More advanced accounting

Question 1

What is the face value of debt?

Answer 1

The amount of debt that the company initially issues and pays interest on.

Question 2

What affects the face value of debt?

Answer 2

Not much, except from debt issuances, principal repayments, and PIK interest

Question 3

What is the book value of debt?

Answer 3

The amount of debt shown on the company’s balance sheet.

Question 4

What affects the book value of debt?

Answer 4

This one is affected by unamortised issuance fees, debt discounts and premiums, debt issuances, principal repayments, and PIK interest

Question 5

What causes the market value of debt to change?

Answer 5

Price can be affected by both company performance as well as the Macroeconomic environment (base rates)

Question 6

On the balance sheet, is it the book value or market value that is listed?

Answer 6

Most of the time, it is the book value

Question 7

What happens if there is a difference between the coupon rate on the debt issuance and prevailing yields at the time of the initial issuance?

Answer 7

May issue the debt at a premium or discount to its face value, which is called original issue discount or original issue premium

Question 8

Why may a bond be issued at OID?

Answer 8

Because of a change in underlying rates between agreement and issuance OR because investors are not confident of its credit quality and they want an additional incentive to buy into its offering

Question 9

What is the accountant treatment of the amortisation of the original issue discount?

Answer 9

Balance Sheet: Deduct the OID from face value to get the book value of debt and amortise the OID until the debt’s maturity

Income Statement: Amortisation of OID counts as interest expense

Cash flow statement: Non-cash add-back

Question 10

Why are convertible bonds often referred to as hedged equity?

Answer 10

If the company does well, investors receive shares in the company. And if it does not, they at least receive back their principal upon maturity

You get to participate in the equity upside, but your downside risk is mitigated.

Question 11

Can you repay part of the convertible bonds early?

Answer 11

No - 100% is due at maturity, the company repays 100% early, or investors convert 100% of the bond into shares early

Question 12

What is the high-level overview of the accounting of convertible bonds?

Answer 12

Split into liability and equity components

To estimate the market value of the liability component, take the value of the future interest payments and future principal repayment, using a discount rate equal to the coupon rate on equivalent, non-convertible debt

Once you have the liability component, the equity component equals the face value of convertible bond minus market value of liability component

Question 13

Difference between secured and unsecured debt?

Answer 13

Secured means it is backed with collateral, unsecured is backed by nothing

Question 14

How would you define ‘influence’ over a company if you had an equity investment?

Answer 14

Usually when a parent company owns a minority stake in another company, such as 20% or 40% of its common shares outstanding.

Technically, companies use the equity investment method when they have significant influence over another company, but NOT control of that other company.

Question 15

What are the typical ownership % to use the equity investment method of accounting

Answer 15

Between 20-50% stakes in a company, but some companies also use the quite method for ownership stakes below 20%

Question 16

When will a parent not employ the equity investment (NOT NCI) method of accounting?

Answer 16

When owns a small % of a company, such as 1%, which will then be treated as a normal security on the balance sheet.

Also, will use NCI when stake is over 50%, as consolidation accounting applies

Question 17

What is the main idea of the equity method of accounting?

Answer 17

Parent company records its ownership percentage * subsidiaries company’s net income on the parent company’s income statement 8under “equity investment earnings”, or a similar name, but nothing else from the subsidiary company - all the items above net income on the parent company’s income statement are only the parent’s

Question 18

What is the impact on the cash flow statement of the equity method of accounting?

Answer 18

Reverses the equity investment earnings from the income statement as the parent company does not receive this in cash.

However, will be aline item for dividends from equity investments

Question 19

What % of ownership is a non controlling interest?

Answer 19

Over 50%

Question 20

How does an NCI affect the income statement?

Answer 20

There is a deduction for the net income for the portion of the subsidiary company’s net income that is not attributable to the parent company

Question 21

How does an NCI affect the cash flow statement?

Answer 21

The deduction to net income that occurs on the income statement is reverted on the cash flow statement because when the parent company controls the subsidiary, it does get the subsidies net income in cash

Question 22

Got to page 35

Answer 22

Got to page 35