of obligation;
2. Debtor is legally released from being primary obligor.
steps to retire debt on the books.
- Record interest, amortization of discount/premium, issue costs to date of retirement;;
- Remove debt and related accounts;
- Record gain or loss.
How are gains/losses from extinguishment of debt reported on the income statement?
Recognized as components of income from continuing operations.
substance defeasance does not meet the definition of debt extinguishment.
True
if interest rates rise, mkt price decrease, resulting in gain in early retirement.
if interest rates decline, mkt price increase, resulting in loss in early retirement
true
Unamortized bond issue costs increase the loss on debt extinguishment or decrease the gain.
true
BV = face value + premium - discount
Cash paid = $ paid at retirement to extinguish bond
Gain = BV - cash paid, - BIC
Loss = cash paid - BV + BIC
true
bonds RECAP
1) determine BV at retirement
2) cash paid to retire bond reflects current yield rate
3) if using effective interest, BV reflects yield from issuance
true
early debt retirement gains/losses are reported in continuing from operations?
true
When a liability is retired for less than its book value, a gain is recorded because the firm reduces its liabilities more than the reduction in its cash or other assets used for retirement.
true
amortize the bond issue costs and recognize the amortized bond issue costs whereas the premium/discount unamortized amount will be used when calculating gain/losses from early debt retirement exercises
true
recognized interest expense under trouble debt when the sum of restructured CFs is
No interest is recognized; all payments are considered principal payments.
IFRS, two modification categories of terms debt restructures?
1) significant
2) non-significant
requirements must exist for a debt restructuring to be troubled?
Creditor makes concession (accepts lower assets), debtor has fiscal difficulty
IFRS, treatment of settlement troubled debt restructures?
Same as GAAP, “troubled” not used, instead extinguishment
nature of restructured CFs under trouble debt when the sum of restructured CFs is
treated as principal payments.
Describe the post-restructure interest rate under trouble debt when the sum of restructured CFs is > BV of original debt.
Rate equals BV of the original debt with PV of restructured CFs
amount of interest to be recognized under trouble debt after modification when the sum of restructured CFs is > BV of original debt.
sum of restructured CFs - BV original debt.
Describe the debtor’s recording of a settlement restructure.
- Gain = book value of debt + unpaid accrued interest - market value of consideration transferred;
- Gain/loss on disposal of assets transferred;
- Remove debt from books;
- Record any stock issued at market value.
Describe creditor’s recording of settlement restructure
- record ordinary loss = BV receivable - MKT assets/stock rec’d
- remove receivables from books
- record assets rec’d at mkt value
creditor in a modification of terms troubled debt restructuring has a loan impairment, regardless of the relationship
true
debtor records interest after a modification under trouble debt when the sum of restructured CFs is > BV of original debt.
cannot have a gain on a settlement troubled debt restructuring
debtor records no gain after a modification under trouble debt when the sum of restructured CFs is > BV of original debt.
true
3 types of troubled debt restructurement?
1) troubled debt restructurement (extinguish)
2) modification (CFs BV) MOD type 2
creditor in a settlement troubled debt restructuring has a loss = BV receivable - FMV assets rec’d
true
gain on TDR?
loss on nonmonetary disposal?
restructuring gain on nonmonetary disposal?
net loss/gain?
The carrying value of the asset transferred is not relevant to the determination of the restructuring gain.
BV of note + accrued unpaid interest - cash paid
BV asset - FV asset
BV note - FV asset
CV note - CV asset
non-significant modification of debt terms defers the gain and amortizes it over the new debt term. According to U.S. standards, the gain is immediately recognized.
true
significant modification of terms for international standards is treated as a debt extinguishment. The new debt instrument is recorded at fair value, as it otherwise would be if not associated with previous debt.
true
When the future payments under the new terms are less than the current obligation, the debtor writes down the carrying amount of the liability by the amount of the difference and thus recognizes a gain.
true
Define debt covenant compliance.
examples?
Steps taken by debtor to meet the restriction and reporting such compliance.
methods: 1) on-going monitoring, 2) internal system, 3) internal self-evaluation, 4) capital budgeting/planning, 5) periodic sensitivity analysis
examples of specific attributes in a covenant.
covenant will disclose a range of values acceptable for the debtor to abide by via minimums and maximums
classification of a liability callable on demand if debt covenant is violated and it is probable that the debtor will cure violation?
non-current liability
classification of liability subject to a subjective acceleration clause (creditor calls debt for reasons not objectively stated such as decline in earnings)?
Current if it is possible the debt will be called; noncurrent if a remote chance exists of calling the debts.
example of a response by a creditor if the debt covenant is violated by the debtor.
contract describes appropriate actions for creditor to take:
1) demand immediate payment
2) increase interest rate, repossess collateral, reduce credit line, accelerate payment terms
3) renegotiate/restructure debt
4) legal action
classification of liabilities that are due on demand?
current liability
Define covenant-lite loan.
loan with less stringent restrictions, can be sold in a secondary market passing risk to investors
what is a debt covenant?
contract/clause/restriction giving creditors protection against debtors and gives creditors a range of readily available actions to take given the appropriate circumstance were to occur
Liabilities may be callable on demand only if the debtor violates a debt covenant
If the violation is waived (forgiven), then the debt will not be called and the liability can remain in the noncurrent category.
If the covenant includes a subjective acceleration clause and there is only a remote chance that debt will be called, then the liability is classified as noncurrent
true
