ACC 3313 EXAM 3 (Chapt 13,14) - Binod Guragai
Why do some companies prefer to report an obligation as Non-current?
Companies typically prefer to report an obligation as non-current rather than current -Non-current classification results in higher working capital and a higher current ratio
Debt issue costs are?
Debt issue costs reduce the cash proceeds from the issuance of debt, so it makes sense that they should reflect a higher cost of borrowing. By deducting debt issue costs, we lower the carrying amount of the debt, which effectively increases the interest rate on that debt. In other words, with debt issue costs, the net amount borrowed is less, but interest payments are the same, so the effective rate of borrowing is higher
What is Discount on bonds payable classified as?
Discount on bonds payable is FUTURE INTEREST
How is carrying value determined in bonds payable for both discount and premium?
Discount: by subtracting the carrying value from the unamortized discount/premium amt Premium: by adding the carrying value from the unamortized discount/premium amt
Define Federal Insurance Contributions Act (FICA)....(Employees' Withholding Taxes)
FICA requires employers to withhold a percentage of each employee's earnings up to a specified maximum - Employer pays matching amount on behalf of employee - Self-employed persons pay both the employer and employee portions
What is the difference between GAAP and IFRS in terms of gain contingencies?
GAAP: Gain contingencies are never accrued ; Disclose when gain realization is "probable" but uses a higher threshold for "probable" IFRS: Gain contingencies are accrued if future realization is "virtually certain" to occur ; Disclose when gain realization is "probable" but uses a lower threshold for "probable"
What is the difference between GAAP and IFRS in terms of Classification of Liabilities to Be Refinanced?
GAAP: Liabilities payable within the coming year are classified as long-term liabilities if refinancing is completed before the date of issuance of the financial statements. IFRS: To be classified as long-term, liabilities must be refinanced before the balance sheet date.
What is the periodic interest for when corporates borrow bonds?
In return for the use of the money borrowed, the company also agrees to pay interest to bondholders between the issue date and maturity. - The periodic interest is a stated percentage of face amount (variously referred to as the stated rate, coupon rate, or nominal rate). - Ordinarily, interest is paid semiannually on designated interest dates beginning six months after the day the bonds are "dated."
What is interest equation?
Interest = Principal or face amt x annual Rate x Time to maturity
How does the amortization of premium of bonds payable affect Carrying value?
It decreases the amount each time to its original par value
How does premium of bonds payable affect Interest expensE?
It is amortized AGAINST interest expense thus reducing interest expense
How is Recording Current Liabilities done? And what are some common examples of them.
Liabilities should be recorded at their present values - Except liabilities payable within one year which are ordinarily recorded at maturity amounts Examples: •Income tax liability •Dividends payable •Accrued liabilities •Accounts payable •Notes payable •Commercial paper
What are secured loans? Define pledging & factoring receivables.
Loan made by pledging a specified asset of the borrower as collateral or security - Pledging accounts receivable: When accounts receivable serves as a collateral - Factoring receivables: When the receivables actually are sold outright to a finance company
At what value are the reported at?
Long-term liabilities are reported at their present values. - The present value of a liability is the present value of its related cash flows (principal and/or interest payments), discounted at the effective rate of interest at issuance
What are some Current Maturities of Long-Term Debt?
Long-term obligations •Bonds •Notes •Lease liabilities •Deferred tax liabilities They are RECLASSIFIED as Current liabilities: - when they become payable within the upcoming year or operating cycle, if longer than a year EX: 20-year bond -to- Long-term liability for 19 years -to- Current liability in the 20th year of term to maturity
Define Serial bonds
Mature serially, that is at regular or staggered intervals. - Retired in installments during all or part of the life of the issue with each bond having its own specified maturity date
How do notes payable defer from bonds payable?
Notes payable are likely to be equal to market rate as the rates were already negotiated .. so discounts and premiums are not probable unlike bonds
What is the difference between comparing market rate with stated rate in discounts and premium?
Premium: You get a higher amount (adjunct liability) Discount: you get a lower amount (contra liability)
What is a face amount at a specified maturity date? (bonds) And when are they used in terms of companies repaying bonds?
Principal, par value, stated amount, or maturity value - Bonds obligate the issuing corporation to repay a stated amount (variously referred to as the principal, par value, face amount, or maturity value) at a specified maturity date - Maturities for bonds typically range from 10 to 40 yrs
What does GAAP require the likelihood that the future event(s) will confirm the incurrence of the liability be? (For loss contingencies)
Probable, reasonably possible, or remote - Probable: confirming event is likely to occur - Reasonably possible: the chance the confirming event will occur is more than remote but less than likely - Remote: the chance the confirming event will occur is slight
How is bond interest determined? Effective Interest method
Refers to recording interest each period as the effective market rate of interest multiplied by the outstanding balance of the debt (during the interest period) Outstanding balance * Effective rate = Effective Interest
What do Advances from Customers represent? Some examples?
Represent liabilities until the product or service is provided or the advance collected Examples • Gift certificates • Magazine subscriptions • Layaway deposits • Special order deposits • Airline tickets
When are Short-Term Obligations Expected to Be Refinanced?
Short-term obligations that are expected to be refinanced on a long-term basis can be reported as non-current liabilities if two conditions are met: 1. The company must intend to refinance on a long-term basis, and 2. The company must actually have demonstrated the ability to refinance on a long-term basis • This is demonstrated by an existing refinancing agreement or actual financing prior to the issuance of financial statements
With installment notes how are periodic amounts calculated?
The periodic amount is easily calculated by dividing the amount of the loan by the appropriate discount factor for the present value of an annuity Amt of loans / PV of an ordinary annuity = Installment payment
What happens when a company fails to live up to the terms of the bond indenture?
Trustee may bring legal action against the company
Define long-term notes
When a company borrows cash from a bank and signs a promissory note, the firm's liability is reported as a note payable
What does it mean When Financial Statements Are Prepared Between Interest Dates?
When an accounting period ends between interest dates, it's necessary to record interest that has accrued since the last interest date
What does it mean when Bonds are sold at a premium?
When bonds sell for more than their face amount
Define Convertible bonds
bonds that are exchangeable at the option of the holder for the issuing firm's common stock - Can be converted into shares of stock
How does discount of bonds payable affect Interest expensE?
it increases interest expense..
How does the amortization of discount of bonds payable affect Carrying value?
it increases the amount to reach its original amount since it was discounted at first
When straight-line method is used to find interest payments done in bonds payable what does the use of this method conceptually mean?
it's the application of the materiality concept, by which an appropriate application of GAAP (the effective interest method), can be bypassed for reasons of practical expediency (convenient without being immoral) in situations when doing so has no material effect on the results
How is interest expense calculated in discount on bonds payable?
market rate (adjusted market rate basically dividing original market rate by amount of times paying interest) * carrying value
In accounting the economic essence of a transaction should prevail what?
the economic essence of a transaction should prevail over its outward appearance. - A basic concept of accounting is substance over form. In keeping with this basic precept, the accountant should look beyond the form of this transaction and record its substance
What is an alternative expected cash flow approach? What are the required conditions?
• An alternative expected cash flow approach is described by SFAC No. 7 - Incorporates specific probabilities of cash flows into the analysis •Required conditions: -When the warranty obligation spans more than one year and -We can associate probabilities with possible cash flow outcomes
How do Unasserted Claims and Assessments work?
• Even if a claim has yet to be made when the financial statements are issued, a contingency may warrant accrual or disclosure • A two-step process is involved: 1. Is it probable that a claim will be asserted? If the answer is "no," stop. If "yes," go on to step 2. 2.Treat the claim as if the claim has been asserted.
Product Warranties and Guarantees
• Most consumer products are accompanied by a guarantee, such as a quality-assurance warranty • Costs of satisfying guarantees should be estimated and recorded as expenses in the same accounting period the products are sold - This is a loss contingency
Define interest
• Paid by borrowing company during the loan term • Return for using lender's money • Stated in terms of a percentage rate to be applied to the face amount of the loan
How the Disclosure of Litigation Contingencies are done?
• Pending litigation is not unusual • Accrual of a loss from pending or ongoing litigation is rare -Outcome of litigation is highly uncertain -Loss is usually not recorded until after ultimate settlement • While companies should provide extensive disclosure of these contingent liabilities, they do not always do so
What is accrued liabilities? And some common examples
• Represent expenses already incurred but not yet paid (accrued expenses) • Recorded by adjusting entries • Usually combined and reported under a single caption in the balance sheet Common examples: - Salaries and wages payable - Income taxes payable - Interest payable
Whats the criteria for accruing contingent loss?
• The criteria for accruing a contingent loss almost always are met for product warranties or guarantees - While we usually can't predict the liability associated with an individual sale, prior experience makes it possible to predict reasonably accurate estimates of the total liability for a period
Whats the traditional way of measuring a warranty obligation?
• The traditional way of measuring a warranty obligation is to report the "best estimate" of future cash flows - The method ignores the time value of money
How do annual bonuses work AKA its features? And most of its common performance measures (Financial & non-financial)?
• Tied to performance objectives to provide incentive to executives • Are compensation expense of the period in which they are earned Most common performance measures: - Financial: Earnings per share , Net income , Operating income - Non-financial: Customer satisfaction , Product or service quality
How are sale of bonds with debt issue done?
•Recorded by combining with any discount or premium; combined valuation account is reported as a direct deduction from the liability; amortized over the life of the debt
What are the characteristics of Short-Term Notes Payable? What are some financing alternatives?
•• Temporary financing from bank •• Promissory note is signed •• Lower interest rates than long-term debt •• Companies have flexibility while selecting financial alternatives Financing alternatives: - Commercial paper - Unsecured loans - Credit lines - Secured loans
How is bond selling price determined?
- Bonds will sell for more than face amount (at a premium) : EX: premium 12% is later 10% - or less than face amount (at a discount), depending on how the 12% stated interest rate compares with the prevailing market or effective rate of interest. : EX: 12% is later 14% hence, the less than face amt coz the 14% is higher
Define Callable bonds (Redeemable bonds)
- Call feature allows the issuing company to buy back, or call, bonds before their scheduled maturity date - Call price must be prespecified and often exceeds the bond's face amount - Sinking fund redemptions: The corporation may be required to redeem the bonds on a prespecified, year-by-year basis
What are convertible bonds?
- Can be exchanged for shares of stock at the option of the investor - Issued to: • Sell bonds at higher price • Use as a medium of exchange in mergers and acquisitions • Enable smaller firms or debt-heavy companies to obtain access to the bond market
What is a Committed & Non-committed credit line?
- Committed line of credit: is a more formal agreement that usually requires the company to pay a commitment fee to the bank to keep a credit line amount available to the company. A typical annual commitment fee is ¼% of the total committed funds and may also require a compensating balance. - Non-committed line of credit: is an informal agreement that permits a company to borrow up to a prearranged limit without having to follow formal loan procedures and paperwork. Banks sometimes require the company to maintain a compensating balance on deposit with the bank, say, 5% of the line of credit. Borrower may be required to maintain a compensating balance in the bank!!!
How are Collections for Third Parties done?
- Companies often make collections for third parties from customers or from employees and periodically remit these amounts to the appropriate governmental (or other) units. Amounts collected this way represent liabilities until remitted. - Most Common Examples: Payroll-related deductions such as: -Withholding taxes -Social Security taxes -Employee insurance -Employee contributions to retirement plans -Union dues
List some types of bonds
- Debenture bonds - Mortgage bonds - Callable bonds (Redeemable bonds) - Serial bonds - Convertible bonds
What is the requirement to classify currently maturing debt as a current liability? (Obligations Callable by the Creditor)
- Debt that is callable (due on demand) by the creditor in the upcoming year/operating cycle, EVEN IF the debt is not expected to be called - When the creditor has the right to demand payment because an existing violation of a provision of the debt agreement makes it callable - Debt is not yet callable but will be callable within the year if an existing violation is not corrected within a specified grace period
Employees' Withholding Taxes
- Employers are legally required to withhold •Federal and state income taxes •Social Security taxes •Withholdings from employees' paychecks •Remitted to taxing authorities - Amount withheld varies with: •Amount of earnings •Amount of exemptions claimed by employee
What are Gift Cards (Gift Certificates) recorded as?
- Gift cards or gift certificates are particularly common forms of advanced payments. - When a company sells a gift card, it initially records the cash received as deferred revenue, and then recognizes revenue either when the gift card is redeemed or when the probability of redemption is viewed as remote (which is called gift card breakage, and based on expiration or the company's experience). - Liabilities for deferred revenue associated with gift cards are classified as current or long-term depending on when the obligation is expected to be satisfied.
What is Detachable Stock Purchase Warrants?
- Give the investor an option to purchase a stated number of shares of common stock at a specified option price, often within a given period of time - Bear a lower interest rate - Can be exercised independently or traded in the market separately from bonds, having their own market price - Issue price is allocated between the two different securities on the basis of their fair values
When Notes Exchanged are for Assets or Services what 2 interest rates might occur?
- Implicit rate of interest: Rate is not expressly stated in the agreement - Imputing an interest rate: Deciding the appropriate rate when value of asset or service is not readily determinable
Sale of bonds with a Debt issue (2 types)
- Indirectly through underwriters who: : Commit to purchase bonds at a set price then resell them to other security dealers and the public. Ex: Investment banks • Issuing company pays underwriting fee - Directly to a single investor (private placement): : Ex: Pension fund or an insurance company •Issuing company incurs only issue costs
What are Installment notes? What do each payment include?
- Installment payments are equal amounts each period - Periodic reduction of the balance is sufficient that at maturity the note is completely paid Each payment includes both an amount that represents: 1. Interest 2. Principal reduction
How are Liabilities from Advance Collections created? What are some advance collections?
- Liabilities are created when deposits and advances are received from customers. Advance collections: - Deposits and advances from customers (present situations where liabilities are created to either make payments or provide goods or services in the future.) : Refundable deposits ; Advances from customers - Gift cards - Collections for third parties (present situations where liabilities are created to either make payments or provide goods or services in the future.)
What is the most common form of corporate debt?
- Medium and large sized corporations often choose to borrow cash by issuing bonds to the public. - In fact, the most common form of corporate debt is bonds
What are the characteristics of CURRENT liabilities?
- Obligation payable within one year or firm's operating cycle - Satisfied from current assets - Satisfied by creation of other current liabilities
When are Accounts Payable and Trade Notes Payable usually used?
- Obligations to suppliers of merchandise or of services - Key accounting considerations are: •Determining existence •Recording in the appropriate accounting period
What are zero=coupon bonds?
- Pay no interest - Offers a return in the form of a "deep discount" from the face amount - Issuers can deduct for tax purposes the annual interest expense, even though no related cash outflow is incurred until the bonds mature - Investors receive no periodic cash interest, even though annual interest revenue is reportable for tax purposes
(Chapt 13) What are the characteristics of liabilities?
- Probable, future sacrifices of economic benefits - Arise from present obligations - Result from past transactions or events It involves the past, the present, and the future
How is Early Extinguishment of Debt done?
- Refers to the transaction when debt is retired prior to its scheduled maturity date - Accounting for early extinguishment: • Account balances of the debt must be removed from the books • Any difference between the outstanding debt and the amount paid to retire that debt represents either a gain or a loss
What is commercial paper?
- Refers to unsecured notes sold in minimum denominations of $25,000 with maturities ranging from 1 to 270 days • Beyond 270 days the firm would be required to file a registration statement with the SEC - Interest often is discounted at issuance - Usually commercial paper is issued directly to the buyer (lender) and is backed by a line of credit with a bank • This allows the interest rate to be lower than in a bank loan
Define Debenture Bonds
- Secured only by the "full faith and credit" of the issuing corporation - No specific assets are pledged as security (Bonds not backed by an asset) - Investors have the same standing as the firm's other general creditors • Exception: Subordinated debentures; not entitled to receive any liquidation payments until the claims of other specified debt issues are satisfied
What is induced conversion?
- Through the call provision: When the specified call price is less than the conversion value of the bonds - Encouraging voluntary conversion: By offering an added inducement in the form of cash, stock warrants, or a more attractive conversion ratio
What are Voluntary Deductions, Employers' Payroll Taxes, and Fringe Benefits?
- Voluntary deductions • Include union dues, contributions to savings or retirement plans, and insurance premiums • Represent liabilities until paid to appropriate organizations - Employers' payroll taxes • Employer's matching amount of FICA taxes • Employer pays federal and state unemployment taxes on behalf of employees - Fringe benefits • Payment of employees' insurance premiums and/or contributions to retirement income plans by employer
Whether a contingency is accrued and reported as a liability depends on?
1. The likelihood that the confirming event will occur 2. What can be determined about the amount of loss
What are the Four conditions for accrual of paid future absences (VACATIONS, SICK DAYS, AND OTHER PAID FUTURE ABSENCES)?
1. The obligation is attributable to employees' services already performed 2. The paid absence can be taken in a later year—the benefit vests or the benefit can be accumulated over time 3. Payment is probable (very high chance you'll pay) 4. The amount can be reasonably estimated
(Chapt 14) What is the nature of Long-term debt?
A company must raise funds to finance its operations and often the expansion of those operations. - Presumably, at least some of the necessary funding can be provided by the company's own operations, though some funds must be provided by external sources. - Ordinarily, external financing includes some combination of equity and debt funding
What is a gain contingency? Are they accrued?
A gain contingency is an uncertain situation that might result in a gain • Gain contingencies are not accrued -This is an example of CONSERVATISM—we record uncertain losses but not uncertain gains • MATERIAL gain contingencies are DISCLOSED in the notes to the financial statements
What is a Credit Line?
A line of credit is an agreement to provide short-term financing, with amounts withdrawn by the borrower only when needed
Define Loss contingencies
A loss contingency is an existing, uncertain situation involving potential loss depending on a future event
How do accrued liabilities occur in terms of Salaries, Commissions, and Bonuses?
Accrued liabilities arise in connection with compensation expense when employees have provided services but will be paid after the financial statement date
What are Payroll-Related Liabilities?
All firms incur liabilities in connection with their payrolls. These liabilities arise primarily from: - Legal requirements to withhold taxes from employees' paychecks - From payroll taxes on the firms themselves. - Some payroll-related liabilities result from voluntary payroll deductions of amounts payable to third parties.
What does an Extended Warranty provide?
An extended warranty provides warranty protection beyond manufacturer's original warranty - Because an extended warranty is priced and sold separately from the warranteed product, it constitutes a separate performance obligation. - Revenue is recognized when performance obligations are satisfied, not necessarily when cash is received. Because an extended warranty provides coverage over a period of time, these arrangements typically qualify for revenue recognition over the period of coverage. However, cash typically is received up front when the extended warranty is sold. Similar to other advanced payments for future products and services, revenue from extended warranty contracts is not recognized immediately, but instead is recorded as a deferred revenue liability at the time of sale and recognized as revenue over the contract period, typically on a straight-line basis.
Determining bond selling price equation
Bond price = Present value of the principal payable at maturity + Present value of the periodic cash interest payments (face amount * stated rate) (both Discounted at the market rate)
Accrual of Litigation Contingencies
(go to timeline on slide 50 for more context) • Subsequent events can clarify a pre-existing claim's -Probability that a loss will occur -Estimated amount of loss • If contingency comes into existence after fiscal year-end -No liability accrues, but description provided in notes
Define Bond indenture
- A bond indenture describes the specific promises made to bondholders - Held by a trustee (usually a commercial bank or other financial institution, appointed by the issuing firm to represent the rights of the bondholders)
Define Accounts payable and Trade notes payable
- Accounts payable: ••Payable on open account ••Credit instrument (recognized by): invoice ••Short duration ••Non-interest-bearing and reported at face amounts - Trade notes payable: ••Credit instrument (recognized by): written promissory note ••Longer duration ••Bear interest
What happens when Bonds Issued Between Interest Dates?
- Accrued interest: • The interest paid by the buyer to the seller for delay in selling the bonds - All bonds sell at their price plus any interest that has accrued since the last interest date When bonds are issued at a discount between interest dates
Define Mortgage bonds
- Backed by a lien on specified real estate - Due to less risk, typically commands a lower interest rate
How are bond prices typically stated?
- Bond prices are typically stated in terms of a percentage of face amounts •Example: A price quote of 98 means a $1,000 bond will sell for $980; a bond priced at 101 will sell for $1,010
