BMGT311 Exam 1 Guide Ch 14 15 16 Chapter 14 Long Term Liabilities Long term debt probably future sacrifices of economic benefits arising from present obligations not payable within a year or the operating cycle whichever is longer has various covenants restrictions that protect lenders and borrowers Bond indenture contract that a bond arises from represents a promise to pay a sum of money at maturity date plus interest periodically at the specified rate on the face value may be sold to an investment bank which acts as selling agent or to a large institution private placement o Bank may either underwrite the entire issue by guaranteeing a certain sum to the company and taking the risk of selling for whatever price they can get firm underwriting or may sell the bond issue for a commission on the proceeds of the sale best efforts underwriting o Main purpose of bonds is to borrow for the long term when the amount of capital needed is too large for one lender to supply Types of bonds o Secured bonds backed by a pledge of some sort of collateral Unsecured bonds not backed by collateral ie debenture bond junk bond o Term bonds mature on a single date Serial bonds mature in installments Callable bonds issuer may call retire the bonds prior to maturity o Convertible bonds convertible into other securities of the corporation for a specified time after issuance o Commodity backed bonds asset linked bonds redeemable in measures of a commodity o Deep discount bonds zero interest debenture bonds bonds that do not bear interest sold at a discount that provides the buyer s total interest payoff at maturity o Registered bonds issued in the name of the owner and require a new certificate to complete a sale Bearer coupon bond not recorded in name of owner and may be transferred easily o Income bonds pay no interest unless issuing company is profitable Revenue bonds interest on them is paid from specified revenue sources Selling price of bonds set by supply demand of buyers and sellers investment community values bond at the present value of its expected future cash flows interest and principal o Stated coupon nominal rate written in the bond s terms expressed as a of the par face principal maturity value of the bond o If bond sells for face value discount investors demand interest rate than stated rate receive interest at stated rate but actually earn at effective rate that the stated rate Companies amortize the discount and charge it to interest expense over the period of time that the bonds are outstanding regardless of callable provision Straight line method amortizes same amount each period over the bond term the balance of the Discount on B P will decrease constantly until it 0 at maturity date Discount on B P is NOT an asset it is a contra account that reduces the maturity amount of the related liability liability valuation account decreases the face amount of bond o If bond sells for face value premium Companies amortize the premium and decrease interest expense each period regardless of callable provision Premium on B P is a liability valuation account adds to maturity amount of related liability reported as direct addition to the face amount of the bond o If bond is sold between interest dates buyer must pay the interest accrued from the last interest payment date to the sale date on next interest payment date purchaser will receive the full semi annual interest payment o Effective yield market rate rate of interest actually earned by bondholders o Effective interest method present value amortization produces periodic interest expense to a constant of the carrying value of the bonds preferred over straight line method better matches expenses revenues even though both generally result in same total interest expense If financial statements different than interest payment dates must prorate the premium discount by the appropriate of months x 6 to find the interest expense o Unamortized bond issue costs are treated as a deferred charge and amortized over the life of the debt prefer effective interest method but may use straight line method Extinguishment of debt payment of debt fair value no gains losses o If held until maturity premium discount issue costs fully amortized carrying amount face value o If before maturity date reacquisition price amount paid including call premium reacquisition expense will not equal net carrying amount amount payable at maturity adjusted for unamortized premium discount cost of issuance must be amortized up to reacquisition date Excess of net carrying amount reacquisition price is gain from extinguishment reverse is loss Refunding replacement of an existing issuance with a new one may be advantageous acquire the entire outstanding bond issue and replace it with a new bond issue with lower interest rate must recognize the difference gain loss between reacquisition price and net carrying amount of redeemed bonds in income of the period of redemption Difference between current notes P and long term N P is the maturity date current is within year or operating cycle whichever longer o Note is valued at the present value of its future interest and principal cash flows must amortize any discount premium over the life of the note and any accrual of interest o If zero interest note present value is the cash received implicit interest rate equates the cash received with the amounts to be paid in the future record the difference between face amount and present value cash received as a discount and amortize the amount to interest expense over the life of the note When exchanging debt instrument for property goods services barter stated interest rate is presumed fair unless no rate stated rate is unreasonable or stated face amount is materially different from current fair value sales price of similar items if not fair measure present value of debt by the fair value of the property interest amount is the difference between the face amount of note and fair value of property o Imputation interest rate approximation uses imputed interest rate determined when note issued subsequent changes ignored Mortgage N P promissory note secured by a mortgage that pledges title to property as a security for the loan most common long term N P used by individuals partnerships more than corporations corporations use bonds o Lender may assess points so the total amount received by the borrower is less than the face amount of the note 1 point 1 of the face value of the note raise the effective