Financial Liabilities Flashcards
Define Long Term Debt
Consist of probable future sacrifices of economic benefits.
These sacrifices obligations are not payable within a year
Are Pensions and leases liabilities?
yes
What is the principal in Notes payable?
face amount of a note
It is also referred as face, par, or maturity value of the note
Why would companies rely on short term payables other than long term payables?
1) short term debt temporarily gains a gap in cash flows when cash is insufficient to meet current liquidity’s needs.
2) It matches the firms OP cycle.
3) Lower interest rates are carried over more frequently than long term notes
4) An alternative for businesses who cannot apply for long term notes due to low credit ratings.
Define term loans
the borrower pays interest for each period and principal at maturity
Define installment loan
fixed payment of principal and interest on same period
What is amortization table?
assist in preparing the JE
it includes date, interest, principal, total payment, and note’s carrying value
Interest solved by multiplying periodic interest rate
Principal payment is the difference between total payment and interest payment.
Define Bond
A debt instrument that requires debtor ( borrower) to repay the principal balance at maturity date
interest payments are fixed intervals ( quarterly, semi-annually)
When CO sell bonds are they the creditor?
no
Co becomes debtor ( borrower or issuer), so Purchaser is the creditor ( lender or bondholder)
True or False: CO effectively borrows from large number of lenders in secondary market
True
Define bond indenture
Contract between the corporation and the bondholders.
It protects the rights of creditors by outlining the debt covenants, enforcement, and type and terms of bond.
Define Debt covenants
place restrictions on the corporation to protect the bondholder’s interest.
Cash must be available for repayment of debt
Define Compensating Balances
restricted deposits that a debtor is required to maintain to support existing lending arrangements
Define technical default
a debtor violates one or more terms of its debt covenants by missing payments ( principal and/or interest payments) also called actual default.
What are the seven types of bonds
1) secured bonds - specific asset as collateral
2) Debenture bonds - unsecured bonds ( no collateral)
3) Serial bonds - multiple maturity dates
4) Term bonds - single maturity date
5) Callable bonds - corporation’s option at specified dates.
6) Convertible bonds - bondholders may convert into capital stock
7) Bonds with stock warrants attached - bonds that include long term options to acquire CS
What are specific terms of future cash payments?
1) Face value - par or marturity value
2) Stated interest rate - annual rate that the bond issuer will pay in cash.
3) Interest payment period - frequency with which interest payments are made.
4) Maturity date - specific date when the bond issuer must pay face value of the bonds to the bondholders.
What are three types of bond pricing
1) Face value
2) discount
3) Premium
What is the market rate also called?
1) effective rate
2) required
3) risk- adjusted
4) yield
Issue price is always in PV
How does a discount and premium amortization effective interest expense?
DIscount amortization increases interest expense
Premium amortization decreases interest expense
Define Effective interest rate ( EIR) method
computes interest expense by multiplying the historical market interest rate by this period’s beginning carrying or book value of the debt. ( BBV * MR)
What is bond discount and premium amortization computation?
Bond interest expense Bond interest paid
CV X Effective interest rate) - ( FA Bonds x SIR
Define Convertible bonds
Corporation issue convertible bonds as a way to raise equity capital when equity prices are temporarily depressed.
What are the benefits of convertible bonds?
issues few shares of stock without diluting share price and EPS.
Bondholders get a fixed interest payment, so they can convert their investment based on MV.
holder can convert them into CS or PS.
Define Beneficial conversion option
convert debt to equity if the market price of the stock exceeds the implied exercise price.
It is measured by intrinsic value
Define Stock warrants
options to acquire a stated number and price of CS shares.
They can either be nondetachable or detachable
detachable can be removed by the holder and sold separately. Non detachachable cannot do either.
Define Proportional method
1) allocate based on the relative fair values of the bond without warrants.
2) must be detachable
Define Incremental method
If the fair value of the bonds or the warrants are not determinable, they should allocate the portion of the proceeds to the instrument.
Define Short Term reclassification
1) extended or replaced by debt that will be due beyond one year
2) replaced or refinanced with equity securities.
What is criteria short term reclassification?
1) management must intend to refinance on a long term basis
a) completing an actual reinancing during the post balance sheet period
b) demonstrating a firm agreement that permits refinancing on a long term basis with determinable terms.
2) management must demonstrate the ability to consummate the refinancing
Define Callable obligations
liabilities for which the credit can require immediate payment when specified conditions exist.
Define Reclassification of obligations callable by creditor
debtor’s debt can be in default. It may require to reclassify long term debt.
A violation of a provision of debt agreement ( debt callable at a balance sheet date)
A violation of a debt agreement that is not addressed within specific grace period.
Define Obligations callable by creditor
debtor may continue to classify the callable obligation as a long term if it meets one of the following:
1) creditor waives or loses the right to demand payment
2) The obligation will not become callable because it is probable that the debtor will address the violation within grace period.
Define fair value option
companies can elect to value most types of financial asset and obligations at fair value
How do company use a fair value option?
the company must elect the fair value option at the time it borrows the money or issues the debt.
Afterwards, it is irrevocable
How a company uses fair value option?
the company reports the liability on the balance sheet at fair value
reports all unrealized gains and losses in net income
