Accounting 201 Chapter 9

return on assets

amount of income generated for each dollar invested in assets = net income / average total assets

each installment payment includes:

an amount that represents interest and an amount that represents a reduction of the outstanding loan balance

carrying value

balance in the Bonds Payable account

most common form of corporate debt

bonds

discount

bonds issued below face amount

Companies' 3 primary sources of long-term debt financing

bonds, notes, and leases

debt financing

borrowing money (liabilities)

interest expense equation

carrying value of bond (amount actually owed during the period) x market interest rate per period = interest expense

secured bonds

bonds supported by specific assets the issuer has pledged as collateral

to measure a company's risk:

calculate debt to equity ratio

companies obtain external funds through_____ and ______.

debt financing (liabilities) and equity financing (stockholder's equity)

bond carrying value at maturity equals their ________.

face amount

cash paid for interest equation

face amount of bond x stated interest rate per period = cash paid for interest

medium-large corporations borrow cash by _________.

issuing bonds

no gain or loss is recorded on bonds retired at _______.

maturity

early extinguishment of debt

when issuer retires debt of any type before it scheduled maturity date

return on equity

= net income / average stockholders' equity

underwritten

selling of bonds

market rate

aka effective-interest rate or yield rate

sinking fund

designated fund to which an organization makes payment each year over the life of its outstanding debt

for bonds retires before maturity, we record gain or loss on:

early extinguishment equal to the difference between the price paid to repurchase paid to repurchase the bonds and the bonds carrying value

bonds can be issued at:

face amount, below face amount (discount), or above face amount (premium)

bond

formal debt instrument that obligates borrower to repay a stated amount, referred to as principal or face amount. Usually issued to many lenders. Interest usually paid semiannually or designated interest dates starting 6 months after issue date

call feature is more common than:

a conversion feature

unsecured bonds

aka debentures, not backed by a specific asset; secured only by "full faith and credit" of the borrower

convertible bonds

allow lender (investor) to convert each bond into a specified number of shares of common stock

basic accounting equation

assets = liabilities + stockholder's equity

private placement

issuing company may choose to sell the debt securities directly to a single investor, such as a large investment

reasons to lease

leasing improves cash flows through up to 100% financing leasing improves the balance sheet by reducing long-term debt leasing can lower income taxes

operating leases

like rentals

equity financing

obtaining additional investment from stockholders (stockholder's equity)

premium

occurs when issue price of a bond is above its face amount

tax-deductible vs not tax-deductible

tax-deductible = interest expense incurred when borrowing money; reduces taxable income not tax-deductible = dividends paid to stockholders; does not reduce taxable income

debt to equity ratio

= total liabilities / stockholder's equity the higher this ratio is, the higher the risk of bankruptcy. When a company assumes more debt, risk increases. Measure of financial leverage

times interest earned ratio

compares interest expense with income available to pay those charges. Measures company's ability to meet interest payments as they become due = (net income + interest expense + tax expense) / (interest expense)

lease

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

the ________ the market interest rate, the _______ the bond issue price will be

higher, lower

callable bonds

most corporate bonds are these; aka redeemable bonds; allows borrower to repay bonds before their scheduled maturity date at a specified call price, usually at an amount just above face value; protect borrower against future decreases in interest rates

capital leases

occur when lessee essentially buys an asset and borrows the money through a lease to pay for the asset

two types of leases

operating leases and capital leases

default risk

possibility that a company will be unable to pay the bond's face amount or interest payments as they become due

calculating issue of price bond:

present value of face amount + present value of the periodic interest payments

amortization schedule

provides a summary of cash paid, interest expense, and carrying value for each semiannual interest period

stated interest rate

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

market interest rate

represents true interest rate used by investors to value the bond issue

serial bonds

require payment installments over a series of years

term bonds

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

most corporate bonds pay interest:

semiannually

annuity

series of equal amounts over equal time periods

most bonds are:

term bonds

retired bonds

when the issuing corporation buys back its bonds from the investors