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