Non Current Liabilities

Finance (Capital) Lease conditions from GAAP

1)ownerhsip of leased asset transfers to the lessee at end of the lease 2)Lease contains an option to buy 3)The lease term is at least 75% or more of the useful life of the asset 4) the present value of lease payments is 90% or more of the fair value of the leased asset only 1 of the above has to be met

Derecognition of Debt

A company may keep bonds on books until maturity, may call them if there is a provision, or may buy them back in open market. If they retire bonds early, the difference between the cash required to redeem the bonds and the carrying amount of the bonds is a gain or loss on the extinguishment of debt.

Defined Contribution Plans

Agreed upon lump sum or amount is called pension expense. Money contributed to plan is treated as operating cash flow

Operating Lease

An operating lease is an agreement allowing the lessee to use some asset for a period of time. If not classified as a finance lease, it is an operating lease. The lessee reports no asset or liability, just lease expense. If lessor does not transfer all risk and reward, the lease is an operating lease, and the lessor keeps the leased asset on its balance sheet.

Debt Covenants

Bond borrowing agreements (the bond indenture) often includes restrictions called covenants the protect creditors by restricting activities of the borrower. Affirmative covenants - require borrower to perform certain actions Negative covenants - restrict a borrower from performing certain actions. When a company violates a covenant, it is a breach of contract. Depending on severity of breach, the lenders may choose to waive the contract, be entitled to a penalty payment or higher interest rate, renegotiate, or call for payment of debt.

Accounting for Bond Issuance

Cash or sales proceeds received by the company when it issues bonds is based on the value of the bonds at the time of issue The cash received from from issuing bonds is reported as a financing cash inflow Bonds payable are initially reported at the face value of the bonds, minus any discount, or plus any premium. IFRS - initially report bonds as sales proceeds - issuance costs GAAP - initally report bonds as just sales proceeds

Leases - Advantages

Companies may want to lease an asset rather than purchase Less costly financing, small down payments, lower interest payments Lessor is in position to take advantage of tax benefits of ownership (depreciation and interest) Certain types of leases are not shown as debt on balance sheet

Evaluating Solvency - Coverage Ratios

Coverage ratios focus on the income statement and cash flows and measure the ability of company to cover its debt-related payments Interest Coverage Ratio = EBIT/Interest Payments Fixed Charge coverage ratio = EBIT + Lease payments/(Interest Payments + Lease Payments)

Finance Lease

Finance or capital lease is the purchase of the asset by the buyer (lessee) that is directly financed by the seller (lessor) If all risks and rewards are transferred to the lessee, the lease is classified as a finance lease. The lessee reports a leased asset and lease obligation on its balance sheet. If lessor transfers all risk and reward, the lease is a finance lease, and the lessor reports a lease receivable on its balance sheet and removes leased asset from its balance sheet.

Accounting for Bond Amortization, Interest Expense, and Interest Payments

If bonds are issued at par, periodic interest expense will be the same as periodic interest payments. If bonds are issued at either premium or discount, the premium or discount is amortized systematically over the life of the bonds as a component of interest expense. Premium Bonds - carrying amount of bonds is initially greater than face value. As premium is amortized, the carrying amount will decrease to face value. The reported interest expense will be less than the coupon payment.

Evaluating Solvency - Leverage Ratios

Leverage ratios are derived from the balance sheet and measure the extent to which a company uses liabilities rather than equity to finance its assets Debt to Assets Rato = Total Debt/Total Assets Debt to Capital Ratio = Total Debt/(Total Debt + Shareholder's Equity) Debt to Equity Ratio = Total Debt/Total Shareholder's Equity Financial Leverage Ratio = Average Total Assets/Average Shareholder's Equity

Presentation and Disclosure of Long Term Debt

The portion of long term debt due within the next 12 months is shown as current liability, not long term liability.

Leasing

When lessee reports lease as operating lease, the lessee usually appears more profitable in the early years of the lease and less so later, and it appears more solvent over the entire period When a lessor reports lease as a finance lease, the lessor appears more profitable in the early years of the lease.

Defined Benefit Plan

company makes promise of future benefits to be paid to employee during retirement If the fair value of the fund's assets is greater than the present value of the estimated pension obligation, the plan has a surplus and the company's balance sheet will show a net pension asset. If fund value is not greater, the company will show a net pension liability Each period, the change in the net pension asset or liability is recognized in either profit or loss on comprehensive income statement

Effective Interest Rate Method for Amortization

interest expense under the Effective Interest Rate Method is calculated as the bonds carrying amount times the market rate in effect when the bonds were issued. The amount of premium amortized in a year is the difference between the interest expense and the interest payment.

GAAP Leases

under GAAP, a lease can be either a capital lease or an operating lease From a lessors perspective, under GAAP, there are two types of capital leases - direct financing leases and sales-type leases. Direct Financing Lease: when the present value of the lease payments equals the carrying amount of the leased asset. the lessor only earns interest revenue Sales-Type Lease: when the present value of the lease payments exceeds the carrying amount of the leased asset. The lessor earns both interest revenue and a profit or loss on the sale of the leased asset