Accounting 302 Final Quizlet

What kind of companies have long operating cycle?

Winerys/alcohol Ships/airplane (construction)

what happens when bonds are extinguished early?

1. Any discount/premium and issue costs must be amortized up to the extinguishment date 2. Carrying value does not necessarily equal the amount to be paid 3. The difference between CV and the amount to be paid is recognized as a gain or a loss

Bonds payable are debt obligations that:

1. Are evidence by a bond indenture 2. Generally are issued to a large number of creditors in increments of $1,000 3. Generally have maturities ranging from ten to forty years 4. Often trade on a security exchange

Notes payable are debt obligations that:

1. Are evidence by a promissory note 2. Often are direct borrowings from a bank 3. Generally have maturities ranging from five to tend years 4. Generally do not trade on a securities exchange

What are some examples of current liabilities?

-Accounts payable -Short term notes payable -Commercial paper -Accrued liabilities -Advance collections

If bonds are extinguished early, they may be

-Called only if this option is specified in the bond indenture - Repurchased on the open market only if bonds are publicly traded

Suppose a company is in danger of violating a working capital debt covenant. How might this situation affect management's accounting choices?

-Could try and convert current liabilities long term -Suddenly change estimates (example by reducing allowance for accounts) -Not writing down inventory to lower of NRV

What are the two instances where long-term obligations are appropriately classified as current

1. Current maturities of long-term debt 2. Obligations callable by the creditor

Why might the debtor want to extinguish bonds early?

-Have a bunch of cash on hand and don't want to pay more interest -If interest rates have dropped, can refinance (issue bonds at lower interest rates and use that cash to pay off old bonds)

Ability can be demonstrated in what two days?

1. Actually refinancing the short-term obligation by issuing long term debt or equity securities after the date of the balance sheet but before the issuance 2. Entering into a financing agreement that permits refinancing of the short-term obligation on a long term basis on terms that are readily determinable before the issuance of the balance sheet

What happens when bonds are extinguished at maturity

1. Any discount/premium and issue costs have been completely amortized 2. Carrying value equals the amount to be paid (face amount) 3. No accounting gain or loss is recognized

Companies can report a short-term obligation as long-term if both of the following conditions are met

1. Intent: company must intend to refinance the obligation on a long-term debt 2. Ability: company must demonstrate an ability to consummate the refinancing

What are the three components of a liability?

1. Probable future sacrifices of economic benefits 2. Present obligations 3. Past transactions

What are three examples of advanced collections?

1. Refundable deposits (ex. Damage Deposit) 2. Advances from customers ("Deferred Revenue") 3. Collections from third parties (Sales Tax)

In what three ways does Topic 842 improve lease accounting?

1. Results in more faithful representation of a lessee's rights and obligations arising from leases 2. It improves understanding and comparability of a lessee's financial statements 3. It results in fewer opportunities to structure leasing transactions to achieve a particular outcome on the balance sheet

What are the three key attributes to loss (gain) contingencies?

1. The cause of a possible loss (gain) has already occurred 2. There is current uncertainty as to whether the possible loss (gain) will be realized 3. The uncertainty will be resolved in the future

What are the creditor's three options when a debtor violates a debt covenant

1. Waive obligation or grant grace period (least costly) 2. Negotiate a new contract 3. Call it (most costly)

What is the difference in interest expense and cash paid/payable represent?

Amortization of the discount or premium. This adjusts the CV for any underpayment or overpayment of interest

When did the FASB and IASB initiate a joint project to improve the financial reporting of lease activities?

2006

Transaction

A company receives an asset in exchange for a promise to pay specified amount(s) on specified future date(s)

Lease

A contract where a lessor conveys to a lessee the right to control the use of identified property, plant, or equipment for a period of time in exchange for consideration (typically, periodic cash payments)

Debt issue costs related to a recognized debt liability are presented in the balance sheet as

A direct deduction from the carrying amount of that debt liability, consistent with debt discounts

Gain contingencies

An existing condition involving uncertainty as to possible gain to an enterprise that will ultimately be resolved when some future event(s) do or do not occur

Loss contingencies

An existing condition involving uncertainty as to possible loss to an enterprise that will ultimately be resolved when some future event(s) do or do not occur

At issuance, how are bonds payable recorded?

At the PV of the future cash flows specified in the contract discounted at the effective rate of interest

What about loss contingencies related to unfiled lawsuits and unasserted claims?

Accounted for using the standard requirements only if the cause for possible damages has occurred and filing of the lawsuit of the lawsuit or the assertion of the claim is probable

How is interest expense calculated for note payable?

Based on the carrying value of the note and the historical effective interest rate

How is cash payable calculated?

Based on the face amount and the stated rate of interest

Why are companies able to raise more cash by issuing bonds than by issuing notes?

Because it is easier to borrow many small amounts from several people. This allows people to diversify their portfolios. Opposed to borrowing one large amount from a bank which is risky

Why is the time value of money ignored for current liabilities?

Because it is short term, it is immaterial so it is easier to just not take the present value

Why?

Because must be calculated on what you actually owe X what you will actually pay

Why is this strange?

Because not the conservative approach that is often applied (i.e. not recognizing gain contingencies but do loss)

Why did the codification add "creation of other current liabilities"

Because of the Penn Central case

Why is this unusual?

Because someone may not agree to this because could force them into bankruptcy since long term debt is used to invest in long term invest

Why are companies able to have long maturities for their bonds than for their notes?

Because they are exchangeable and no one has to hold it until maturity

Commercial paper

Borrowing money from another corporation

How does the total amount of cash to be paid in the future relate to principle and interest?

Can only equate if you are told how much you borrowed or the interest rate

Current assets

Cash and other assets expected to be sold, consumed, or converted into cash in one year or the normal operating cycle, whichever is longer

Lessee gives the lessor _____________ Lessor gives the lessee ____________

Cash payments, control of use of asset

Debt issues cost

Companies incur costs in connection with issuing bonds and notes (i.e. legal fees, printing costs, registration fees, underwriting fees)

What happens the other times

Disclosure only

The historical effective interest rate is calculated as the

Discount rate that equates the present value of the future cash flows and the amount initially recorded for the note payable (inferred present value)

In all three cases, what rate of interest does the seller of the bond pay? What rate of interest does the purchaser of the bond receive?

Effective rate

If the note payable is exchanged for assets or services, the inferred present value is the

Fair value of the note given or the fair value of the asset/services received (whichever is more readily determinable)

T or F: Gain contingencies are recognized?

False

Liability

Probable future sacrifices of economic benefits arising from present obligations of a particular entity as a result of past transactions

What are the three types for likelihood?

Probable, reasonably possible, or remote

What is an example of a contingent liability?

Product warranties and guarantee Litigation and claims

What is the initial measurement of liabilities?

Generally recognized at maturity value (i.e. the amount necessary to settle the obligation when it is due)

How can these amounts be paid?

In periodic payments over the life of the debt, paid in a lump sum at the maturity date of the debt, or a combination of both

How are straight line amortization of debt issue costs reported?

Interest expense

If stated rate = effective rate

Selling price = face amount Sells at par

What does the balance in a discount account reported on the balance sheet represent?

Interest that will be paid upon maturity that you do not owe yet

What does the balance in the discount on note payable account represent?

Interest you don't owe yet. You only owe interest with the passage of time

Bond indenture

Is a contract that specifies the terms of the agreement such as the face amount, stated rate, and covenants

Interest expense

Is calculated based on the carrying value of the bond and the historical effective rate of interest

How could you determine the call price on the date of extinguishment?

It is stated in the contract

Penn Central

Largest bankruptcy case in U.S. history. It was very sudden and unexpected. They were financing there short term debt (rolling over when short term debt was due). So, they would classify short term debt as long term debt because they would keep doing this role over. Eventually, the bank denied the role over and they were not able to pay the present obligation.

If stated rate > effective rate

Selling price > face amount Sells at a premium

Why is less interest paid with an installment note?

Since you are repaying part of the principle as you go, you owe less interest since liability is decreasing

Does a recognition of an accounting loss on extinguishment indicate the company has made a bad decison?

No

Current liability

Obligations expected to be settled with the use of current assets or by the creation of other current liabilities

In 2005, the SEC issued a report on what?

Off balance sheet activities that recommended changes be made to lease accounting requirements to ensure greater transparency in financial reporting

How could you calculate the repurchase price on the date of extinguishment?

Present value of the bonds with the current effective interest rate

How could you calculate the carrying value on the date of extinguishment?

Present value of the future lows using historical effective rate

The promised future cash flows include what two components?

Principle and interest

What does the balance in the premium account reported on the balance sheet represent?

Principle that will be repaid as part of the periodic payments that will not be owed yet

What happens when only a range can be estimated and no amount within the range appear to be better estimate than any other amount within the range?

Recognize the amount at the low end of the range and disclose the possible additional loss

Why do likelihood and estimability matter?

Relevance and faithful representation. FR = reasonably measured Relevance = estimability

Leases span a spectrum from

Rental agreements to virtual installment purchases/sales agreements

How would you expect the accounting for a transaction to differ depending on whether it involved a pure rental agreement or an installment purchase/sale agreement?

Rental: Property is still on lessor balance sheet, and rent revenue on Income Statement. Rent expense on lessee income statement. Installment: Property is now on lessee books, and liability to pay. Lessor puts down a receivable. On the income statement, interest expense or revenue and depreciation expense are recognized

Covenants

Restrictions and/or agreements that constrain managements behavior to protect borrowers (i.e. Working capital requirements, dividend restrictions, additional debt restrictions)

If stated rate < effective rate

Selling price < face amount Sells at a discount

Principle

The amount that is borrowed

Carrying value of the bond

The balance in bonds payable less any balance in the discount account or plus any balance in the premium account

Interest

The charge the creditor imposes on the debtor for using his/her money

What happens when a debt covenant on a long term bond has been violated?

The debt is callable or will be callable by the creditor within one year or the normal operating cycle, whichever is longer, the debt is classified as current unless it is probable that the violation will be corrected within a specified grace period or that it will be waived

How is bonds payable accounted credited for?

The face amount of the bonds

Stated rate

The interest rate stated as a percentage of face amount that determines the cash to be paid periodically

Obligations callable by the creditor

When long-term debt includes a call provision whereby the creditor may call the debt within one year or the normal operating cycle, whichever is longer, the debt is classified as current

In a rental agreement

The lessor retains the risks and rewards of ownership of the asset and simply allows the lessee to control the use of the asset temporarily

In an installment purchase/sales agreement

The lessor transfers all the risks and rewards of ownership of the asset and gives the asset to the lessee permanently

For loss contingencies, what does the accounting requirements depend on?

The likelihood that future events will confirm the incurrence of a loss and whether the amount of loss can be reasonably estimated

What happens when long-term debt is due in installments?

The portion due within on year or the normal operating cycle, whichever is longer, is classified as current

How do you find this amount?

The present value of the future cash flows discounted at the prevailing effect rate of interest given the debtor's level of default risk

Face amount

The single sum to be paid at the end of the contract period. Is not necessarily equal to the principle

How are loss contingencies related to file lawsuits and asserted claims are accounted for using

The standard requirements

Why might the effective rate differ from the stated rate?

There is a time lag between when they set the terms of the bond and when they actually sell them

When are gain contingencies disclosed?

When material but must avoid misleading implications as to the likelihood of realization

What is a likely motivation to repurchase bonds?

To refinance

On February 25th 2016, what did the FASB issue?

Topic 842 which they believed improves lease accounting in several ways?

T or F: Bonds may be extinguished by the debtor at maturity or early

True

When is the only time you recognize and disclose?

When probable and reasonably estimated

When do you never disclose or recognize?

When the likelihood is remote

Current maturities of long-term debt

When what was originally long term debt is due within one year or the normal operating cycle, whichever is longer, the debt is classified as current

What is the selling price of the bond?

What the investment community is willing to pay today in exchange for the specified future cash flows

What does the carrying value reported on the balance sheet represent?

What you owe

If the note payable is exchanged for cash, the inferred present value is the

amount of cash received

Conceptually, the accounting for long-term notes payable is the same as for

bonds payable

The note payable is initially recorded at the

inferred present value of the future cash flows specified in the note discounted at the historical effective interest rate