Intermediate Accounting Debt Financing.ppt

1、,Intermediate Accounting,17E,Stice | Stice | Skousen, 2010 Cengage Learning,PowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine University,Debt Financing,Definition of Liabilities,The FASB defined liabilities as “probable future sacrifices of economic benefits arising

2、 from present obligations to a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.”,Classification of Liabilities,Liabilities are usually classified as current or noncurrent. If a liability arises in the course of an en

3、titys normal operating cycle, it is considered current if: current assets are used to satisfy the obligation within one year or one operating cycle, whichever period is longer.,When debt that has been classified as noncurrent will mature within the next year, the liability should be reported as a cu

4、rrent liability. The distinction between current and noncurrent is important because of the impact on a companys current ratio.,Classification of Liabilities,Measurement of Liabilities,For measurement purposes, liabilities can be divided into three categories:,Liabilities that are definite in amount

5、 Estimated liabilities Contingent liabilities,Short-Term Operating Liabilities,The term account payable usually refers to the amount due for the purchase of materials by a manufacturing company or the purchase of merchandise by a wholesaler or retailer. No recognition of interest is required.,Short-

6、Term Debt,In most cases, debt is evidenced by a promissory note, which is a formal written promise to pay a sum of money in the future. Notes issued to trade creditors for the purchase of goods or services are called trade notes payable. Nontrade notes payable include notes issued to banks or to off

7、icers and stockholders.,Short-Term Obligations Expected to be Refinanced,A short-term obligation that is expected to be refinanced on a long-term basis should not be reported as a current liability. The FASB issued Statement No. 6, which contains the authoritative guidelines for classifying short-te

8、rm obligations expected to be refinanced.,(continues),FASB Statement No. 6,(continues),According to Statement No. 6, both of the following conditions must be met before a short-term obligation can be properly excluded from the current liability classification.,Management must intend to refinance the

9、 obligation on a long-term basis. Management must demonstrate an ability to refinance the obligation.,FASB Statement No. 6,Concerning the second point, the ability to refinance may be demonstrated by either of the following:,Actually refinancing the obligation during the period between the balance s

10、heet date and the date the statements are issued. Reaching a firm agreement that clearly provides for refinancing on a long-term basis.,Lines of Credit,A line of credit is a negotiated arrangement with a lender in which the terms are agreed to prior to the need for borrowing.,Present Value of Long-T

11、erm Debt,A mortgage is a loan backed by an asset that serves as collateral for the loan. On January 21, 2011, Crystal Michae purchases a house for $250,000 and makes a down payment of $50,000. The remainder is financed with a 12%, 30-year mortgage.,(continues),Present Value of Long-Term Debt,As the

12、$2,057 monthly mortgage payment is made, the interest portion must be recognized. On February 1, the interest is $2,000 ($200,000 1/12 0.12). The balance, $57, is applied to the principal. On March 1, the interest is $1,999 $200,000 $57 (1/12 0.12). This pattern continues throughout the mortgage.,Fi

13、nancing with Bonds,The issuance of bonds or notes instead of stock may be preferred by management and stockholders for the following reasons:,Present owners remain in control of the corporation. Interest is a deductible expense in arriving at taxable income; dividends are not. Current market rates o

14、f interest may be favorable relative to stock market prices. The charge against earnings for interest may be less than the amount of expected dividends.,Accounting for Bonds,Conceptually, bonds and long-term notes are similar types of debt instruments. The trust indenture (the bond contract) associa

15、ted with bonds generally provides more extensive detail than the contract terms of a note.,Accounting for Bonds,There are three main considerations in accounting for bonds:,Recording the issuance or purchase Recognizing the applicable interest during the life of the bonds Accounting for retirement o

16、f bonds either at maturity or prior to the maturity date,Nature of Bonds,Bond certificates, commonly referred to simply as bonds, are frequently issued in denominations of $1,000. The amount printed on the bond is the face value, par value, or maturity value of the bond. The group contract between t

17、he corporation and the bondholders is known as the bond indenture.,Debt securities issued by state, county, and local governments and their agencies are collectively referred to as municipal debt. Bonds that mature on a single date are called term bonds. When bonds mature in installments, they are r

18、eferred to as serial bonds.,Nature of Bonds,Secured bonds offer protection to investors by providing some form of security, such as a mortgage on real estate or the pledge of other collateral. A collateral trust bond is usually secured by stocks and bonds of other corporations owned by the issuing c

19、ompany. Unsecured bonds (frequently termed debenture bonds) are not protected by the pledge of any specific assets.,Nature of Bonds,Registered bonds call for the registry of the owners name on the corporation books. Bearer bonds or coupon bonds are not recorded in the name of the owner; title to the

20、se bonds passes with delivery. Zero-interest bonds or deep-discount bonds do not bear interest. Instead, these securities sell at a significant discount.,Nature of Bonds,High-risk, high-yield bonds issued by companies that are heavily in debt or otherwise in a weak financial condition are often call

21、ed junk bonds. Convertible bonds provide for their conversion into some other security at the option of the bondholder. Commodity-backed bonds or asset- linked bonds are redeemable in terms of commodities.,Nature of Bonds,Bond indentures frequently give the issuing company the right to call and reti

22、re the bonds prior to maturity. Such bonds are termed callable bonds.,Nature of Bonds,Market Price of Bonds,The amount of interest paid on bonds is a specified percentage of the face value. This percentage is termed the stated rate, or contract rate. If the stated rate exceeds the market rate, the b

23、onds will sell at a discount. If the market rate exceeds the stated rate, the bonds will sell at a premium. The actual return rate on a bond is known as the market, yield, or effective interest rate.,Bond Stated Interest Rate 10%,Yield,Market Price of Bonds,Market Price of Bonds,Ten-year, 8% bonds o

24、f $100,000 are to be sold on the bond issue date. The effective interest rate for bonds of similar quality and maturity is 10%, compounded semiannually. The computation of the market price of the bonds may be divided into two parts (as shown in Slide 12-26).,Part 1 Present value of principal (maturi

25、ty value): Maturity value of bonds after 10 years, or 20 semiannual periods$100,000 Effective interest rate: 10% per year,or 5% per semiannual period$37,689,Part 2 Present value of twenty interest payments: Semiannual payment, 4% of $100,000$4,000 Effective interest rate: 10% per year, or 5% per sem

26、iannual period 49,849 Total present value (market price) of bond$87,538,Market Price of Bonds,Issuance of Bonds,Each of the bond situations in the following slides will be illustrated using the following data: $100,000, 8%, 10-year bonds are issued; semiannual interest of $4,000 ($100,000 0.08 6/12)

27、 is payable on January 1 and July 1.,Bonds Issued at Par on Interest Date,Jan.1Cash100,000 Bonds Payable100,000,Issuers Books,July 1Interest Expense4,000 Cash4,000,Dec. 31Interest Expense4,000 Interest Payable4,000,(continues),Bonds Issued at Par on Interest Date,Jan. 1Bond Investment100,000 Cash100

28、,000,Investors Books,July 1Cash4,000 Interest Revenue4,000,Dec. 31Interest Receivable4,000 Interest Revenue4,000,Bonds Issued at Discount on Interest Date,Jan. 1Cash87,538 Discount on Bonds Payable12,462 Bonds Payable100,000,Issuers Books,Jan. 1Bond Investment87,538 Cash87,538,Investors Books,Bonds

29、Issued at Premium on Interest Date,Jan. 1Cash107,106 Premium on Bonds Payable7,106 Bonds Payable100,000,Issuers Books,Jan. 1Bond Investment107,106 Cash107,106,Investors Books,Bonds Issued at Par between Interest Date,Jan. 1Cash101,333 Bonds Payable100,000 Interest Payable1,333,Issuers Books,July 1In

30、terest Expense2,667 Interest Payable1,333 Cash4,000,(continues),Bonds Issued at Par between Interest Date,Jan. 1Bond Investment100,000 Interest Receivable1,333 Cash101,333,Investors Books,July 1Cash4,000 Interest Receivable1,333 Interest Revenue2,667,Bond Issuance Costs,The issuance of bonds normall

31、y involves bond issuance costs to the issuer for legal services, printing and engraving, taxes, and underwriting.,In Statement of Financial Accounting Concepts No.3, the FASB stated that deferred charges such as bond issuance costs fail to meet the definition of assets.,Accounting for Bond Interest,

32、When bonds are issued at a premium or discount, an adjustment is made to periodic interest expense to reflect the effective interest rate incurred on the bonds. This periodic adjustment is referred to as bond premium or discount amortization.,Straight-Line Method,The straight-line method provides fo

33、r the recognition of an equal amount of premium or discount amortization each period.,$100,000, 8%, 10-year bonds were issued on January 1 at a $12,462 discount. Interest is payable on July 1 and December 31.,(continues),Straight-Line Method,July 1Interest Expense4,623 Discount on Bonds Payable623 C

34、ash4,000,Issuers Books,Dec. 31Interest Expense4,623 Discount on Bonds Payable623 Interest Payable4,000,(continues),Straight-Line Method,July 1Cash4,000 Bond Investment623 Interest Revenue4,623,Investors Books,Dec. 31Interest Receivable4,000 Bond Investment623 Interest Revenue4,623,(continues),Straig

35、ht-Line Method,July 1Interest Expense3,645 Premium on Bonds Payable355 Cash4,000,Issuers Books,Dec. 31Interest Expense3,645 Premium on Bonds Payable355 Interest Payable4,000,(continues),Assume the bonds were sold for $107,106.,Straight-Line Method,July 1Cash4,000 Bond Investment355 Interest Revenue3

36、,645,Investors Books,Dec. 31Interest Receivable4,000 Bond Investment355 Interest Revenue3,645,Effective-Interest Method,The effective-interest method of amortization provides for a uniform interest rate based on a changing loan balance.,Provides for an increasing premium or discount amortization eac

37、h period.,Effective-Interest Method,Consider once again the $100,000, 8%, 10-year bonds sold for $87,539, based on an effective interest rate of 10%.,Effective-Interest Method,Assume the $100,000, 8%, 10-year bonds is sold for $107,106, based on an effective interest rate of 7%.,Extinguishment of De

38、bt Prior to Maturity,Bonds may be redeemed by the issuer by purchasing the bonds on the open market or by exercising the call provision (if available). Bonds may be converted, that is, exchanged for other securities. Bonds may be refinanced by using the proceeds from the sale of a new bond issue to

39、retire outstanding bonds.,Redemption by Purchase of Bonds in the Market,Triad, Inc.s $100,000, 8% bonds are not held to maturity. They are redeemed on February 1, 2011, at 97. The carrying value of the bonds is $97,700 as of this date. Interest payment dates are January 31 and July 31.,(continues),R

40、edemption by Purchase of Bonds in the Market,Investors Books,Feb. 1Cash 97,000 Loss on Sale of Bonds700 Bond Investment Triad Inc.97,700,Convertible Bonds,Convertible debt securities usually have the following features: An interest rate lower than the issuer could establish for nonconvertible debt A

41、n initial conversion price higher than the market value of the common stock at time of issuance A call option retained by the issuer Convertible debt gives both the issuer and the holder advantages.,Assume that 500 ten-year bonds, face value $1,000, are sold at 105 ($525,000). The bonds contain a co

42、nversion privilege that provides for exchange of a $1,000 bond for 20 shares of stock, par value $1.,Convertible Bonds,Issued with Conversion Feature Nondetachable and Debt and Equity Not Separated,Cash 525,000 Bonds Payable500,000 Premium on Bonds Payable25,000,Convertible Bonds,Cash 525,000 Discou

43、nt on Bonds Payable20,000 Bonds Payable500,000 Paid-In Capital Arising from Bond Conversion Feature45,000,Issued with Conversion Feature Nondetachable and Debt and Equity Separated,Convertible Bonds,Cash 525,000 Discount on Bonds Payable20,000 Bonds Payable500,000 Paid-In Capital Arising from Bond C

44、onversion Feature45,000,Issued with Conversion Feature Nondetachable and Debt and Equity Separated,Accounting for Conversion Debt According to IAS 32,IAS 32 does not differentiate between convertible debt with nondetachable and detachable conversion features. IAS 32 states that for all convertible d

45、ebt issues, the issuance proceeds should be allocated between debt and equity.,Accounting for Conversion,HiTec Co. offers bondholders 40 shares of HiTec Co. common stock, $1 par, in exchange for each $1,000, 8% bond held. An investor exchanges bonds of $10,000 for 400 shares of common stock having a

46、 market value at the time of the exchange of $26 per share.,Accounting for Conversion,Investment in HiTec Co. Common Stock10,400 Bond InvestmentHiTec Co. 9,850 Gain on Conversion of HiTec Co. Bonds550,Investors BooksGain Recognized,Accounting for Conversion,Bond Refinancing,Cash for the retirement o

47、f a bond issue is frequently raised through the “sale of a new issue” and is referred to as bond refinancing. When refinancing before the maturity date of the old issue, the APB selected the immediate recognition of a gain or loss for all early extinguishment of debt.,Fair Value Option,SFAS No. 159

48、allows a company to report, at each balance sheet date, any or all of its financial assets and liabilities at their fair market value on the balance sheet date.,The FASB reasoned that the objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in

49、 reported earnings.,Off-Balance-Sheet Financing,Off-balance-sheet financing procedures to avoid disclosing all debt on the balance sheet in order to make the companys financial position look stronger. Common techniques used: Leases Unconsolidated subsidiaries Variable interest entities (VIEs) Joint

50、ventures Research and development arrangements Project financing arrangements,Leases,Leases are considered to be either rentals (operating leases) or asset purchases with borrowed money (capital leases). The four classification criteria are as follows:,Lease transfers ownership Lease includes a barg

51、ain purchase option Lease covers 75% or more of the economic life of the asset Present value of lease payments is 90% or more of the asset value,Unconsolidated Subsidiaries,The FASB issued Statement No. 94 in 1987, effectively eliminating one opportunity that companies have used for off-balance-shee

52、t financing. Companies are able to avoid recognizing debt associated with subsidiaries that are less than 50% owned by the company.,Joint Ventures,When companies join forces with other companies to share the costs and benefits associated with specifically defined projects, it is called a joint ventu

53、re. Because the benefits of joint ventures are uncertain, companies could incur substantial liabilities with few, if any, assets resulting from their efforts.,Research and Development Arrangements,These arrangements involve situations in which an enterprise obtains the results of research and development activities funded partially or entirely by others. Accounting issue: Is this arrangement, in essence, a means of borrowing to fund research and developmen