A304 - Exam 3
Calculating Interest Expense
(Original principle) *(interest rate)* (# of months)/12
Short-Term Non-interest bearing note
- Don't calculate the PV of the loan --> record amount borrowed as the original loan balance
>50% Equity Investment
- Investment Type: Control - Reported/ Measured: Acquisition & Consolidation - Balance Sheet Classification: N/A - Statments consolidated - Other Notes: Investment in VOTING common stock
Debt Securities Held to Maturity
- Investment Type: Passive - Reported/ Measured: Amoritized cost - Balance Sheet Classification: Noncurrent (unless due in next year) - Other Notes: Affects net income as it is amoritized
<20% Equity Investment
- Investment Type: Passive - Reported/ Measured: Fair Value (Net Income) - Balance Sheet Classification: Current or NonCurrent - Other Notes: Investment in VOTING common stock
Available for Sale (AFS) Debt Securities
- Investment Type: Passive - Reported/ Measured: Fair Value (OCI) - Balance Sheet Classification: Current or Noncurrent - Other Notes: Planning to sell before maturity, but not necessarily in the next year... when sold, impacts net income
Debt Securities For Trading
- Investment Type: Passive - Reported/ Measured: Fair Value (net income) - Balance Sheet Classification: Current Asset - Other Notes: Planning to sell soon... they impact net income
20-50% Equity Investment
- Investment Type: Significant Influence - Reported/ Measured: Equity Method - Balance Sheet Classification: Noncurrent - Other Notes: Investment in VOTING common stock
Bonds Payable
- Loans with regular interest payments and a large payment at maturity date - Calculate PV of the single payment and PV of the annuity
bond discount account
- a contra-liability account - does not have to be used to record the JE for bonds issued at a discount
Long-term non-interest bearing note
- calculate the PV of the loan, record this as the original loan balance
AOCI common accounts
- change in foreign currency translation - changes in unrealized gains/losses on derivatives - change in unrealized gans/losses on marketable securities (AFS securities)
If a parent buys less than 100% of the stock:
- company reports noncontrolling interest - which is the amount attributable to the other investors
CF from financing activities
- external sources of financing - issuing stock/repurchasing - dividends paid
Why might a company buy back stock
- feels the market is discounting it's value - reduce the number of shareholders; increase ownership percentage for remaining owners - increase financial ratios like EPS - if they know they need to issue stock in the future (prevents dilution from things like stock options)
If a parent buys 100% of the stock:
- financial statements look the same as if they were one company
Non-interest bearing note
- note where the interest is deducted in advance from the face value of the note - You accrue interest expense and increase the liability balance throughout the ownership - COMPOUND interest at the end of each year (meaning interest expense increases)
CF from investing activities
- purchase/sale of long-term assets - debt and equity investements - short-term marketable securities
CF from operating activities
- revenues and expenses - cash paid or recieved for interest - dividends recieved
Purpose of M&A
- to achieve vertical integration - Horizontal growth - or operational synergy
Advantages of Bonds
1. Bonds do not affect owner control 2. Interest on bonds is tax deductible 3. Bonds can increase return on equity
Disadvantages of Bonds
1. risk of bankruptcy 2. bonds require payment of both periodic interest and the par value at maturity (negative impact on cash flows)
Calculating the present value of the periodic interest payments
1.) Annuity cash payment: coupon rate * (months per period/12) * face value 2.) Present value of that annuity Payment value from step 1 * PV of an annuity - Make sure you have the correct "n" (number of payment periods) and "I" (market interest rate * months per period/12) 3.) add steps 1 & 2
bond amortization
1.) Cash payment - always the same amount coupon rate * (months per period/12) * face value 2.) Interest expense Book Value * Market rate 3.) Discount Amoritization Cash interest - interest expense 4.) Par Value Previous Book Value + Discount Amoritization
Recording Interest Expense on bonds issued at a discount
1.) Compute interest expense Book Value * Market Rate/Period 2.) Compute cash owed for interest Face Value * Coupon rate/Period 3.) Compute Amortization amount Interest Expense - Cash owed for interest
How many years are reported for stockholders equity?
3 years
Indirect Method - liability balance increased - add or subtract?
Add the Change
Indirect Method - Asset balance decreased - add or subtract?
Add the change
Equity Method
An accounting method in which the investment in common stock is initially recorded at cost, and the investment account is then adjusted annually to show the investor's equity in the investee. - Ex. if you own 40% of the shares, increase by 40% of NI and decrease by 40% of dividends/net losses
Cumulative Dividend Preference
Any unpaid dividends from previous years (dividends in arrears) must be paid before common dividends are paid.
Statement of cash flows includes:
Cash and cash equivalents
Bond Interest Calculation: use the
Coupon rate
Importance of cash generated from operations
Creditors & investors will not provide financing inf they don't believe cash flows from operations is sufficient
Which is riskier: Debt or Equity (and why)?
Debt is riskier because: - Debt payments are legal obligations - Creditors can force bankruptcy - Creditors can require the sale of assets
noncumulative dividends
Dividends that the issuer of preferred stock does not pay later if unpaid at the due date.
(short-term) Journal Entry When Money Is Borrowed
Dr. Cash (+A) Cr. Note Payable (+L)
(short-term) Journal Entry during the life of the loan
Dr. Interest Expense (+E) Cr. Interest Payable (+L)
(short-term) Journal Entry When loan is paid off
Dr. Note Payable (-L) Dr. Interest Expense (+E, -SE) -- interest from the current period Dr. Interest Payable (-L) -- interest from prior periods Cr. Cash (-A)
IPO journal entry
Dr. cash Cr. common stock Cr. APIC
T or F: The Statement of comprehensive income must be stated independently from the income statement
False ... it can be presented seperatly, or it can be combined/
T or F: The Statement of comprehensive income is only required by FASB?
False ... it's required by both the FASB and IASB
recording intangible assets that have a limited life
Finite intangible assets are typically amortized using the straight-line method over the useful life of the asset.
GAAP & IFRS Definition of probable
GAAP: Likely; greater than 70% IFRS: More Likely than not; greater than 50% - This means that companies reporting with IFRS would report a liability when GAAP would simply disclose in notes.
Calculating goodwill
Goodwill = P-(A-L) P = Purchase price of the target company A = Fair market value of assets L = Fair market value of liabilities.
recording intangible assets with an unlimited life
Intangible assets with an indefinite life are not amortized but are assessed yearly for impairment.
Coupon Rate
Interest rate specified on a bond - Used to compute the periodic cash interest payment - also called the stated rate, contract rate, or nominal rate
Which of the following is reported on the balance sheet: Bonds Payable, Bond Discount, Net Bonds Payable
Net Bonds Payable
Are R&D expenses capitalized?
No
Relation between price of bonds and market interest rates
Opposite direction - this means that if the market interest rate goes up, the company may retire (buy back) the bond early
Preferred dividend calculation
Par value * number of preferred shares * dividend %
Contingent Liabilities that should be disclosed in notes
Probable & Impossible to Estimate Reasonably Possible & Subject to Estimate Reasonably Possible & Impossible to estimate
Contingent Liabilities that must be recorded as a liability
Probable & Subject to Estimate - Record at lowest end of the range
Contingent Liabilities not needed to be disclosed
Remote Probability & Subject to Estimate Remote Probability & Impossible to Estimate
The direct method of reporting operating cash flows:
Report cash effects of each operating activity
Temporary accounts
Revenue, expense, and dividend accounts whose balances a company transfers to Retained Earnings at the end of an accounting period.
the indirect method of reporting opertating cash flows:
Start with net income and add/subtract to arrive at OCF
Indirect Method - Asset balance increased - add or subtract?
Subtract the change
Indirect Method - liability balance decreased - add or subtract?
Subtract the change
unrealized gains or losses
The change in the value of an asset (gain or loss) that has not been sold yet.
IPO (initial public offering)
The first time a company sells shares of its stock to the public.
Calculating issue price of a bond
The issue price of a bond equals the present value of the bond's face amount plus the present value of its periodic interest payments.
Amoritized Cost Method
Used for Debt Securities held to Maturity - Amoritized adjustments for premium or discount
Fair Value Method
Used for all other passive investments - reflects market gains or losses ... recorded on either income statement or OCI - Unrealized gains or losses
Bond issue price
When a company sells a bond, it receives the PV of future cash flows
Is interest always given as an annual rate?
Yes
Does Stockholders equity include OCI?
Yes -- shows impact of unrealized gains/losses on AFS debt securities
subsidiary company
a company in which more than 50% of its stock is owned by another company
parent company
a company that owns more than 50% of the common stock of another entity
unissued shares
authorized shares that have not been sold by the corporation
Permanent Accounts
balance sheet accounts whose balances are carried forward to the next accounting period
Bond Sells at Discount
contract rate < market rate
Bond Sells at Par
contract rate = market rate
Bond Sells at Premium
contract rate > market rate
Calculating the present value of the face amount
face value * PV of a single payment - based on market rate
outstanding shares
issued shares that are owned by stockholders
treasury shares
issued shares that have been reacquired by the corporation - contra-equity account ... not an asset - recorded at cost, not par value
Installment Loans
loans repaid in regular payments over a period of time - interest expense decreases as the amounts are paid back
intangible assets
long-term assets (e.g., patents, trademarks, copyrights) that have no real physical form but do have value
Bond PV calculation: use the
market rate
Peferred stock dividends
preferred stock dividends are paid before common stock dividends are paid
issued shares
represent the total number of shares of stock that have been sold
Authorized shares
shares of common stock that a firm's corporate charter allows it to issue
Bond Principal
the amount: (a) payable at the maturity of the bond (b) on which the periodic cash interest payments are computed - also called face value, par value, or maturity value
current cash equivalent
the cash amount a creditor would accept to settle the liability immediately - This is the price that liabilities are recorded at
Capital Structure
the mixture of debt and equity maintained by a firm
seasoned offering
the sale of additional securities by a firm whose securities are already publicly traded
T or F: Statement of cash flows gives insight to capital structure and growth potential of a company
true ... it shows how a company has elected to fund its growth
Rights of Common Stock
vote, share in the profits, elect board of directors
When are intangible assets not recognized on the balance sheet?
when they are internally developed