MGMT 35100 1st EditionExam # 1 Study Guide Ch. 12, 19, 16, 15(Liabilities, Bonds, Notes, Leases, Income Taxes)Current Liabilities (Ch. 19)-Liabilities:Main Criteria1) Probably future sacrifice of economic resources (assets) to fulfill 2) Present obligations that 3) Result from past events a. Current Liability: to be cleared/paid by (1) sacrificing economic resource, or (2) creating another liability in one operating cycle, whichever is longer - Report at Present Value in theory1) Determinable- no need to estimate, amounts are known- reported on balance sheet [A/P, D/P, N/P, Interest, Rent accrued Exp, taxes, Unearned Rev]2) Estimated: with “reasonable” accuracy- [Warranty liab- record at point of sale, liability for sales promotions, liability for gift cards]1. You don’t know total warranty expense until all warranty claims have gone throughb. Line of Credit: special financing arrangement with lender that allows a borrower to uselender’s money up to a limit without going through usual approval process- only used amount=liability 3). Contingency- pending lawsuit, may result in a gain or loss, only loss is recognized if: (1) Likelihood is “probable” and (2) Its amount is reasonably estimable -An environment liability is considered probable when the company admits responsibility *Gain contingency is not recognized as an asset unless its likelihood is highly likely -Disclose Reasonably possible in Notes - Fair Value Option: Companies have the option to report financial (A&L) at their balance sheet date, fair values on B/S BV is not equal to FV o FV>BV—gain (unrealized) o FV<BV—loss (unrealized) --- gain or loss is recorded in NI on I/S -Executory Contract: contract in which neither party has performed anything yet, thus not a real/legal contract at this time—not a liability Chapter 12: Long-term Liabilities (Bonds and Notes)1) Long-term liability- initially recorded at Historical Cost (Acquisition Cost) – PV of all Future Cash flows 2) BV=Initial Cost + Sum of discount amortization (or – premium amortization)a)OR: = Face Value- Discount Balance or + Premium Balance i) Face Value= market value given at a point in time ii) *It is important to use PV concepts because it is important to record real value of Long-term liabilities, not just FaV or sum of all Future Cash Flws 3) Long-term Notes Payable a)Market (trading)--? If sold on market there is a prevailing interest rate on similar notes= effective rate (market wide or yield rate) b)No- market; stated rate only i) *PV(Price)= PV of interest + PV of Face Amount (1) (I)(PVOA,n,r) + (FaV)(PVS,n,r)—market rate, unless there isn’t one then use statedrate ii) ^ at which it should be selling – market value and time of issuance (1) Rs= Rm—PV= FaV(2) Rs < Rm – PV< FV (3) Rs> Rm—PV > FaV 4) Bonds Payable: securities issued for long-term debt financing; liability to issuer and investment asset to the buyers a)Issuer: records receipt of cash and receipt of long-term liability b)Purchaser: records payment of cash and bond investment i) (Know the Various Types of Bonds) 5) Three ways to retire bonds prior to Maturity a)Redemption – purchasing them from bond holders on market b)Conversion i) Features: higher price and lower interest rate c)Refinancing – intrest rate on new debt is lower than old i) Gain or loss may result (1) Two methods (a) BV Method – no gain or loss, recorded at BV(b) MV Method: recorded at MV of debt or stock whichever is more clearly evident (usually stock)- gain (loss) recognized 6) Pricing—same way as Notes Payable a)Record in 4 steps: Issuance/ Interest payment/ FYE adjustment/ Maturity 7) Effective Interest Methoda)Interest Expense= (Rm)(CVbeg)= cash interest + discount amortization (or – premium amortization) 8) Restructuring Troubled Debt – special arrangement under which the creditor grants a concession to the debtor because the financial difficulties a)Asset Swap i) Debtor: recognizes (gain or loss) on disposal--- gain= (FMV-BV) of asset (1) And Value of debt- FMV= gain on restructuring (2) *what the debor gains, the creditor loses b)Equity Swap c)Continuation of Modified Terms – involves interest, maturity date, or both i) No gain situation (value of old debt > new)- new being Face Val + Future interestii) Gain Situation= (Value of old > New) less future value of debt 9) Off-balance Sheet Financing: using non-owners capital yet keeping debt of B/Sa)Why?= they are in essence debt or liabilities but no recognized as debt on the b/s- so not included in companies assessment of risk b)Problem: they don’t show on b/s so users (creditors and investors) don’t see them and canbe misinformed Chapter 15: Leases1) Lease: contract underwhich one party (Lessee) pays rents and acquires the right to use an asset that is owned by another party (lessor) a)FV: normal selling price- discount (if any) i) MLP (Minimum Lease Payments)= MRP+ GRV(BPO)+ any possibly payment required at end of lease (1) BPO: bargain purchase option: to purchase leased asset at the end of the lease for bargain price b)PVee= (MRP-ExCosts)(PVOA,n,r)+ (GRVor BPO)(PVS,n,r)c)PVor- same as PVee except include RV regardless d)ExCosts: ownership costs of a leased asset (maintentance) i) GroInvest= lessors gross investment in leases asset 2) Lessee’s Capital Lease a)Criteriai) Ownership transfer to lessee when lease experies ii) BPO: makes it reasonable assured that a purchase will occur (1) ^ if either hten use economic life for depreciation iii) Lease term >= 75% of assets economic life iv) PVee of MLP >= 90% of the assets FV to lessor—assets life for 3 and 4 b)CL: assumes ownership of the leased asset is almost transferred to the lessee, under 4 criteria, so lessee takes as much benefits from assets as would the owner c)For interest expense: lessee uses lower of implicit or borrowing rate d)If BPO- PV of MLP would be increased by the PV of the Bp amount – used to record initial asset and liability – if not purchased loss would be recorded- if GRV treated same way 3) Operating Lease (Lessee)- treated as a rental, unless long-term4) Lessors’s CL:a)Sales Type Leases: must meet 4 criteria at same time—treated like a sale i) Meets 1+ of CL criteria ii) Profit or loss iii) Collectability is assured iv) No lessor’s costs yet to be considered – all costs need to be reflected in the rent b)Direct Financing Lease: recorded at PV; u/I/Rev is computed as difference between the total expected lease