ACC 210 Chapter 9: long term liabilities

Debt Financing

borrowing money ( liability) -short term- generally due within 1 year -long term- generally due beyond 1 year -interest is tax deductible, dividends are not - match your debt to your use

secured bonds:

bonds are backed by collateral

term

bonds issue matures on a single date

objective at the end all the way to it's maturity

book value is equal to face value

callable

borrower can pay off bonds early

serial

bond issue matures in installments

Bond Retirements - at maturity

bond requirements occur when the issuing corporation buys back its bonds from the investors no gain/loss on bonds retired at maturity

debt to equity ratio

a measure of financial leverage - leverage enables a company to earn a higher return using debt that without debt, in the same way a person can lift more weight with the lever than without it debt to equity ration= total liabilities/ stockholders' equity

what's the discount

amount below the face value

what's the premium

amount over the face value

what are bonds?

-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 - the borrower also agrees to pay interest over the life of the bond at a stated rate - traditionally,interest bonds is paid twice a year ( semiannually) on designated interest dates, beginning 6 months after the original bond issue date

times interest earned ratio

an indication to creditors of how many "times" greater earnings are than interest expense time interest earned ratio= net income + interest expense + tax expense/ interest expense

bond issue price calculation

calculate present value of principal - principal x PVIF ( periods, market rate) $10,000 x 0.8227 ( n=4, i=5%)=$8,227 - calculate present value of cash interest payments --principal x stated rate x PVIFA $450 x 3.54595 ( n=4, i=5%)=$1,596 add two amounts together %8,227 + $1,596=$9,823 (vs bond face value of $10000)

for a bond issued at a premium

carrying value decreased over time

for a bond issued at a discount

carrying value increases over time

interest expense =

carrying value x market rate note that the initial carrying value is the issued price (issuer price=face amount + premium or - discount)

Leases

contractual arrangement by which the lessor ( owner) provides the lessee ( user) the right to use an asset for a specified period of time types: -operating lease: lessor owns the asset, and the lessee uses the asset for the term of the lease ( never earn the asset and don't have to put cash up right away) - capital leases: lessee buys and asset and finances the purchase through a lease ( Basically financing to own)

debt leverage

debt financing offer the opportunity to magnify your gains... but with the risk of magnifying your losses

bond premium or discount amortization ( change in carrying value)

difference between cash paid and interest expense premium: cash paid > interest expense ( stated rate > market rate) discount: interest expense > cash paid ( stated rate < market rate)

Installment notes

each installment payment is for the same amount,but payments represent both: 1. interest on borrowed amount 2. reduction in outstanding loan balance - most car loans and home loans call for payments in monthly installments rather than by a single amount at maturity

Redemption before maturity

eliminate the carrying value of the bonds - debit bonds payable for the face value of the bond - eliminate any remaining unamortized discount ( credit) or premium (debit) - credit cash for the amount paid to redeem bonds -recognize any gain ( credit) or loss (debit) on the redemption = he difference between the cash paid to redeem the bonds and the carrying value of the bonds

cash interest payments=

face amount x stated rate

Market rate

interest rate investors demand to own a bond with a given level of risk

equity financing

investment from stockholders ( stockholders equity)

bond issuance Journal entries

issued at par dr. Cash(A) x,xxx cr. bonds payable (L) x,xxx issued at discount dr.cash(A) x,xxx dr. discount on bonds payable (l) x,xxx cr.bonds payable(L) x,xxx issued at premium dr.cash(A) x,xxx cr.premium on bonds payable (L) x,xxx cr. bonds payable (L) x,xxx

convertible

lender can convert bonds to common stock

at a discount the carrying value is

less than the face value

Pricing bonds at face value using a financial calculator

lets first assume the market interest rate is 7%, the same as the stated interest rate. The bonds issue a face value Bond Characteristic, key, Amount calculator input 1. face amount, FV, $100,000 2. Interest payment, PMT, $3,500=$100,000*7%*1/2 year 3. market interest rate, I, 3.5=7%/2 periods per year 4. period to maturity, N,20=10 years x 2 period each year calculator output issue price, PV, $100,000

debt analysis

long-term debt is one of the first place decision makers look when trying to get a handle on risk two ratio used to measure financial risk related to long-term liabilities - debt to equity ratio - times interest earned ratio

at a premium the carrying value is

more than the face value

bonds retired at maturity

no gain or loss recorded

unsecured bonds

not backed by collateral

bond carrying value

prior carrying value + discount amortization or - premium amortization - premium amortization decreased carrying value ( down to face amount) - discount amortization increases carrying value ( up to face amount)

discount

stated rate < market rate

face value

stated rate = market rate

premium

stated rate > market rate

bond certificate

the cash flows associated with the bonds are defined by the terms on the face of the bond, the selling price of bonds are a function of the bond cash flows and current market rate of interest

capital structure

the mixture of liabilities and stockholders' equity used to finance a business (external financing)

why would you retire your bond early

the price to retire the bonds in the is greated than the carrying value of the bonds indicating that interest rates have fallen and are lower than the bonds stated rate. Given our bonds stated interest rate a buyer would be willing to pay more for the bond because its interest payments will be at a higher than market rate we can issue a new debt ( if necessary) at a lower interest rate now than before. this is kind of like refinancing a mortgage when rates have fallen

bonds retired before maturity

we record a gain or loss on redemption equal to the difference between the price paid to repurchase the bonds and the bond's carrying valye