Chapter 14: Long-Term Liabilities

All of the following statements are true regarding IFRS treatment of reporting and recognition of liabilities except: A. IFRS allows the recognition of liabilities for future losses. B. IFRS requires that companies present current and noncurrent liabilities on the face of the balance sheet, with current liabilities generally presented in order of liquidity. C. For contingencies, IFRS requires insurance recoveries be "virtually certain" before recognition of an asset is permitted. D. The recognition criteria for asset retirement obligations is less stringent under IFRS than it is under U.S. GAAP.

A

Pontchartrain Company issues $20,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2014. Interest is paid on June 30 and December 31. The proceeds from the bonds are $19,604,145. The company uses effective-interest amortization. Interest expense reported on the 2014 income statement will total

$1,568,498

General characteristics

1. Promise to pay a state amount at a specified maturity date 2. Requires periodic interest as a stated percentage of face. 3. Represent a liability to the company that issues the bonds and an asset to the company that purchases the bonds (investor).

Straight-Line Method

1. Allocate equal portion of discount/premium amortization to each period 2. cash paid for interest: face value x stated value 3. difference is recorded as interest expense

On January 1, 2014, Kimbrough Inc. issued $5,000,000, 9% bonds for $4,695,000. The market rate of interest for these bonds is 10%. Interest is payable annually on December 31. Kimbrough uses the effective-interest method of amortizing bond discount. At December 31, 2014, Kimbrough should report unamortized bond discount of

$285,500.

On June 30, 2014, Prouty Co. had outstanding 9%, $5,000,000 face amount, 10-year bonds that pay interest semi-annually on June 30 and December 31. The unamortized balances in the bond discount and deferred bond issue costs accounts on June 30, 2014 were $200,000 and $50,000, respectively. On June 30, 2014, Prouty acquired all of these bonds at 101 and retired them. What amount of gain or loss would Prouty record on this early extinguishment of debt?

$300,000 loss.

Ferrone Company issues $10,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2014. Interest is paid on June 30 and December 31. The proceeds from the bonds are $9,802,072. Ferrone uses effective-interest amortization. What amount of interest expense will Ferrone record for the June 30 payment?

$392,082

On June 30, 2014, Baker Co. had outstanding 8%, $6,000,000 face amount, 15-year bonds maturing on June 30, 2024. Interest is payable on June 30 and December 31. The unamortized balances in the bond discount and deferred bond issue costs accounts on June 30, 2014 were $210,000 and $60,000, respectively. On June 30, 2014, Baker acquired all of these bonds at 94 and retired them. What net carrying amount should be used in computing gain or loss on this early extinguishment of debt?

$5,730,000

Pricing

1. Bonds sell at price plus accrued interest 2. price= present value of total cost flows (principal and interest) using the market rate 3. bonds are typically stated in terms of a percentage of face value 4. coupon rate = market rate (Face value) 5. coupon rate < market rate (Discount) 6. coupon rate > market rate (Premium) 7. Bond Discount/Premium are recorded as contra/adjunct accounts to Bonds Payable and investment in bonds 8. Bonds are reported at Carrying Value (face amount less discount/plus premium)

Modification of Terms-Type 1

1. Creditor accepts new loan with cash flows < Debt CV and records a loan impairment 2. no interest recognized on new loan (all principal payments)

Modification of Terms-Type 2

1. Creditor accepts new loan with cash flows > Debt CV and records a loan impairment 2. interest is recognized at a new lower rate over new term

Bonds

1. General Characteristics 2. Pricing 3. Interest 4. Bond Issue Costs 5. Off-Balance Sheet Financing 6. Fair Value 7. Early Extinguishment of Debt 8. Financial Statement Disclosures

Financial Statement Disclosures

1. Include the details of each issue: a) interest rates b) payment terms c) maturity dates d) collateral and conversion privileges 2. Aggregate amounts maturing for each of the next 5 years.

Effective Interest Method

1. Interest expense: carrying value x market rate 2. cash paid for interest: face x stated rate 3. difference is reflected as amortization of discount or premium

Off-Balance Sheet Financing

1. Non-Consolidated Subsidiary 2. Special Purpose Entity (SPE) 3. Operating Leases*

Early Extinguishment of Debt

1. Record gain/loss = reacquisition price - debt CV

Restructuring Options

1. Settlement 2. Modification of Terms-Type 1 3. Modification of Terms-Type 2

Troubled Debt Restructuring

1. The original terms of a debt agreement are changed due to financial difficulties experienced by the borrower 2. Restructuring Options

Fair Value

1. US GAAP allows companies to value financial assets and liabilities at fair value instead of the amortized initial amount. 2. Adjust to fair value at each reporting period from changes in interest rates. 3. FVA account ending balance= CV-Fv 4. An unrealizing gain/loss is recorded to adjust the FVA account from beg to end bal 5. Reporting implications a) unrealized gains/loss in earnings b) bond CV is adjusted to fair value using FVA account

Settlement

1. creditor accepts assets < Debt CV 2. creditor recognizes a loss 3. debtor recognized a gain

Bond Issue Cost

1. include legal and accounting fees, printing fees, registration and underwriting fees 2. under US GAAP, bond issue costs are capitalized as an asset and amortized to expense over the term to maturity

When the effective rate of a bond is lower than the stated rate, the bond sells at a discount.

False

Which of the following is not an example of off-balance-sheet financing? A. Non-consolidated subsidiary. B. Special purpose entity. C. Non-interest bearing note. D. Operating lease.

C

Which of the following is not an example of "off-balance-sheet financing"?

Capital leases

Interest

Effective Interest Method Straight-Line Method 1. both methods result in the same amount of total interest expense over the life of the bond 2. if an accounting period ends between interest dates, interest should be accrued.

Bellingham Inc. sold bonds with a face value of $100,000,000 and a stated interest rate of 8% for $922,780,000, to yield 10%. If the company uses the effective interest method of amortization, interest expense for the first six months would be $4,000,000.

False

Best-efforts underwriting means that the investment bank guarantees the proceeds of the bond issue will be a certain amount.

False

Bonds that are not recorded in the name of the bondholder are called unsecured bonds.

False

Boomchickapop Company elects the fair value option for a long-term note payable. In 2014, the company reported an unrealized holding gains which was reported as a component of Other Comprehensive Income.

False

If a company elects the fair value option for its long-term liabilities, a decrease in the fair value of a bond payable will result in an unrealized holding loss.

False

The effective interest method calculates interest expense by multiplying the carrying value of the bonds by the stated rate of interest.

False

The loss recorded by the creditor in a troubled debt restructuring is based on the expected future cash flows discounted at the current effective interest rate.

False

When assets such as buildings and equipment are transferred in a troubled debt restructuring, the creditor should record a gain or loss for the difference between the fair value and the debtor's book value.

False

When a note is exchanged for property in a bargained transaction, the stated interest rate is presumed to be fair unless:

Mortgage notes payable are always reported as a long-term liability.

Gains and losses on early extinguishment of debt are reported as other gains and losses on the income statement.

True

On January 1, 2014, Trinity Company loaned $901,560 to Litton Industries in exchange for a 3 year, zero-interest-bearing note with a face amount, $1,200,000. The prevailing rate of interest for a loan of this type is 10%. The adjusting journal entry made by Litton at December 31, 2014 with regard to the note will include

a credit to Discount on Notes Payable for $90,160.

On January 1, Gasperson Inc. issued $100,000,000, 7% bonds at 102. The journal entry to record the issuance of the bonds will include

a credit to Premium on Bonds Payable for $2,000,000.

The printing costs and legal fees associated with the issuance of bonds should

be accumulated in a deferred charge account and amortized over the life of the bonds.

The covenants and other terms of the agreement between the issuer of bonds and the lender are set forth in the

bond indenture.

When a bond sells at a premium, interest expense will be:

less than the bond interest payment.

A bond for which the issuer has the right to call and retire the bonds prior to maturity is a

callable bond.

When a business enterprise enters into what is referred to as off-balance-sheet financing, the company

can enhance the quality of its financial position and perhaps permit credit to be obtained more readily and at less cost.

A gain or loss from extinguishment occurs when the reacquisition price differs from the bonds'

carrying value

under the effective interest method, bond interest expense is computed by multiplying the bonds'

carrying value by the effective interest rate

The interest rate written in the terms of the bond indenture is known as the

coupon rate, nominal rate, or stated rate.

If bonds are initially sold at a discount and the straight-line method of amortization is used, interest expense in the earlier years will

exceed what it would have been had the effective-interest method of amortization been used.

If a bond sold at 97, the market rate was:

greater than the stated rate.

The numerator in the times interest earned ratio is:

income before interest and taxes.

Bonds which do not pay interest unless the issuing company is profitable are called

income bonds

Under the effective interest method, interest expense:

is the same total amount as straight-line interest expense over the term of the bonds.

The selling price of a bond is the sum of the present values of the principal and the periodic interest payments. The present values are determined by discounting using the

market rate

Bonds will sell at a premium when the

market rate is lower than the stated rate

Note disclosures for long-term debt generally include all of the following except

names of specific creditors.

Under IFRS, bond issuance costs, including the printing costs and legal fees associated with the issuance, should be:

recorded as a reduction in the carrying value of bonds payable.

A bond issued in the name of the owner is a:

registered bond

A bond that matures in installments is called a:

serial bond

Franzia Co. prepares its financial statements using IFRS. The company has a loss contingency to accrue. The loss amount can only be reasonably estimated within a range of outcomes. No single amount within the range is a better estimate than any other amount. The amount of loss accrual should be

the mid-point of the range

A debt instrument with no ready market is exchanged for property whose fair market value is currently indeterminable. When such a transaction takes place

the present value of the debt instrument must be approximated using an imputed interest rate.

Stonehenge, Inc. issued bonds with a maturity amount of $5,000,000 and a maturity eight years from date of issue. If the bonds were issued at a premium, this indicates that

the stated rate of interest exceeded the market rate.