ACC 210 Chapter 9: long term liabilities
Debt Financing
borrowing money ( liability) -short term- generally due within 1 year -long term- generally due beyond 1 year -interest is tax deductible, dividends are not - match your debt to your use
secured bonds:
bonds are backed by collateral
term
bonds issue matures on a single date
objective at the end all the way to it's maturity
book value is equal to face value
callable
borrower can pay off bonds early
serial
bond issue matures in installments
Bond Retirements - at maturity
bond requirements occur when the issuing corporation buys back its bonds from the investors no gain/loss on bonds retired at maturity
debt to equity ratio
a measure of financial leverage - leverage enables a company to earn a higher return using debt that without debt, in the same way a person can lift more weight with the lever than without it debt to equity ration= total liabilities/ stockholders' equity
what's the discount
amount below the face value
what's the premium
amount over the face value
what are bonds?
-formal debt instrument that obligates the borrower to repay a stated amount, referred to as the principal or face amount, at a specified maturity date - the borrower also agrees to pay interest over the life of the bond at a stated rate - traditionally,interest bonds is paid twice a year ( semiannually) on designated interest dates, beginning 6 months after the original bond issue date
times interest earned ratio
an indication to creditors of how many "times" greater earnings are than interest expense time interest earned ratio= net income + interest expense + tax expense/ interest expense
bond issue price calculation
calculate present value of principal - principal x PVIF ( periods, market rate) $10,000 x 0.8227 ( n=4, i=5%)=$8,227 - calculate present value of cash interest payments --principal x stated rate x PVIFA $450 x 3.54595 ( n=4, i=5%)=$1,596 add two amounts together %8,227 + $1,596=$9,823 (vs bond face value of $10000)
for a bond issued at a premium
carrying value decreased over time
for a bond issued at a discount
carrying value increases over time
interest expense =
carrying value x market rate note that the initial carrying value is the issued price (issuer price=face amount + premium or - discount)
Leases
contractual arrangement by which the lessor ( owner) provides the lessee ( user) the right to use an asset for a specified period of time types: -operating lease: lessor owns the asset, and the lessee uses the asset for the term of the lease ( never earn the asset and don't have to put cash up right away) - capital leases: lessee buys and asset and finances the purchase through a lease ( Basically financing to own)
debt leverage
debt financing offer the opportunity to magnify your gains... but with the risk of magnifying your losses
bond premium or discount amortization ( change in carrying value)
difference between cash paid and interest expense premium: cash paid > interest expense ( stated rate > market rate) discount: interest expense > cash paid ( stated rate < market rate)
Installment notes
each installment payment is for the same amount,but payments represent both: 1. interest on borrowed amount 2. reduction in outstanding loan balance - most car loans and home loans call for payments in monthly installments rather than by a single amount at maturity
Redemption before maturity
eliminate the carrying value of the bonds - debit bonds payable for the face value of the bond - eliminate any remaining unamortized discount ( credit) or premium (debit) - credit cash for the amount paid to redeem bonds -recognize any gain ( credit) or loss (debit) on the redemption = he difference between the cash paid to redeem the bonds and the carrying value of the bonds
cash interest payments=
face amount x stated rate
Market rate
interest rate investors demand to own a bond with a given level of risk
equity financing
investment from stockholders ( stockholders equity)
bond issuance Journal entries
issued at par dr. Cash(A) x,xxx cr. bonds payable (L) x,xxx issued at discount dr.cash(A) x,xxx dr. discount on bonds payable (l) x,xxx cr.bonds payable(L) x,xxx issued at premium dr.cash(A) x,xxx cr.premium on bonds payable (L) x,xxx cr. bonds payable (L) x,xxx
convertible
lender can convert bonds to common stock
at a discount the carrying value is
less than the face value
Pricing bonds at face value using a financial calculator
lets first assume the market interest rate is 7%, the same as the stated interest rate. The bonds issue a face value Bond Characteristic, key, Amount calculator input 1. face amount, FV, $100,000 2. Interest payment, PMT, $3,500=$100,000*7%*1/2 year 3. market interest rate, I, 3.5=7%/2 periods per year 4. period to maturity, N,20=10 years x 2 period each year calculator output issue price, PV, $100,000
debt analysis
long-term debt is one of the first place decision makers look when trying to get a handle on risk two ratio used to measure financial risk related to long-term liabilities - debt to equity ratio - times interest earned ratio
at a premium the carrying value is
more than the face value
bonds retired at maturity
no gain or loss recorded
unsecured bonds
not backed by collateral
bond carrying value
prior carrying value + discount amortization or - premium amortization - premium amortization decreased carrying value ( down to face amount) - discount amortization increases carrying value ( up to face amount)
discount
stated rate < market rate
face value
stated rate = market rate
premium
stated rate > market rate
bond certificate
the cash flows associated with the bonds are defined by the terms on the face of the bond, the selling price of bonds are a function of the bond cash flows and current market rate of interest
capital structure
the mixture of liabilities and stockholders' equity used to finance a business (external financing)
why would you retire your bond early
the price to retire the bonds in the is greated than the carrying value of the bonds indicating that interest rates have fallen and are lower than the bonds stated rate. Given our bonds stated interest rate a buyer would be willing to pay more for the bond because its interest payments will be at a higher than market rate we can issue a new debt ( if necessary) at a lower interest rate now than before. this is kind of like refinancing a mortgage when rates have fallen
bonds retired before maturity
we record a gain or loss on redemption equal to the difference between the price paid to repurchase the bonds and the bond's carrying valye
