Chap 14 – long term financial liabilities LTD 1. Bonds payable – sell to general public – for raising 100 million dollars – no bank would lend this at one go 2. LT Note Payable – borrow money from bank, note payable – requires collateral – good credit – for 1 million dollars 3. Mortgages – LTD backed by real estate 4. Pension Liabilities – understand from recording 5. Lease liabilities – lease was an alternative for company to receive financing without having to record a liability – now every company has to record the PV of a long term lease and record it as a liability – asset must be depreciated and liability must be amortized **restrictive covenants – agreement between creditor and debtor that certain ratios cannot cross a defined floor/ceiling – restricts how much debt a company can raise in order to protect the initial lender 1. Bonds - Can be sold to unique entities as well like pension funds - Bond indenture – indenture means agreement – buyer gets money paid at specific date – periodic interest paid semiannually at a rate on the Face value - Sold through an investment banker or by private placement 2. - a. b. c. d. Notes payable Get from bank or insurance company Repay principal and periodic interests Debt will not trade in open market like regular bonds Accounting is same as bonds Recorded at PV of future interest and principal and premium/discount is amortized over the life of the note Bearer/ coupon bonds – 99% bonds on the market that require no registry – Secured debt – usually comes with collateral Serial bonds – matures in installments Income and revenue bonds – income bond – company pays interest only when company makes money e. Deep-discount bonds – f. Callable bonds – can be retired at the will of the issuer g. Convertible bonds – bonds that can be converted into shares – to make bonds more attractive Bond rating - Without rating, bonds cant get buyers properly – understand how the rating system works – rating tells investor what type of risk they are bearing Defeasance - Device to remove LTD from balance sheet Why? – to reduce perceived risk of high debt to equity ratio Appoint trustee - transfer cash to trustee – trustee generates interest – creditor takes interest payment and principal from trustees’ trust fund – only with consent from creditor Legal defeasance and illegal defeasance IFRS says its legal only if creditor agrees to it Types of companies that need LTD 1. Company that has a lot of assets – transportation, hotel and real estate companies Optimal Capital Structure - Relationship between debt and equity is called capital structure Capital structure affected by nature of the companies’ business, cash flow and income Preferred source of capital is always internally – less preferred is borrowing money – least preferred is issuing shares – because interest is tax deductible but dividend is not Interest is mandatory but dividend is not 1st example – 10 year bond sells at par value Determining bond prices - PV of the cash flow determines periodic interest payment and principal Listen to recording – very important info here - Coupon rate – determines periodic interest payment - Market rate – check recording Amortizing the bond premium/discount 1. Straight line method 2. Effective interest method – IFRS mandatory Bonds sold with a delay - Corportate bonds – listed on public exchange Rating agency needed for the bond rating Regulatory obstacles are the reason for delay Pricing when there is delay ? Price without the delay period A 5 year bond with 2 month delay – calculate pv for 10 periods with subtracting 2 months – i.e 9.75 period But interest must be paid based on 6 months always PV of delayed bond = PV of principal at 9.75 periods + PV of interest payments (each of 6 months) Investor must compensate the debtor company for the interest they will receive for the 2 months they did not hold the bond for The interest can be directly paid or kept unpaid i.e it can be recorded as a payable as well. Non market interest rates - If bond has no interest or very low, it will have no effect on the accounting for the bond Bond selling price will be very low because the bonds don’t pay any interest Only PV used to determine price Only market rate us used to calculate pv Interest expense calculated at market rate **Non-marketable instruments - The government gives/ pays investor money in exchange of a promisory note – the government may want the investor to build companies that would create jobs How to account for difference of value between 1 millions dollars and true value of promisory note? FV of promisory note New journal account – building – government grant Check slides again Notes issued for property, goods and services - Buying assets with loans Buying car with a promisory note – what is the value of the car? True value of the note ? Zero interest offers are always a marketing gimmick where the actual price is inflated to include the interest that would have been paid anyway When q transaction does not have include cash, then the transaction will be priced based on the asset that is given or received – asset used for pricing is always monetory asset i.e the promisory note – if the value of the note cannot be determined reliably, then the FV of the car can be used – read and understand again from slides Fair value option - Usually LT liability is carried at cost IFRS/ASPE allows measuring any financial LTL/asset at FV IFRS doesn’t allow every asset/LTL to be measured at FV – it allows some of them only when they are part of investment portfolio and its performance must be measured Default risk rises, FV goes lower – buy at lower price – gain is obtained due to high risk – gain is recorded to OCI IFRS records gain to OCI, ASPE records gain to net income – both under unrealized gain Extinguishment of debt - Buy back debt on the open market by paying the creditor Debt may be cancelled or may expire – involuntary extinguishment Repayment before maturity - Terminate a bond before maturity date by paying a premium No premium in most cases – only transcation costs may occer Update the book value of coupon bonds Gain/loss from extinguishment – reported with other gains/losses Record loss/gain on redemption of bonds – journal account used - gain/loss on redemption of bonds Troubled debt restructurings - Favorable concession granted by creditor to debtor over an existing loan Settlement – at less than carrying value vs continuations – with modification of terms **Mid term exam - Straight out of homework Changes wording and numbers 2 from chap 9 and 2 from chap 13 Cheat sheet allowed – write on both sides – A4 paper
