L8 - Non-Current Liabilities Flashcards
Definition
long term liability probable sacrifice of economic benefits in periods generally > 1 year Examples: - log term debt - leases - ff balance sheet debt
- Bonds
Definition
contractual promises made by company (or other borrowing companies) to pay cash in the future to its lender (bondholders) in exchange of receiving future cash payments
promise of 2 types:
a) FV of bonds = amount of cash payable by the company to bondholders when bond matures
FV also refers to principal, par value, stated value, maturity value
b) periodic interest payments = coupon rate, nominal ate, stated rate
- BONDS
Marktet interest rate
discounting
future cash payments are discounted to PV arrive at market value of bonds
market rate of interest = rate demanded by investors
but often differs from the coupon rate because of IR fluctuations (in market volatility)
- if IR = CR - issued at par price = FV
- if IR < CR - issued at premium P > FV
- if IR > CR - issued at discount P < FV
- zero coupon bonds always issued at discount
- BONDS
background
liability amount report does NOT = total cash flow required to satisfy the deb
only principal is recorded
keep in mind:!!!
- debt = “PV of remaining future stream payments (int &ppal)
- book value uses “market interest rate” when debt was incurred
- interest expense = amount paid in excess of amount borrowed
- total amount of int. paid over time is KNOWN - its allocation to indv. time periods may vary!!
- BONDS
effects of debt issuance and amortisation affects
IS - BS - CF
1,. income statement
- Interest expense reported = interest on loan (based on market IR in effect at issuance) * Bs liability at beg. of period
- Interest of IS are direct function of BS liability
- if bond issued at PREMIUM - int expenses decreased over time
- DISCOUNT = int. expense increases over time
- Balance Sheet
- at any point BS liability = PV of remaining payments discounted at effective IR at issuance
- BS liability = opening Liability + change in Liability (debt amortisation - principal outstanding) - Effects of Cash Flow Statement
cash payment may/not be equal to interest expense
but equal to reduction in CFO
initial cash received + face value payment both treated as cash from financing
reported cash flow incorrectly describe the economic of bond transaction - results from reporting coupon payments as CFO
Bond sold at premium
- part of coupon payment = reduction in principal should be treated as CFF
- -> CFO is understated and financing CF is overstated by an equal amount
Bond sold at discount
- part of discount amortisation represents additional interest expense
- -> CFO overstated; CFF understated
- BONDS
Zero Coupon Debt
no periodic payments and hence issued at deep discount to face value
at maturity - lump payments includes all unpaid interest from the time of issuance
interest payments - never reported as CFO - all is reported in CFF
CFO always overstated
Other financing liabilities
1. convertible bond
to reduce borrowing cost firms issue debt convertible into shares
a) at issuance: convertibility feature completely ignored
- entire proceeds of bonds are recorded as liability
- interest expense recorded as if bonds were noncovertible
b) when bond can be converted (share pice above conversion price) - convertible bond is reclassified from DEbt –> equity
from analytic perspective - recognition should be given to the equity feature prior to conversion:
- stock price > conversion price - equity
- SP < conversion price - debt
- SP = CP - difficult
- BONDS
Bond with warrants
proceeds must be allocated between 2 instruments
a) fair value of bond is recorded as liability:
- bond issued at discount &interest expense includes amortisation of that discount
b) fair value of warrants is included in equity
- no income statement impact
- when warrants are exercised - additional cash increased equity capital
1 Bonds comparison
Interest expense:
bond > bonds with warrants > convertibles
BS liabilities:
bond = convetible > bonds with warrants
OP. CF
bond < convertible = bond with warants
- BONDS
Preferred Stock
perpetual debt
priority over common shares with respect to dividends and sale/liquidation
usually fixed dividend payment, callabl, cumulative
–> if not paid they are an unrecorded liability,
–> dividend in arrears must be paid before any dividend
calculate net worth of a company
- subtract liquidating value of the preferred - not the stated
- subtract any cumulative dividends hat are in arrears
Ambiguity whether debt or equity
- case by case basis
- some issues are debt
- others are called “debt” but designed functionally to be equity
- if redeemable - then not equity
estimate market value of debt
- a) publicity traded debt = market value
- b) not traded - current market rates obtained from
- other publicly traded debt of company with same maturity
- publicly trade debt of equivalent companies
- estimating premium over government debt (rating)
- LEASING
background/motivation
new environment
- change in commodity and other input prices
- volatility of cash flows
trends
- acquiring right to assets through methods other than traditional purchases
- avoid recognition of debt and asset (higher probability ratios&lower leverage)
participants:
a) LESSOR = owner, prefer capital leases
- earlier recognition of rev. vs instalment sales or financing arrangement
- higher profitability &turnover ratios
b) LESEE: user prefers operating leases
- LEASING
Leases
= contract between owner of assets (lessor) and another party (lessee) seeking to use of the asset
a lease = form of financing that enlñables the lessee to purchase the use of the leased asset
lessor grants the right to use the asset to lessee
the right to use asst can be for along period or much shorter (month)
in exchange for right of use - the lessee makes periodic lease payments to lessor
- LEASING
capital lease
transfer to the lessee substantially all risks/reward in the property
a lease meeting:
- ownership transfers property at end of lease term
- lease contains a bargain purchase option
- lease term is at last equal tot 75% of estimated economic life of leased property
(not applicable to land, wor when leased term begins within the final 25% of economic life of assets)
- PV of minimum lase payments (MLPs) >= 90% of failr value of leased property to lessor
- LEASING
operating leases
leases not meting any of four criteria
a) short term or “operating” allows lesee to use property for only a portion of its economic life
b) long term or “capital” transfers all risk/rewards treated fo accounting purposes as sales with financing agreements
- LEASING
Effects on
Balance Sheet
OL = no asset or liabilties recognised
CL = major impact at inception and throughout life of lease
- at inception a/l = PV of lease payments
- current component = principal to be made in the following year
Income statement
capitalisation results in higher operating income (EBIT) since annual straightline depreciation < annual rental expenses
OL = charges periodic rental payments to expense as accrued
CL = recognise depreciation &int. expense over the lease term
Net Income effects
lease expense = interest expense + depreciation of leased asset
a) over life - OLcost = CL
b) initially expense of capital < rental expense
c)after expense of capital < rental expense
Cash FLow Effects
OL = all cash are operating
CL = differs
a) interest exposed - treated as CFO
b) amortisation of lease obligation - cash from finance
at inception (yr=0) no cash flows are reported
due to amortisation - lease capitalisation allows fims to report higher operating CF
