Kế toán, kiểm toán - Chapter 11: Long - Term liabilities: notes, bonds and leases

2Chapter 11:Long-Term Liabilities: Notes, Bonds and Leases3Learning Objective 1List three major long-term liability categories and identify key financial ratios relied upon to assess the importance of these liabilities as a form of financing.4Long-Term LiabilitiesMany companies finance their operations and growth opportunities through the use of long term debt instruments:Notes Payable – Formal borrowing agreementBonds Payable – Issued to bondholders, smaller dollar amounts and larger amount of notesLeasehold Obligations – Future cash payments for use of an asset5The Relative Size of Long-Term Liabilities6Economic Consequences of Reporting Long-Term LiabilitiesImproved credit ratings can lead to lower borrowing costsLeverage and solvency measures have taken on increasing importanceManagement has strong incentive to manage financial statement numbers by employing reporting strategies like “off-balance-sheet financing”7Which of the following will result from receiving cash upon issuing long-term debt?a. Increase in the company’s indebtednessb. Decrease of the current ratioc. Increase of retained earningsd. Increase of total shareholders’ equity8Learning Objective 2List three basic contractual forms that underlie long-term liabilities, and in each case show how the effective interest rate is computed. 9Basic Definitions and Different Contractual FormsSome contracts, called interest-bearing obligations, require periodic (annual or semiannual) cash payments (called interest) that are determined as a percentage of the face, principal, or maturity value, which must be paid at the end of the contract period.Non-interest-bearing obligations require no periodic payments, but only a single cash payment at the end of the contract period.Installment obligations require periodic payments covering both interest and principle throughout the life of the contract. 10These contractual forms may contain additional terms that specify assets pledged as security or collateral in case the required cash payments are not met (default), as well as additional provisions (restrictive covenants).Basic Definitions and Different Contractual FormsFigure 11-2 Six possible kinds of notes11Effective Interest RateThe effective interest rate is the actual rate paid by the issuer of the obligation.It is based on the discount rate that sets the present value of the obligation’s cash outflows equal to the fair market value (FMV) of that which is received in the exchange.This requires and understanding of present value.12Installment and Non-Interest-Bearing ObligationsAssume that a company enters into an installment obligation requiring the payment of $10,000 at the end of each of two years in exchange for a benefit of $16,900.The effective interest rate is 12 percent because a $10,000 ordinary annuity discounted at 12 percent is equal to $16,900, the fair market value of the benefit received.13Installment and Non-Interest-Bearing ObligationsThe method for non-interest bearing obligations is the same as installment obligations, except that the Present Value of a Single Sum table is used instead of the Present Value of an Ordinary Annuity table. A non-interest bearing obligation requiring a single payment of $5,000 at the end of three years, receiving a benefit of $3,969.14Interest-Bearing ObligationsFor interest bearing obligations, the present value of all future payments must be taken into account. This includes all interest payments (typically using the Present Value of an Ordinary Annuity table) and the final principal payment (using the Present Value of a Single Sum table)15If the maximum debt/equity ratio as specified by a debt covenant is close to being violated, which one of the following actions would increase the likelihood of violating the debt covenant?a. Issuing capital stockb. Skip current cash dividendc. Acquire money by issuing a non-interest-bearing note payabled. Acquire money by collecting accounts receivable16A non-interest-bearing obligationa. requires recognition of interest expense over the life of the obligation.b. is an example of an installment obligation.c. requires collateral.d. is free of interest expense.17Learning Objective 3Define the effective interest method, and show how it is applied when accounting for bonds and notes payable. 18Accounting for Long-Term Obligations: The Effective Interest MethodThe effective interest rate represents the actual rate of interest associated with an obligation.The interest expense reported during each period of a long-term obligation’s contractual life is computed by multiplying the effective interest rate by the balance sheet value of the obligation as of the beginning of the period. 19Accounting for Long-Term Notes PayableLong-term notes are a popular way for U.S. companies to raise cash.Secured notes are backed by collateral.Mortgage secured by real estateMachines and equipment are often received in exchange for notes Unsecured notes are not backed by an asset. 20Accounting for Long-Term Notes PayableFigure 11-3 Accounting for non-interest-bearing note in exchange for equipment21Bonds PayableCompanies issue bonds to raise large amounts of capital, usually for expensive, long-term projects.Sold to the public through a third party (underwriter) such as an investment banker or financial institution. Typically interest-bearing that involve formal commitments requiring cash interest payments and a principal payment when the bond matures.22Bonds PayableFigure 11-4 (partial) Bond Terminology23Bonds Issue ExampleFigure 11-5 Example of bond issuance: Northern States Power Company (dollars in thousands)24The Effective Rate and the Stated Rate25Accounting for Bonds PayableCase 1: Bonds at ParCase 2: Bonds at a DiscountCash Flows for Bonds Payable26Case 1: Bonds Issued at ParThe bonds are issued at par ($10,000) and the effective rate (10 percent) is equal to the stated rate (10 percent). Figure 11-8 Bonds issuedat face value: Case 127Bonds Issued at a DiscountIf bonds are issued at a discount, the carrying value will be below face value at the date of issue.Interest expense is calculated each period by multiplying the effective rate by the balance sheet balance of the bond liability at the beginning of the period. The Discount account is amortized with a credit (starts with a normal balance debit). Note that the difference between Cash paid and Interest Expense is the amount of amortization.Interest expense for bonds issued at a discount will be greater than cash paid.The amortization table will show the bonds amortized up to face value.28Case 2: Bonds Issued at a DiscountThe bonds are issued at a $346 discount, and the effective rate of interest (12 percent) is greater than the stated rate (10 percent). Figure 11-9 Bonds issued at a discount: Case 229Issuing Bonds at Par and at a Discount: A Comparison - Amortization TablesFigure 11-10 Bonds amortization tables30Concept Practice 3 31Concept Practice 3 (cont.) 32Learning Objective 4Explain why and how gains and losses are recognized when bonds or notes are redeemed before maturity.33The Effective Interest Method and Changing Interest RatesThe effective interest method ensures long-term liabilities on the balance sheet are valued at the present value of the liability’s future (remaining) cash flows, discounted at the effective interest rate as of the date of issuance. Market rates change meaning that the economic value of bond liability will change though the amortized cost does not. 34Financial Instruments, Fair Market Values, and Off–Balance–Sheet RisksCompanies under U.S. GAAP and IFRS may choose to use the fair market value option vs. the effective interest method.Most companies choose to disclose the fair market value of the debt in the notes to the financials rather than to revalue the liability. Companies also disclose in the notes other financial instruments such as the guarantee of credit for subsidiaries and commitments to provide financing under certain circumstances.35Bond RedemptionsWhen bonds are redeemed at the maturity date, the issuing company simply pays cash to the bondholders in the amount of the face value and removes the bond payable from the balance sheet. To illustrate the redemption of a bond issuance prior to maturity at a loss, assume that bonds with a $100,000 face value and a $5,000 unamortized discount are redeemed for $102,000. The $7,000 loss on redemption would decrease net income.36Concept Practice 4 37Learning Objective 5Define and differentiate a capital lease from an operating lease.38LeasesA contract granting use of occupation of property during a specified period of time in exchange for rent payments. LandBuildingsMachineryEquipmentAvoid risks and associated costs of ownershipOperating Leases – pure rental agreement where the lessor maintains all ownership responsibilitiesOff-Balance-Sheet FinancingCapital Leases – Risks and benefits of ownership have effectively transferred to the lessee39Leases (cont.)Capital leases record the leased asset as a capital asset, and reflect the present value of the related payment contract as a liability.Risks and benefits of ownership have transferred to the lessee.Present value of periodic leases approximate the fair market value of the property.Property may revert to the lessor at the end of the lease or go to the lessee for a bargain price.Period of the lease may be equivalent to the asset’s useful life.40Capital LeaseDistinguishing capital from operating leases is important because of the financial statement impact. FASB criteria for capital leases are listed below. If any criteria are met, the lease should be accounted for as a capital lease. 41Capital Lease42International Perspective: The Importance of Debt Financing in Other Countries The accounting disclosure requirements in non-U.S. countries and IFRS are not as comprehensive as those in the United States, partially because the information needs of the major capital providers (i.e., banks) are satisfied in a relatively straightforward way—through personal contact and direct visits.A second way in which the heavy reliance on debt affects non-U.S. accounting systems is that the required disclosures and regulations tend to be designed either to protect the creditor or to help in the assessment of solvency.43Operating leases are treated asa. increases in liabilities for both the lessor and the lessee.b. a sale is the leased asset has been transferred from the lessor to the lessee.c. capital leases by the lessee.d. rental expenses by the lessee.44Learning Objective 6Appendices 11A and BExplain how investors decide whether to buy bonds and how the effective interest method is used to account for bond investments. 45Appendix 11A – The Determination of Bond PricesWhat will investors pay for the right to receive the interest payments and the face value of the bond at maturity? This is the amount investors will pay for the bond. Determine the Effective (Actual) Rate of ReturnDetermine the Required Rate of ReturnCompare the Effective Rate to the Required Rate46Determine the Effective (Actual) Rate of Return – when used to discount the bond’s future cash flows, results in a present value equal to the bond priceDetermine the Required Rate of Return – what rate would you require with the terms offered by the company?Required Rate of Return = Risk-Free Return + Risk PremiumDetermine the Risk-Free Return – what rate could be received on a riskless security (treasury notes and certificates of deposit may provide an estimate)Appendix 11A – The Determination of Bond Prices47Determine the Risk Premium – represents the probability that the company issuing the bonds will default on interest or premium payments, expressed as a percentageCompare the Effective Rate to the Required Rate – if the effective rate is favorable in comparison to the required rate the bond will be purchased. If the effective rate is not favorable to the required rate because of the risk free rate or judgement of risk premium, the bond should not be purchased. Appendix 11A – The Determination of Bond Prices (cont.)48Many companies invest in bonds as they are relatively low risk and provide periodic interest income. The accounting method is dependent on the intent of the management.Trading securities - are bought and held with the intent of being sold in the near future with the hope of generating profits in the short-termAvailable-for-sale securities - are neither intended to be sold in the near future nor held until maturityHeld-to-maturity securities - management intends to hold until the final payment of principleAppendix 11B – Investing in Bonds49Appendix 11B – Investing in BondsFigure 11B-1 Accounting for held-to-maturitybond investments