Non-Current Liabilities

Question 1

Effective interest rate

Answer 1

• 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

Question 2

A bond is issued at face value when the coupon rate

Answer 2

Face value

coupon rate = effective interest rate

Question 3

A bond is issued at a discount when the coupon rate

Answer 3

Discount

coupon rate < effective interest rate

Question 4

A bond is issued at a premium when the coupon rate

Answer 4

Premium

coupon rate > effective interest rate

Question 5

A bond issued at a discount is perceived by the investor as ____ risky and therefore require a ____ rate of return

Answer 5

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

Question 6

Initially, bonds are reported as a liability on the BS. This amount on the BS is known as the ______

Answer 6

known as the carrying value or book value of a bond

Question 7

Carrying amount (beginning) =

Answer 7

the present value of the bond, or the amount the investor pays initially

Question 8

Interest expense formula

Answer 8

interest expense = carrying amount * required return

carrying amount aka bond liability

Question 9

Interest payment formula

Answer 9

interest payment = face value * coupon rate

Question 10

Amortization of discount formula

Answer 10

interest expense - interest payment

Question 11

Carrying amount (end) =

Answer 11

beginning carrying amount + amortization of discount

Steps:

1. Beginning carrying amount (bond liability)
2. Interest expense
3. Interest payment
4. Amortization of discount ( int exp - int payment)
5. Carrying amount end

Question 12

The carrying amount is shown on which financial statement

Answer 12

the balance sheet

Question 13

The interest expense is shown on which financial statement

Answer 13

the income statement

Question 14

Interest expense def

Answer 14

• different than the interest paid

- its more or less what the interest paid would be using the required rate vs using the coupon rate

Question 15

Will the effective interest rate change during the life of the bond?

Answer 15

no, the effective rate is the required return and wont change

Question 16

What are the two types of bond amortization methods? and which reporting methods can they be used with?

Answer 16

1. Effective interest rate amortization
2. Straight-line method

Effective int rate is the preferred method under GAAP and IFRS.
ST line is allowed under GAAP only

Question 17

Debt Covenants definitions

• affirmative
• negative
• technical default

Answer 17

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

Question 18

Bond indenture definition

Answer 18

the terms of borrowing between investor and issuer of the bond

Question 19

Lessor

Answer 19

lessor: the owner of the asset for lease

Question 20

Lessee

Answer 20

the user of the asset for lease

Question 21

5 criteria for finance lease (counts if any are met)

if non are met, then the lease is classified as an operating lease

Answer 21

• 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

Question 22

Impact of using an Operating Lease instead of a Finance Lease:

Answer 22

EBITDA margin, asset turnover, CF per share and others will be lower if an operating lease is used

Question 23

Operating Lease v Financing Lease

Answer 23

Operating:
- entire lease payment is expensed in operating activities

Financing:
- interest expense is expensed rest is amortized

Question 24

Defined contribution plan

Answer 24

• risk on the employee
• the company contributes an agreed-upon amount to the plan
• “pension expense” shows on the IS

Question 25

Defined benefit plan

Answer 25

• SAFPPF

Question 26

Net pension asset

Answer 26

pension is overfunded

Question 27

Net pension liability

Answer 27

pension is underfunded

Question 28

At time of issue of 6% coupon bond, the effective interest rate was 5.5%. The bond was issued at a _____

Answer 28

a premium

coupon rt > effect int rt