Long Term Debt (Financial Liabilities)

Question 1

Long term liabilities are recorded how on balance sheet.

Answer 1

at present-value basis, which is the sum of the future payments discounted at an appropriate rate of interest. Any related discount or premium should be amortized using the interest method. The unamortized discount/premium should be reported in the BS as a direct deduction from or addition to the face amount of the liability

Question 2

How are issue costs on bonds recorded?

Answer 2

they are included in the cost of the bonds and are therefore amortized over the life of the debt

Question 3

What are notes payable?

Answer 3

liabilities that are formally recognized by a written promissory note. These notes most often occur when the company cannot pay short term AO or obligations for items that have entered into the operating cycle. In those instances, the company may sign an interest-bearing note to defer payment for a short time.

Question 4

What is a credit line?

Answer 4

A credit line allows a company to borrow up to an arranged limit without using formal loan paperwork

Question 5

What is commercial paper?

Answer 5

It is an unsecured note generally sold in minimum amounts of $25,000 with maturities of 30 to 270 days. It is issued directly to the buyer

Question 6

When a bond is issued, the bond contract (indenture) specifies the amount and timing payments the issuer is obligated to pay. What 2 items will the issuer pay?

Answer 6

1. the face or principal amount at the maturity date of the bonds
2. interest at specified intervals, usually semi-annually, during the life of the bond based on a state percentage of the face amount.

Question 7

The interest rate on bonds is also known by what 4 names?

Answer 7

1. stated rate
2. coupon rate
3. contract rate
4. nominal rate

Question 8

What is the effective interest rate for bonds?

Answer 8

The effective interest the issuer will pay is determined in the marketplace, not in the bond contract. This is the rate that the investor (purchaser of bond) can command in the marketplace for the particular type of bond and risk level

Question 9

What method should be used to amortize a bond discount or premium?

Answer 9

Interest method which results in a constant rate of interest. Other methods such as SL may be used if the results are not materially different

Question 10

What are serial bonds?

Answer 10

Bond issues provide for the payment of the principal in periodic installments. In essence, the bond issue is a series of separate bonds issues that mature at different dates.

Question 11

An exchange of debt instruments with substantially different terms is treated how?

Answer 11

as a debt extinguishment

Question 12

If a substantial modification of terms are made to an existing debt instrument, how is it treated?

Answer 12

like an extinguishment of debt

Question 13

What happens when it is determined that an original and new debt instruments are not substantially different?

Answer 13

a new effective interest rate shall be determined based on the carrying amount of the original debt instrument, adjusted for an increase (never a decrease) in the FV of an embedded conversion option (calculated as the difference between the FV of the embedded conversion option immediately before and after the modification or exchange) resulting from the modification, and the revised cash flow.

Question 14

The FASB concluded that all extinguishments of debt are fundamentally alike and should be accounted for alike except for what?

Answer 14

The conversion of convertible debt by the holder of the debt is not deemed to be an extinguishment of debt, although it can be treated as such.

Question 15

FASB ASC 405-20-40-1 specifies that debt is extinguished if either of two conditions are met. What are they?

Answer 15

1. the debtor pays the creditor and is relieved of its obligation for the liability. (Paying the creditor includes delivery of cash, other financial assets, goods or services or reacquisition by the debtor of its outstanding debt securities whether the securities are canceled or held as so-called treasury bonds)
2. the debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor

Question 16

How should the difference between the reacquisition price and the net carrying amount of the extinguished debt be accounted?

Answer 16

In income in the period of extinguishment. Such gain/loss is a gain/loss on extinguishment of debt and should be classified as whether ordinary or extraordinary as any other gain/loss

Question 17

What is a reacquisition price?

Answer 17

It is the amount paid, including any call premium and other costs incidental to reacquisition. If the extinguishment is achieved by issuing new securities (debt or equity) the reacquisition price is the total present value of the new security

Question 18

What is net carrying amount of debt?

Answer 18

It is the carrying value of the debt, less any unamortized issue costs

Question 19

What constitutes a restructuring of debt?

Answer 19

A troubled debt restructuring (TDR) if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. This concession may stem from an agreement between the creditor and the debtor, or it may be imposed by law or a court

Question 20

A troubled debt restructuring is normally accomplished by one or a combination of what 4 things?

Answer 20

1. Transfer from the debtor to the creditor of assets to satisfy fully or partially the debt
2. issuance of an equity interest to the creditor by the debtor to satisfy fully or partially the debt
3. modification of terms of the debt, such as
   
   1. reduction in the interest rate for the remainder of the life of the debt
   2. extension of maturity date(s) at an interest rate less than the current rate for new debt
   3. reduction of the face amount or maturity amount of the debt
   4. reduction of accrued interest

Question 21

In a modification of terms, if the total scheduled cash payments exceed or equal the carrying value of the deb, the TDR is accounted for by the debtor in what 2 ways?

Answer 21

1. change in payments handled on a prospective basis

2. interest expense recognized at reduced amount

Question 22

In a modification of terms, if the total scheduled cash payments are less than the carrying value of the debt, the TDR is recorded by the debtor in what 3 ways?

Answer 22

1. reduce carrying value of debt to total scheduled cash payments
2. recognize gain (equal to the difference between the carrying value of the debt and the total scheduled cash payments)
3. recognize all future payments - whether designated as principal or interest - as principal, reducing the payable

Question 23

FASC ASC 310-10-35-22 requires the creditor to account for a restructured loan how?

Answer 23

at its present value, computed at the original contractual interest rate.

Question 24

When a TDR is accomplished by a combination of the types of restructuring, in what order is the note receivable or payable reduced?

Answer 24

First reduced by the fair value of the assets or equity interest transferred. For the remainder of the debt, the rules for the modification of terms are followed

Question 25

What 5 things must a debtor disclose, either in the body or the notes to the financial statements in regards to TDR?

Answer 25

1. For each TDR, a description of the principal change in terms and/or the major features of the settlement
2. the aggregate gain on restructuring of payables and the related income tax effect
3. the aggregate net gain or loss on transfers of assets recognized during the period
4. per-share amount of the aggregate gain on restructuring of payables, net of income tax effects
5. contingent amounts payable, if any, and the condition under which amounts became payable

Question 26

What must a creditor disclose, either in the body or in the notes to the financial statements?

Answer 26

the amount of the commitments, if any, to lend additional funds to the debtors owing receivables whose terms have been modified.

Question 27

FASB ASC 310-10-35-7 provides guidance for loan impairment. What are the 4 general principles?

Answer 27

1. creditors should apply their normal loan review procedures in making the judgment of collectability
2. an insignificant delay or insignificant shortfall in the amount of payments does not require application of FASC ASC 310-10-35-2
3. a loan is not considered impaired during a period of delay in payment if the creditor expects to collect all amounts due, including interest accrued at the contractual interest rate, for the period of delay
4. the term “probable” in the general principle is consistent with its use in FASB ASC 450-20-20. This means future events (i.e. collection of the loan) are likely to occur

Question 28

Measuring impairment of loans requires what 2 things?

Answer 28

1. judgment

2. estimation

Question 29

What 5 things are required to be disclosed when the impairment of a loan has been recognized?

Answer 29

1. as of the date of each statement of financial position, the total recorded investment in the impaired loans at the end of each period, the amount of that recorded investment for which there is a related allowance for credit losses and the amount of that allowance, the amount of that recorded investment for which there is no related allowance for credit losses, and the total unpaid principle balance of the impaired loans
2. the creditor’s policy for recognizing interest income on impaired loans, including how cash receipts are recorded
3. for each period for which results of operations are presented, the average recorded investment in the impaired loans during each period, the related amount of interest income recognized during the time within that period that the loans were impaired and, unless not practicable, the amount of interest income recognized using a cash=basis method of accounting during the time within that period that the loans were impaired
4. the entity’s policy for determining which loans the entity assesses for impairment
5. the factors considered in determining that the loan is impaired

Question 30

Long-term debt often has covenants in the debt contract. What are they and why are they used?

Answer 30

They are standards for the financial strength and performance of the borrower and are intended to protect the interest of the lending institution

Question 31

Name 3 common ratios used in covenants?

Answer 31

1. current ratio
2. interest coverage ratio
3. debt/equity ratio

Question 32

What happens when a loan covenant is violated?

Answer 32

It could result in the bonds becoming callable giving the lending institution the right to receive the maturity value of the bonds prematurely or the right to convert the debt. Such debt would no longer be classified as LT but would be considered ST