Long-Term Liabilities and Bonds Payable Flashcards
When is a bond issued at a discount? A premium?
A bond is issued at a discount when the coupon/stated interest rate is less than the market/effective rate of interest.
A bons is issued at a premium when the bond interest rate is greater than the market rate of interest.
How is the bond selling price computed?
The price is the sum of the present value of the future principal payments plus the present value of the periodic interest payments discounted using the market/effective rte on the date the bonds are issued.
Name two methods of amortizing bond premium (discount).
Straight-Line Method
Premium (Discount) / # of periods outstanding
Interest (Effective Rate) Method (U.S. GAAP/IFRS)
Premium (Discount) amortized = (carrying value x effective rate) - (face value x stated rate)
Interest expense = (face value x stated rate ) + discount amortized - premium amoritzed = carrying value x effective rate
Note: The straight-line method is permitted under U.S. GAAP if not materially different from the effective interest method. It is prohibited under IFRS.
What is the preferred method of accounting for bond issue costs under U.S. GAAP and IFRS?
U.S. GAAP
Capitalized as a deferred charge (asset) and amortized to expense over the period the bond is outstanding using straight-line method.
IFRS
Deducted from the carrying amount of the liability and amortized using the effective interest method.
How are convertible bonds accounted for when issued under IFRS and U.S. GAAP?
U.S. GAAP
Like nonconvertible bonds. No separate recognition of the conversion feature.
IFRS
Both a liability (bond at fair value) and equity (difference between proceeds and fair value) recognized.
Describe the two methods of accounting for the conversion of convertible bonds.
Book Value Method (GAAP)
No gain/loss is recognized.
Market Value Method (not GAAP)
Gain/loss is recognized for the difference between market value of stock and book value of bond.
Define stock warrants.
Option contracts that are issued with, and are usually detachable from, bonds and notes. Gives the bondholder the right to buy stock at a fixed price within a specific time period.
Describe the two methods of accounting for bonds with detachable stock purchase warrants.
Warrants Only Method
Warrants are valued at fair value in stockholders’ equity. Residual of bond proceeds is assigned to the bond.
Market Value Method
Bond proceeds are allocated to the bonds and warrants according to their relative fair values.
When is a liability considered extinguished?
If either one of the following conditions is met:
- If the debtor pays the creditor and is relieved of its obligations for the liability.
- If the debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor.
Define in-substance defeasance.
An arrangement in which a company places purchased securities into an irrevocable trust and pledges them for the future principal and interest payment on its long-term debt.
The company remains the primary obligor; therefore, the liability is not considered extinguished.
How is the gain or loss on early extinguishment of debt treated?
Ordinary gain or loss on the income statement, shown as a separate line item, if material, in income from continuing operations, unless it meets the criteria of unusual in nature and infrequent in occurrence, in which case is treated as an extraordinary item and reported net of taxes, below income from continuing operations.
The gain or loss is the difference between net carrying value (including unamortized bond issue costs asset (U.S. GAAP only) and (premium or discount) and the reacquisition price of the debt.
What are the major disclosures for long-term debt?
- Maturity dates
- Interest rates
- Call and conversion privileges
- Assets pledged as security
- Future sinking fund payments
- Maturities for each of the next five years
