Chapter 10 Reporting and Analyzing Liabilities
Bond certificate
A legal document that indicates the name of the issuer, the face value of the bonds, and other data such as the contractual interest rate and the maturity date of the bonds.
Effective-interest method of amortization
A method of amortizing bond discount or bond premium that results in periodic interest expense equal to a constant percentage of the carrying value of the bonds.
Face value
Amount of principal due at the maturity date of the bond.
Can the company obtain short-term financing when necessary?
Available lines of credit, from notes to the financial statements. Compare available lines of credit to current liabilities. Also, evaluate liquidity ratios.
Unsecured bonds
Bonds issued against the general credit of the borrower.
Convertible bonds
Bonds that can be converted into common stock at the bondholder's option.
Secured bonds
Bonds that have specific assets of the issuer pledged as collateral.
Callable Bonds
Bonds that the issuing company can redeem (buy back) at a stated dollar amount prior to maturity.
*Describe the accounting for long-term notes payable.
Each payment consists of (1) interest on the unpaid balance of the loan, and (2) a reduction of loan principal. The interest decreases each period, while the portion applied to the loan principal increases each period.
Contingencies
Events with uncertain outcomes that may represent potential liabilities.
Does the company have significant off-balance-sheet financing, such as unrecorded lease obligations?
Information on unrecorded obligations, such as a schedule of minimum lease payments from the notes to the financial statements Compare liquidity and solvency ratios with and without unrecorded obligations included
Can the company meet its obligations in the long term?
Interest expense and net income before interest and taxes times interest earned = net income + interest exp + income tax exp. ----------------------------------------------- interest exp.
Long-term liabilities
Obligations that a company expects to pay more than one year in the future.
Effective-interest rate
Rate established when bonds are issued that maintains a constant value for interest expense as a percentage of bond carrying value in each interest period.
Contractual (stated) interest rate
Rate used to determine the amount of interest the borrower pays and the investor receives.
Describe the major characteristics of bonds.
The following different types of bonds may be issued: secured and unsecured bonds, and convertible and callable bonds.
Time value of money
The relationship between time and money. A dollar received today is worth more than a dollar promised at some time in the future.
*Apply the straight-line method of amortizing bond discount and bond premium.
The straight-line method of amortization results in a constant amount of amortization and interest expense per period.
Present value
The value today of an amount to be received at some date in the future after taking into account current interest rates.
Explain how to account for bond transactions.
When companies issue bonds, they debit Cash for the cash proceeds and credit Bonds Payable for the face value of the bonds. In addition, they use the accounts Premium on Bonds Payable and Discount on Bonds Payable to show the bond premium and bond discount, respectively. Bond discount and bond premium are amortized over the life of the bond, which increases or decreases interest expense, respectively. When companies redeem bonds at maturity, they credit Cash and debit Bonds Payable for the face value of the bonds. When companies redeem bonds before maturity, they (a) eliminate the carrying value of the bonds at the redemption date, (b) record the cash paid, and (c) recognize the gain or loss on redemption.
Operating lease
A contractual agreement allowing one party (the lessee) to use the asset of another party (the lessor); accounted for as a rental.
Capital Lease
A contractual agreement allowing one party (the lessee) to use the assets of another party (the lessor); accounted for like a debt-financed purchase by the lessee.
Explain how to account for current liabilities.
A current liability is a debt that a company can reasonably expect to pay (a) from existing current assets or through the creation of other current liabilities, and (b) within one year or the operating cycle, whichever is longer. The major types of current liabilities are notes payable, accounts payable, sales taxes payable, unearned revenues, and accrued liabilities such as taxes, salaries and wages, and interest payable. When a note payable is interest-bearing, the amount of assets received upon the issuance of the note is generally equal to the face value of the note, and interest expense is accrued over the life of the note. At maturity, the amount paid is equal to the face value of the note plus accrued interest. Companies record sales taxes payable at the time the related sales occur. The company serves as a collection agent for the taxing authority. Sales taxes are not an expense to the company. Companies hold employee withholding taxes, and credit them to appropriate liability accounts, until they remit these taxes to the governmental taxing authorities. Unearned revenues are initially recorded in an unearned revenue account. As a company recognizes revenue, a transfer from unearned revenue to revenue occurs. Companies report the current maturities of long-term debt as a current liability in the balance sheet.
Current liability
A debt that a company reasonably expects to pay (1) from existing current assets or through the creation of other current liabilities, and (2) within one year or the operating cycle, whichever is longer.
Bonds
A form of interest-bearing notes payable issued by corporations, universities, and governmental entities.
Mortgage note payable
A long-term note secured by a mortgage that pledges title to specific assets as security for the loan.
Times interest earned
A measure of a company's solvency, calculated by dividing the sum of net income, interest expense, and income tax expense by interest expense.
Straight-line method of amortization
A method of amortizing bond discount or bond premium that allocates the same amount to interest expense in each interest period.
Notes payable
An obligation in the form of a written note.
Discuss how liabilities are reported and analyzed.
Current liabilities appear first on the balance sheet, followed by long-term liabilities. Companies should report the nature and amount of each liability in the balance sheet or in schedules in the notes accompanying the statements. They report inflows and outflows of cash related to the principal portion of long-term debt in the financing section of the statement of cash flows. The liquidity of a company may be analyzed by computing the current ratio. The long-run solvency of a company may be analyzed by computing the debt to assets ratio and the times interest earned. Other factors to consider are contingent liabilities and lease obligations.
Does the company have any contingent liabilities?
Knowledge of events with uncertain negative outcomes
Maturity date
The date on which the final payment on a bond is due from the bond issuer to the investor.
Discount (on a bond)
The difference between the face value of a bond and its selling price when a bond is sold for less than its face value.
Premium (on a bond)
The difference between the selling price and the face value of a bond when a bond is sold for more than its face value.
*Apply the effective-interest method of amortizing bond discount and bond premium.
The effective-interest method results in varying amounts of amortization and interest expense per period but a constant percentage rate of interest. When the difference between the straight-line and effective-interest method is material, GAAP requires use of the effective-interest method.
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.
Market interest rate
The rate investors demand for loaning funds to the corporation.
