H. LONG-TERM DEBT - 1. NOTES AND BONDS PAYABLE

Question 1

_{H. LONG-TERM DEBT}

_{1. NOTES AND BONDS PAYABLE}

Modification of Terms vs Extinguishment of Debt

Understanding Event and Treatment

Answer 1

What happens here is something like interest rates changing and the issuer of debt recalling the debt and then reissuing it at the current interest rates.

Then the question is,

• was this an “extinguishment of debt” (and a “substantially different” new loan) or
• just a “modification of the terms” (substantially the same loan)?

Question 2

_{H. LONG-TERM DEBT}

_{1. NOTES AND BONDS PAYABLE}

To be considered an extinguishment:

Answer 2

To be considered an extinguishment:

There needs to be a 10% or greater difference in the present value of the new loan’s cash flows and the present value of the old loan’s remaining cash flows.

Also, if any embedded conversion options were changed, it could be considered “substantially different” and would be considered an extinguishment.

If neither of these apply, then the new loan is not substantially different, and it would just be considered a modification.

Question 3

_{H. LONG-TERM DEBT}

_{1. NOTES AND BONDS PAYABLE}

What Constitutes a Troubled Debt Restructuring?

Answer 3

What Constitutes a Troubled Debt Restructuring?

The simplest definition for a TDR is when the creditor grants the debtor a concession that they wouldn’t normally consider.

This is based on two conditions:

• The debtor must be experiencing financial difficulties
• The creditor must grant a concession as a result of the debtor’s financial difficulties

Another way to look at it is if the creditor modifies the debt in a way that results in less overall money being paid back then before the restructure, indicating the creditor has made a concession.

Would rather get paid back a portion of what is owed then nothing if the debtor is forced to default.

When this happens,

• the creditor will record a loss (they essentially have a note receivable that just went down in value), and
• the debtor records a gain, because they were released from a portion of debt they otherwise would have paid back.

Question 4

_{H. LONG-TERM DEBT}

_{1. NOTES AND BONDS PAYABLE}

Debt vs Equity Instruments

Answer 4

Debt vs Equity Instruments

Some instruments have features of both debt and equity. There are certain characteristics that help clarify what an instrument should be classified as on the balance sheet.

Question 5

_{H. LONG-TERM DEBT}

_{1. NOTES AND BONDS PAYABLE}

Convertible debt:

Answer 5

Convertible debt:

• Debt that can at a later date be exchanged for common stock
  will be classified as debt until the conversion takes place.
• If the conversion can be settled with cash, then it remains classified as debt.

Question 6

_{H. LONG-TERM DEBT}

_{1. NOTES AND BONDS PAYABLE}

Bonds with detachable warrants:

Answer 6

Bonds with detachable warrants:

The proceeds from the issuance are allocated to

1. the fair value of the warrants without the debt (paid in capital account-equity) and
2. the fair value of the debt instrument (classified as debt).

Question 7

_{H. LONG-TERM DEBT}

_{1. NOTES AND BONDS PAYABLE}

Issuing shares worth a fixed dollar amount:

Answer 7

Issuing shares worth a fixed dollar amount:

• If a firm agrees to a transaction where they will issue shares worth a fixed dollar amount in the future, this would be considered debt.
• They are essentially just agreeing to pay a certain price in the future for the transaction… which fits the description of debt.

Question 8

_{H. LONG-TERM DEBT}

_{1. NOTES AND BONDS PAYABLE}

Issuing a fixed number of shares:

Answer 8

Issuing a fixed number of shares:

If a firm agrees to a transaction where they will issue a certain number of shares, but not at a fixed price, this would be classified as equity.