Chapter 9
Leases
- A contractual arrangement by which the lessor (owner) provides the lessee (user) the right to use an asset for a specified period of time - It has become the number one method of external financing in the U.S companies
Debt to Equity Ratio
Measures Financial Leverage total liabilities/stockholders equity
Amortization Cash Paid
Monthly payments remain the same
three primary sources of long-term debt financing
Notes Leases Bonds - Most likely to encounter in life: Notes and Leases
Amortization Date
Payments made at the end of each month
Retired bonds at maturity
Regardless whether bonds are issued at face amount, at a discount , or at premium, their carrying value at maturity will equal their face amount.
premium bonds
Same thing as discount BUT THIS IS SUBTRACTED instead Interest expense DECREASES Premium on Bonds Payable DECREASES Cash: ALWAYS STAYS THE SAME
Amortization Decrease in carrying value
The cash paid in expense reduces the carrying value (remaining loan balance)
A long term lease creates
and asset and a liability for the lesee (user)
Amortization Installment Note Steps
carrying value X % percentage x 1/12 (#of months)
Why Lease
- Leases reduces upfront cash needed to use an asset - Lease payments often are lower than installment payments - Leasing offers flexibility and lower costs when disposing of an asset - Leasing may offer protection against the risk of declining assets values
Installment Payments
- Most car loans and home loans call for payment in monthly installments rather than by a single amount at maturity - Each installment payment include both: 1. Interest on borrowed amount 2. Reduction of outstanding loan balance Companies, too, often borrow cash using installment loans
Accounting for bonds payable
1) Record the bond issue Cash Bonds Payable 2) Record the first semiannual interest payment based on the bond's stated interest rate Interest Expense Cash
Convertible Bonds
Allow the investor to convert each bond into a specified number of shares of common stock
callable bonds
Allows the issuing company to repay the bonds before their scheduled maturity date at a specified call price, usually at an amount just above face value
Retired bonds before maturity
Bonds Payable (face value) Premium on Bonds Payable (whatever is left that is above the face value and after the semiannual charges) Loss (difference) Cash (amount paid (provided on test))
Secured Bonds
Bonds that have specific assets of the issuer pledged as collateral.
Premium amortization schedule
DECREASES down to original issuance
Record a lease
Even though leases payments total to more over the specified amount of years, we record the lease payable for only its present value. As lease payments are made over time , the carrying values of the asset and the liability will be reduced to zero
Classification of Debt
For financial reporting, this amount needs to be split into its current and long-term portions already paid: what you paid this year (2020) current portion: The amount of the loan that will be settled within one year of the balance sheet date. (2021) Long-term liability: The amount left over after the current portion
Market Interest Rate (Yield, Effective Interest Rate)
Implied rate based on the price investors pay to purchase a bond Stated interest rate LESS than the market rate causes a discount Stated interest rate MORE than the market rate causes a premium
Amortization Interest Expense
Interest expense equals the prior months carrying value time the interest rate
Bonds
a formal debt instrument issued by a company to borrow money borrower promises to pay back investor with: 1) a stated amount, referred to as the principal or face amount 2) periodic interest payments over the life of the bond - Bonds are usually for greater amounts and are issued to many lenders - they are SEMIannual (2) - sold or underwritten by investment houses -lower interest rate
Cost of financing
Debt: Interest Expense (Tax deductible) Equity: Dividends (not tax-deductable)
Bonds issued/recorded at a discount (2)
- Interest expense: calculated with carrying present value of bond x Market interest per period - Discount on bonds payable (the difference between interest expense and interest paid) - Cash (interest paid) (face amount of bond x states interest rate per period) *NEXT SEMI-ANNUAL PERIOD* - Interest expense: carrying present value of bond ADDING the previous discount payable (difference) TIMES MARKET interest rate - Discount on bonds payable (the difference between interest expense and interest paid) - Cash: REMAINS SAME AS BEFORE ALWAYS
early extinguishment of debt
debt is retired prior to its scheduled maturity date.
Calculating the present value of lease payments (annuity)
done with either excel or financial calculator: Not able to do for
external financing
funds coming from outside of the company - liabilities - debt financing - stockholders' equity - Equity financing
Interest paid versus interest expense
it is still necessary to pay back the full amount so we have to go and find out how much and record it 1) Find Stated interest amount (interest paid The face amount of bond x stated interest rate per period = cash paid for interest 2) Do the effective interest method (interest expense) Carrying/present value of bond x Market interest per period
internal financing
profits generated by the company
Amortization Schedule (Table)
provides a table format detailing the: cash payment each period the portions of each cash payment that represents interest and the change in carrying value and the balance of carrying value
Bond Characteristics
secured unsecured term serial callable convertible
Bonds issued at a discount
The stated interest rate is LESS than the market interest rate Is considered a contra liability which is deducted from Bonds Payable 1)Issued at discount Cash (is gonna be given on test bc it requires present value) Discount on Bonds payable Bonds Payable
Unsecured Bonds
bonds are secured only by the "full faith and credit" of the issuing company also called debentures, not backed by a specific asset
Serial Bonds
require payments in installments over a series of years - rather than issuing 20 million due at the end of the 10th year, 2 million will be due each year for the next ten years.
Bond issued at a premium
stated rate > market rate
Bond Amortization Schedule
summarizes the cash paid for interest, interest expense, and change in the bind's carrying value for each se annual interest period. THIS SCHEDULE ADDS UP BC IT IS A DISCOUNT WERE YOU HAVE TO PAY BACKK
Capital Structure
the mixture of debt (liabilities) and (stockholders') equity maintained by a firm
Times Interest Earned Ratio (Interest coverage ratio)
Measures. companies Ability to meet interest payments as they become due. (Net Income +Interest Expense + Tax Expense) / Interest Expense
Amortization carrying value
The carrying value begins at the original amount of the loan. With each monthly cash payment, the portion that reduces the carrying value becomes more. By the end of the loan, the loan amount is paid off and the carrying value equals 0
Changes in carrying value over time
- When bonds issue at face amount, the carrying value and the corresponding interest expense REMAIN CONSTANT 7%=7% - When bonds issue at a discount (below face amount), The carrying value and the corresponding interest expense INCREASE over time. 7% < 8% - When bonds issue at a premium (above face amount), the carrying value and the corresponding interest expense DECREASE over time. 7% > 6% - it always comes back to its maturity date
debt financing
- borrowing money from creditors (liabilities) - debt can be a less costly source of external financing - Interest expense incurred when borrowing money is tax-deductable - debt financing contains three primary sources of long-term debt financing
Term bonds
- require payment of the full principal amount of the bond at a single maturity date - The issuing company usually sets aside money in a sinking fund: an investment fund to which an organization makes payments each year over the life of its outstanding debt.
Recording a Note Payable
1) Issue a note payable Cash Notes Payable 2) Pay monthly installment on note Interest expense (o.g amount x interest % x 1/12) Notes Payable(difference) Cash (monthly payment) 3) Pay monthly installment on note Interest expense (reduced o.g amount from last month) Notes Payable (difference) Cash (monthly payment)
How to calculate for bond issue
1. Face amount: Find face amount and when its due ( $100,000 + 10 yr) 2. Find stated interest rate= (face amount x % interest x 1/2 yr) 100,000 x 7% x 1/2 = 3,500 2. Interest payment = (stated interest rate)(amount of years x 2) (3,500)(10 years x 2) = $70,000 3) Total: Add face amount to interest payment $100,000 + $70,000 = $170,000