Accounting 100- ch 10

Bonds that are subject to retirement at a stated dollar amount prior to maturity at the option of the issuer are called a. callable bonds. b. early retirement bonds. c. options. d. debentures.

a. callable bonds.

callable bonds

bonds that the issuing company can redeem (buy back) at a stated dollar amount prior to maturity

Effective-Interest Method steps

1. Compute bond interest expense 2. Compute bond interest paid 3. Compute amortization amount

Features of Bonds

1. Face value (small denominations of $1,000 or multiples of $1,000) 2. Maturity dates 3. Contractual interest rates (i.e. stated rate) - given as annual % -Used to determine amount of cash interest issuer pays

Record contingency as liability on balance sheet if...

1. Reasonably estimable loss AND 2. Probable the loss will occur -if not BOTH then just show in notes NOT balance sheet

Two ways to record sales taxes:

1. Record sales taxes & sales revenues separately upon sale -Dr. Cash, Cr. Sales Rev., Cr. Sales Taxes Payable 2. Do not record separately -Divide total sale amount by 1+sales tax percentage to calculate sales tax amount

Why would companies want to hide debt?

1. Solvency / liquidity implications 2. Debt covenants - certain loans have rules that companies can only have so much debt on their books otherwise the loan will be due immediately.

Two methods for calculating interest:

1. Straight-line - NOT ALLOWED BY GAAP 2. Effective Interest Method of Amortizing - Appendix 10B

Bonds

A form of interest-bearing notes payable issued by corporations, universities, and governmental agencies.

5. Describe the difference, in one sentence, between a secured and unsecured bond:

A secured bond is backed by specific assets as collateral, whereas unsecured bonds are issued against the general credit of the borrower with no specific assets as collateral.

All of the following are true regarding financial statement analysis ratios associated with liabilities except A. a high times interest earned ratio indicates that a company is more likely to meet interest payments as scheduled. B. high liquidity ratios mean that lines of credit should be high to compensate. C. if a company's current ratio is lower than the industry average, then it may lack liquidity. D. unrecorded obligations causing sizeable differences between liquidity and solvency ratios can be ignored.

B. high liquidity ratios mean that lines of credit should be high to compensate. ???

convertible bonds

Bonds that can be converted into common stock at the bondholder's option -Good for bondholder because opportunity to benefit if market price increases -Good for issuer because higher price and lower interest than non-convertible

2. can be redeemed by the issuing company prior to maturity.

Callable Bonds

On May 1, 2017 Picard Industries signed a $200,000, 12%, four-month note maturing on September 1 with Federation Credit Union. Record the necessary entries for Picard: Receipt of cash?

Cash 200,000 Notes Payable 200,000

1. Convertible bonds can be converted to . This is done at whose discretion?

Common Stock; Converted at the bondholder's discretion.

What business activity are we engaging in when issuing bonds?

Financing

Payroll and payroll taxes payable

Companies are required to withhold a variety of amounts for their employees from their employees' paychecks which they must then pay to other parties. -Employers must ALSO pay their portion of certain payroll taxes --FICA tax --Federal Unemployment Taxes --State Unemployment Taxes ->The amounts withheld on behalf of employees are included in salaries and wages payable ->The employer's portion is recorded as a payroll tax expense

"Debt Masking"

Companies try to "hide" debt by entering into transactions that briefly remove debt at end of year and bring it back after beginning of next year.

Contingencies

Events with uncertain outcomes that may represent potential liabilities. -lawsuits -environment clean up obligation

On May 1, 2017 Picard Industries signed a $200,000, 12%, four-month note maturing on September 1 with Federation Credit Union. Record the necessary entries for Picard: Adjusting Entries on May 31, 2017?

Interest Expense 2,000 Interest Payable 2,000 (200,000*.12*1/12)

Why is the distinction between current liabilities and noncurrent liabilities important to users of the financial statements?

Liquidity & Solvency considerations

On May 1, 2017 Picard Industries signed a $200,000, 12%, four-month note maturing on September 1 with Federation Credit Union. Record the necessary entries for Picard: **Assume all adjusting entries have been made up to September 1** Record Picard's entry for the repayment of the loan:

Notes Payable 200,000 Interest Payable* 8,000 Cash 208,000

Unearned revenues

Represents cash we have received for future services we are required to perform. i.e. ticket sales, subscriptions, rental payments, etc.

Current maturities of long-term debt

Signifies the portion of long-term debt that is due within the year or the operating period.

4. What does the other party, not listed in question 3, receive in exchange for cash?

The bond holder receives the bond certificate.

3. Who get's cash in a bond transaction?

The bond issuer

Effective-Interest Method

To follow expense recognition principle, companies allocate bond discount/premium to expense to each period the bonds are outstanding. -However - to completely comply with expense recognition we must keep interest expense as a percentage of carrying value constant over bonds life ->This percentage is the effective interest rate --Effective interest rate = market rate used

Notes Payable

Written documentation of the obligation to pay the claim or debt. -Notes payable is the borrower's perspective, notes receivable is the lender's perspective.

If bonds are issued at a premium, the stated interest rate is a. higher than the market rate of interest. b. lower than the market rate of interest. c. too low to attract investors. d. adjusted to a higher rate of interest.

a. higher than the market rate of interest.

Which of the following is not an advantage of issuing bonds instead of common stock? a. Stockholder control is not affected b. Earnings per share on common stock may be lower c. Tax savings result d. Each of these answer choices is an advantage.

b. Earnings per share on common stock may be lower

The amount of sales tax collected by a retail store when making sales is a. a miscellaneous revenue for the store. b. a current liability. c. not recorded because it is a tax paid by the customer. d. recorded as an operating expense.

b. a current liability.

A company receives $264, of which $24 is for sales tax. The journal entry to record the sale would include a a. debit to Sales Taxes Expense for $24. b. credit to Sales Taxes Payable for $24. c. debit to Sales Revenue for $264. d. debit to Cash for $240.

b. credit to Sales Taxes Payable for $24.

From an accounting standpoint, all of the following are contingencies that must be evaluated for off-balance sheet purposes except a. product warranties. b. general business risks. c. money-back guarantees for products. d. environmental cleanup obligations.

b. general business risks.

Sales taxes collected by a retailer from a customer are expenses a. of the retailer. b. of the customers. c. of the government. d. that are not recognized by the retailer until they are submitted to the government.

b. of the customers.

Liabilities are classified as current or long-term based on their a. description. b. payment terms. c. due date. d. amount.

c. due date

Secured bonds are bonds that a. are in the possession of a bank. b. can be converted into common stock. c. have specific assets of the issuer pledged as collateral. d. mature in installments.

c. have specific assets of the issuer pledged as collateral.

As interest is recorded on an interest-bearing note, the Interest Expense account is a. increased; the Notes Payable account is increased. b. increased; the Notes Payable account is decreased. c. increased; the Interest Payable account is increased. d. decreased; the Interest Payable account is increased.

c. increased; the Interest Payable account is increased.

The statement "Bond prices vary inversely with changes in the market rate of interest" means that if the a. market rate of interest increases, the contractual interest rate will decrease. b. contractual interest rate increases, then bond prices will go down. c. market rate of interest decreases, then bond prices will go up. d. contractual interest rate increases, the market rate of interest will decrease.

c. market rate of interest decreases, then bond prices will go up.

The market value (present value) of a bond is a function of all of the following except the a. dollar amounts to be received. b. maturity date. c. market interest rate. d. type of bonds.

d. type of bonds.

Very often, failure to record a liability means failure to record a(n) a.revenue. b.asset conversion. c.footnote. d.expense.

d.expense

secured bonds

have specific assets of the issuer pledged as collateral for the bonds -small companies

unsecured bonds

issued against the general credit of the borrower -big companies

Types of bonds

secured, unsecured, convertible, callable

Off-balance-sheet financing

the intentional effort by a company to structure its financing arrangements so as to avoid showing liabilities on its balance sheet common forms: -operating leases (reported in a note) -Transactions that remove debt at end of the year and bring back on at beginning of next year