DEBT FINANCING 1 Long term note payable Borrows money for a period longer than a year 2 Find amount of interest in single payment to a loan a Interest Previous Year s Loan Amount Principal x Interest Time Factor Mo s 3 Mortgage Borrowing from a bank that is secured by pledging certain assets as collateral almost always real estate a Liability initially recorded at its face value i Reduction of Principal Value Financing Interest Expense Value Operation ii 4 Lease Contract that specifies the terms under which the owner of an asset agrees to transfer the right to use the asset to another party i Lessor Owns asset ii Lesse given the right to use the asset b OPERATING LEASE Rental Agreement Off Balance Sheet Financing i Lessee assumes no risk of ownership ii Each lease payment is classified as a rent expense iii At the end of the lease term right to use the property reverts back to the lessor iv DON T DO ANYTHING IN JOURNAL ENTRIES UNTIL YOU PAY YOUR YEARLY PAYMENT THEN YOU DEBIT EXPENSE AND CREDIT CASH EACH PAYMENT c CAPITAL LEASE i Treated as if the lessee had purchased the asset ii Lessee assumes rights and risks of ownership iii Lessee records an asset on their balance sheet with related liability and depreciation d TOTAL EXPENSE WILL BE EXACT SAME AT THE END OF THE TIME FOR BOTH OPTIONAL AND CAPITAL e Companies prefer to classify all leases as Operating Leases Because they are not liable for the asset Off Balance Sheet Financing i Puts them in a better financial position and better debt ratios ii FASB issues SFAS No 13 sets specific criteria for capital and operating leases 5 Debt To Equity Ratio Total Liabilities Total Stockholders Equity a Measures the percentage of funds being provided by creditors versus stockholders b DtE Ratio of 1 30 means liabilities are larger than equity c Higher debt ratio higher risk for creditors 6 Times Interest Earned Ratio Net Income Income Tax Expense Interest Expense Interest Expense a Margin of Safety Ability to meet interest payments as they come due b Higher is better
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