accounting chapter 9 vocabulary

Convertible bonds allow the lender to convert each bond into:

common stock

________ bonds are retired when the bondholder exchanges them for the issuing companys stock.

convertible

The higher the debt to equity ratio is for a company, the ______ the risk of bankruptcy is for that company.

higher

The debt to equity ratios for three otherwise comparable companies are as follows: Adams: 1.5; Flagler: 1.8; Roberts: 1.4. The risk of bankruptcy appears to be lowest for:

Roberts

installment payment

includes both an amount that represents interest and an amount that represents a reduction of the outstanding balance.

In order to assess a company's financial risk, investors and creditors frequently consider and analyze the company's:

long term debt

Quattro Lending Company is considering lending a large sum to Eleance Inc. During its decision process, Quattro should especially consider Eleance's existing:

long-term liabilities

The true interest rate used by investors to value a bond issue is referred to as the:

market interest rate

A common reason for redeeming a bond prior to its maturity date is that

market interest rates decreased.

what are the three sources of long-term debt financing?

notes, leases, and bonds.

equity financing

refers to obtaining investment from stockholders (stockholders equity)

convertible

shares can be exchanged for common stock

the ______ rate of interest is used to compute the cash interest paid to bondholders.

stated

Callable bonds can be redeemed at the choice of

the bond issuer

early extinguishment of debt

the issuer retires debt before its scheduled maturity date.

capital structure

the mixture of liabilities and stockholders' equity in a business.

return on assets

net income divided by average total assets; measures the amount of net income generated for each dollar invested in assets.

two ratios frequently used to measure financial risk related to long-term liabilities

debt to equity, and times interest earned.

financing with _______ requires borrowing, whereas financing with ________ requires issuing shares of stock.

liabilities; equity

the ______ rate of interest is an implied rate based on the price investors pay to purchase a bond.

market

the amount investors pay to the company is known as the

issue price

a long term lease creates an asset and a liability for the lessee.

the lease arrangement gives the lessee (user) the right to use an asset for a period of time. this right is recorded as an asset. the user also has an obligation to make payments over the lease period. this obligation is recorded as a liability.

market interest rate

the market rate that we'll use to determine the present value of the face amount and the present value of the interest payments.

profits generated by the company are a source of internal financing

true

Cabot Inc. has 6%, $100,000 face amount bonds outstanding. The bonds were issued at a discount. At end of the current fiscal period, unamortized bond discount is $1,200.The balance sheet presentation of Cabot's bonds should include:

bonds payable of $100,000 and less discount on bonds payable of $1,200.

secured bonds

bonds that are supported by specific assets pledged as collateral.

serial bonds

bonds that require payment of the principal amount of the bond over a series of maturity dates.

term bonds

bonds that require payments of the full principal amount at a single maturity date. most bonds have this characteristic.

annuity

cash payments of equal amounts over equal time periods.

The possibility that a company will be unable to pay its loans and its interest payments when due refers to the company's ______ risk.

default

The possibility that a company will be unable to pay its bonds payable and the related interest when due is commonly referred to as:

default risk

if the bonds' stated interest rate is LESS THAN the market interest rate, then the bonds will issue below face amount

discount

Totito Inc. issues $100,000 face amount bonds at $98,000. The journal entry to record the issuance of the bonds should include debit(s) to:

discount on bonds payable for $2000 and cash for $98,000.

The debt to equity and the times interest earned ratios provide investors and creditors with a measure of ________ risk

financial

_______bonds require payment of the full principle amount of the bond at the end of the loan term.

term

Bonds that require payment of the full principle amount of the bond at the end of the loan term are referred to as

term bonds

the right side of the equation reveals the two sources of external financing- debt financing and equity financing (liabilities and stockholders equity)

true

The debt to equity and the times interest earned ratios provide investors and creditors with a measure of ______ risk

financial

companies obtain external funds through debt financing and equity financing.

true

funds coming from those outside of the company are sources of external financing.

true

Omar Inc. has 6%, $200,000 face amount bonds outstanding. The bonds were issued at a discount. At the end of the current fiscal period, unamortized bond discount is $4,500. The total bond-related liability reported on Omar's balance sheet should be:

$195,500

times interest earned ratio=

(net income + interest expense + tax expense) / interest expense

bond characteristics

1. secured- bonds are backed by collateral 2. unsecured- bonds are not backed by collateral 3. term- bond issue matures on a single date 4. serial- bond issue matures in installments 5. callable- issuing company can pay off bonds early 6. convertible- investor can convert bonds to common stock

callable

a bond feature that allows the borrower to repay the bonds before their scheduled maturity date at a specified call price.

lease

a contractual arrangement by which the lessor (owner) provides the lessee (user) the right to use an asset for a specified period of time.

ABC Company issues a bond with a face value of $100,000 at face amount on January 1. The bond carries a stated annual interest rate of 6% payable in cash on December 31 of each year. If ABC issues monthly financial statements, it must make an adjusting entry on January 31 that includes ______.

a debit to interest expense of $500 and a credit to interest payable of $500.

In a private placement of bonds, bonds may be sold to

a single large investor

market interest rate

an implied rate based on the price investors are willing to pay to purchase a bond in return for the right to receive the face amount at maturity and periodic interest payments over the remaining life of the bond.

sinking fund

an investment fund used to set aside money to be used to pay debts as they come due.

A formal debt instrument that obligates the borrower to repay a stated amount (referred to as the principal or face amount) at a specified maturity date can be a note or a(n)

bond

A corporation that wishes to borrow from the general public rather than a bank will issue

bonds

If ABC Company receives $100,000 cash in exchange for issuing 100 bonds at their $1,000 face value, the transaction will be recorded with a

debit to Cash of $100,000 and a credit to Bonds payable of $100,000.

If ABC Company receives $100,000 cash in exchange for issuing 100 bonds at their $1,000 face value, the transaction will be recorded with a

debit to cash of $100,000 and a credit to Bonds payable of $100,000.

the two types of financing are

equity financing and debt financing

The rate of interest printed on the face of a bond is referred to as the ________ interest rate

face/stated

True or false: At the date of issue, the stated rate of interest on the bond is always equal to the market rate of interest on the bond.

false

True or false: The debt to equity ratio is calculated as total liabilities divided by common stock.

false. the debt to equity ratio is total liabilities divided by total stockholders' equity.

Bonds will be issued a premium if the stated interest rate is

greater than the market interest rate.

loans requiring periodic payments of interest and principle are referred to as ______ notes

installment

The times interest earned formula is calculated as net income plus interest expense plus tax expense divided by

interest expense

if the bonds' stated interest rate is MORE THAN the market interest rate, the bonds will issue above face amount

premium

Dorothea inc is selling all of its bonds to a large pension fund. this an example of a _____ placement.

private

amortization schedule

provides a table format detailing the cash payment each period, the portions of each cash payment that represents interest and the change in carrying value, and balance of the carrying value.

times interest rate ratio

ratio that compares interest expense with income availability to pay those charges.

debt financing

refers to borrowing money from creditors (liabilities)

private placement

sale of debt securities directly to a single investor.

Munster Inc. issues $20 million in bonds and pledges its land holdings as collateral. Munster's bonds are:

secured

______ bonds are supported by a specific asset the issuer pledges as collateral

secured

a ______ bond is backed by a lien on specified real estate owned by the issuer.

secured

Corporate bonds most often pay interest

semiannually

stated interest rate

the rate specified in the bond contract used to calculate the cash payments for interest.

default risk

the risk that a company will be unable to pay the bonds face amount or interest payments as they become due.

identify two ratios commonly used to assess a company's financial risk.

times interest earned ratio and debt to equity ratio.

debt to equity ratio

total liabilities divided by stockholders' equity; measures a company's risk.

features of an amortization schedule

1. date- payments are made at the end of each month. 2. cash paid- monthly payments remain the same over the loan period. 3. interest expense- interest expense equals the prior months carrying value times the interest rate. (6% annual rate x 1/12). 4. decrease in carrying value- the cash paid in excess of interest expense reduces the carrying value (remaining loan balance) 5. carrying value- the carrying value begins at the original amount of the loan. with each monthly cash payment, the portion assigned to interest expense becomes less and the portion that reduces the carrying value becomes more. by the end of the four year loan, it has been paid off and the carrying value is 0.

ABC Company is in the process of issuing bonds. The bonds have a stated interest rate of 6%, which is 2% above the current market rate. What effect will the two interest rates have on the bond issue price?

The issue price will be above the bond's face value.

why do some companies issue bonds rather than borrow money directly from a bank?

a company that borrows by issuing bonds is effectively bypassing the bank and borrowing directly from the investing public-usually at a lower interest rate than it would in a bank loan.

ABC Company issues a bond with a face value of $100,000 at face amount on January 1. ABC prepares financial statements only at December 31, so no adjusting entries are made during the year to accrue interest. If the bond carries a stated interest rate of 6% payable in cash on December 31 of each year, the journal entry to record the first bond interest payment includes

a debit to interest expense of $6,000 and a credit to cash of $6,000.

bond

a formal debt instrument issued by a company to borrow money. the issuing company (borrower) is obligated to pay back to the investor (lender): 1. a stated amount, referred to as the principal or face amount, at a specified maturity date and 2. periodic interest payments over the life of the bond.

On January 1, Year 1, Liang Corporation issues a $100,000 bond at a discount for $95,083. The coupon rate is 10% and the market interest rate is 12%. The bonds pay interest semiannually on June 30 and December 31. The journal entry to record the interest payment on June 30, Year 1 will include which of the following entries?

credit cash $5000, debit interest expense $5,705, and credit discount on bonds payable $705.

why would a company choose to borrow money rather than issue additional stock in the company?

interest expense incurred when borrowing money is tax-deductible, whereas dividends paid to stockholders are not tax-deductible. interest expense incurred on debt reduces taxable income; paying dividends to stockholders does not reduce taxable income because dividends are not an expense. therefore, debt can be a less costly source of external financing.

A contract in which an owner provides a user the right to use an asset in return for periodic cash payments over a period of time is called a(n)

lease

a ______ is a contractual arrangement in which an owner provides a user the right to use an asset for a specified period of time.

lease

to calculate the present values, we need to know

1. the face amount of the bond 2. the interest payment each period based on the stated interest rate of the bond. 3. the number of periods until the bond matures. 4. the market interest rate per period.

Totito Inc. issues $100,000 face amount bonds at $98,000. The journal entry to record the issuance should include:

A debit to discount on bonds payable for $2,000 and a credit to bonds payable for $100,000

unsecured bonds (debentures)

bonds that are not supported by specific assets pledged as collateral.

The journal entry to record the issuing of 100 bonds at their $1,000 face value will include a debit to ______ and a credit to ______.

cash; bonds payable

The Discount on Bonds Payable account is classified as a(n)

contra-liability

Werner issues bonds at a discount. The related Discount account should be classified as a(n)

contra-liability

Which of the following are common characteristics or provisions of bonds?

convertible, callable, secured or unsecured.

for the first interest payment, interest expense is calculated as

interest expense= carrying value of bond x market interest rate per period.

lease characteristics

1. future value. 2. lease payment. 3. number of payments (# of years x # of periods each year). 4. interest rate (% / # of periods each year).

why do many companies lease rather than buy?

1. leasing reduces upfront cash needed to use an asset. 2. lease payments often are lower than installment payments. 3. leasing offers flexibility and lower costs when disposing of an asset. 4. leasing may offer protection against the risk of declining asset values.

periodic payments on installment notes typically include

a portion that reduces the outstanding loan balance and a portion that reflects interest.

one advantage of debt financing is that interest on borrowed funds is tax-deductible.

true