Non-Current Liabilities Flashcards
Effective interest rate
- the market interest rate
- ie required rate of return
- when a bond is issued - the rate demanded by investors when a bond is issued
- not rate documented on the bond indenture
A bond is issued at face value when the coupon rate
Face value
coupon rate = effective interest rate
A bond is issued at a discount when the coupon rate
Discount
coupon rate < effective interest rate
A bond is issued at a premium when the coupon rate
Premium
coupon rate > effective interest rate
A bond issued at a discount is perceived by the investor as ____ risky and therefore require a ____ rate of return
Riskier and higher rate of return.
If a bond is seen as risky, an investor will want a higher rate of return
the higher return is achieved by paying less for the bond
Initially, bonds are reported as a liability on the BS. This amount on the BS is known as the ______
known as the carrying value or book value of a bond
Carrying amount (beginning) =
the present value of the bond, or the amount the investor pays initially
Interest expense formula
interest expense = carrying amount * required return
carrying amount aka bond liability
Interest payment formula
interest payment = face value * coupon rate
Amortization of discount formula
interest expense - interest payment
Carrying amount (end) =
beginning carrying amount + amortization of discount
Steps:
- Beginning carrying amount (bond liability)
- Interest expense
- Interest payment
- Amortization of discount ( int exp - int payment)
- Carrying amount end
The carrying amount is shown on which financial statement
the balance sheet
The interest expense is shown on which financial statement
the income statement
Interest expense def
- different than the interest paid
- its more or less what the interest paid would be using the required rate vs using the coupon rate
Will the effective interest rate change during the life of the bond?
no, the effective rate is the required return and wont change
What are the two types of bond amortization methods? and which reporting methods can they be used with?
- Effective interest rate amortization
- Straight-line method
Effective int rate is the preferred method under GAAP and IFRS.
ST line is allowed under GAAP only
Debt Covenants definitions
- affirmative
- negative
- technical default
Covenants are restrictions imposed by the creditor/bondholder on the issuer/borrower to protect the creditor’s interest
- affirmative: require the borrower to take certain actions like make interest payments, maintain level of working capital, keep certain financial rations
- negative: restrict the borrower’s actions. cant take on additional debt, pay dividends, sell assets, etc
- technical default: occurs when the borrower violates a debt covenants
Bond indenture definition
the terms of borrowing between investor and issuer of the bond
Lessor
lessor: the owner of the asset for lease
Lessee
the user of the asset for lease
5 criteria for finance lease (counts if any are met)
if non are met, then the lease is classified as an operating lease
- the lease transfers ownership of the asset to the lessee
- the lessee has an option to purchase the asset and is reasonably certain it will do so
- the lease term is for a major part of the asset’s useful life
- the present value of the sum of the lease pmts equals or exceeds substantially all the fair value of the asset
- the underlying asset has no alternative use to the lessor
Impact of using an Operating Lease instead of a Finance Lease:
EBITDA margin, asset turnover, CF per share and others will be lower if an operating lease is used
Operating Lease v Financing Lease
Operating:
- entire lease payment is expensed in operating activities
Financing:
- interest expense is expensed rest is amortized
Defined contribution plan
- risk on the employee
- the company contributes an agreed-upon amount to the plan
- “pension expense” shows on the IS
Defined benefit plan
- SAFPPF
Net pension asset
pension is overfunded
Net pension liability
pension is underfunded
At time of issue of 6% coupon bond, the effective interest rate was 5.5%. The bond was issued at a _____
a premium
coupon rt > effect int rt
