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Terms in this set (26)
Q4: Explain how bond discounts and premiums usually arise. Describe how they are accounted for in the b/s and income statement
Bond discounts and premiums arise when there are differences in the coupon rate and the effective interest rate of the bond. When the effective rate is lower than the coupon, the bond is sold at a premium (meaning the PV is greater than Face Value). When the effective rate is greater than the coupon rate, the bond is sold at a discount.
In a discount scenario, the bond will be listed on the b/s at its discounted price. The next year, the bond will increase on the b/s by the amount that is amortized that year. On the income statement, the only amount shown is the interest expense.
In a premium scenario, the premium is subtracted from the pv of the bond each year while interest is reported on the income statement.
Q6: How do we account for short term debt? What is the logic for this approach?
Short term debt is accounted by classifying it as a current liability. This means that the company plans to pay off the debt within a year. They are made up of revolving lines of credit and Commercial Paper (along with others). These are usually required to be paid within a short fixed amount of time, thus fitting them into this category. The details of this debt are in the notes of the financial statements.
Q7: Describe the major disclosure requirements for long term debt
information regarding the future maturities of debt, details of contractual provisions such as collateral and covenants, unused balances in lines of credit.
Major disclosure requirements of long term debt include: a detailed break-up of outstanding and available debt, a payment schedule, the fair value of the debt,
Q18: Discuss the implementations of lease accounting for the analysis of financial statements.
When analyzing financial statements, leases must be identified as to whether there are operating leases being reported. Operating leases do not depict an accurate picture of the current state of the company. These leases are not placed on the books as an asset or liability, thus understating both. This can impact ratios that are important for analyzing. Also, operating leases impact net income.
Lease must meet any of the 4 criteria to be considered a capital lease
1)The lease transfers ownership at the end of the lease term
2) the lease contains an option to purchase the property at a bargain price
3) The lease term is 75% of the useful life
4) The PV of the min lease payments at the beginning of the lease term is 90% or more of the fair value to the leased property
Q20: When a lease is considered a capital lease for both the lessor and the lessee, describe what amounts will be found on the b/s of both the lessor and the lessee related to the lease obligation and the leased asset
Lessor: Has a receivable account that is equal to the pv of minimum lease payments. If there is a difference between the receivable and the amount of the asset, an unrecognized gain is recorded. (Sales type lease).
Lessee: Records a payable for the amount of the PV of minimum lease payments. Records the asset at PV as a Leased Equipment
Q24: Explain a loss contingency.
Explain the two conditions necessary before a company can record a loss contingency against income
Loss Contingency is potential claims on a company's resources. They can arise from threat of litigation, expropriation, collectability of receivables and claims arising from warranties.
Must meet two conditions: First, it must be probable that a future event will confirm the loss, and second the amount must be reasonable estimable. Examples include uncollectible receivables and product warranties
Q30: Explain how off balance sheet financing items should be treated for financial analysis purposes
Off b/s financing refers to the nonrecording of certain financing obligations (operating leases). Special purpose entities are another example.
Its important that you add back in these effects. (add back liabilities)
Special Purpose Entity
An SPE is formed by the sponsoring company and is capitalized with equity investment, some of which must be from independent third parties
The SPE leverages this equity investment with borrowing from credit markets and purchases earning assets from or for the sponsoring company
The cash flow from the earning assets is used to repay the debt and provide a return to the equity investors
Two primary reasons for using SPEs
1. lower financing cost
2. Off balance sheet financing
Variable interest entities
Many SPEs are not corporations and do not have stock ownership. For these entities, control is conferred via legal docs rather than stock ownership, and the typical 50% stock ownership threshold for consolidation does not apply. The FASB now classifies these SPEs as variable interest entities if either the total equity at risk is insufficient to finance its operations (less than 10% of assets) or the VIE lacks any one of the following 1)ability to make decisions 2) obligation to absorb losses 3) right to receive returns. If it is a variable interest entity, must be consolidated.
Q44: What does current pension accounting (SFAS 158) recognize in the b/s? How is it different from what was recognized earlier (SFAS 87)?
Current pension accounting recognizes the funded status of the pension plans on the balance sheet. The funded status is the difference between the current market value of the pension plan assets and the pension obligation (PBO-estimated).
SFAS 158: BALANCE SHEET-Companies report the funded status of the pension (net amount) whether being an asset or a liability. Funded Status = Plan assets- Pension Obligation.
Under SFAS 87 (income statement approach),prepaid or accrued pension cost, which is the net of a firm's pension assets, liabilities, and unrecognized amounts, is reported on the balance sheet.
Q47: What are the primary categories of info disclosed in the postretirement benefit footnote
1. An explanation of the reported position in the balance sheet
2. Details of net periodic benefit costs
3. Info regarding actuarial and other assumptions
4. Info regarding asset allocation and funding policies
5. Expected future contributions and benefit payments
Q51: What determines a company's cash flows related to pensions and OPEBS? Why are current cash outflows relating to pensions not a good predictor of future cash flows?
Cash outflow is equal to the contribution made to the plan by the company.
It is not useful for future measurement because a company will contribute to a plan only to the extent to which is necessary. A company with an overfunded pension could go 20 years without contributing cash, or it could contribute little now, but a lot later. This does not reflect the state of the obligation.
E11:Explain what makes a cash distribution a dividend
Its a distribution of cash to owners. Its generated from revenues.
one of the ways a company can divest in a subsidiary. A spin of is a distribution of subsidiary stock to shareholders as a dividend; assets are reduced as are retained earnings
the exchange of subsidiary stock owned by the company for shares in the company owned by the shareholders
P4: Difference between the amortized cost method and the fair value method when valuing bonds
Amortized cost method-
reports the bond on the books at the PV using the effective interest rate when the bonds were issued and then amortized those bonds
Fair value method
Uses current interest rates instead of interest rate at the time of issue.
Not as useful as debt being held to maturity. More useful for debt that may be retired early.
MAKE SURE TO REVIEW THE PROBLEM
Analyzing Debt:Future Debt Retirement
Looks that the ability for the company to pay off debt in the long run and can help with cash flow forecasting in the short run
Analyzing Debt: Unutilized Credit lines
Need to see what kind of debt they can take out. if its all short term debt, then that's not good
Debt Protections: Seniority
Refers to the order in which different parties will be paid when a company's business is dissolved. Senior before junior. Governmental claims, unpaid dues and wages are senior while equity is last.
Less risky the higher your seniority
Debt Protections: Security
Security or collateral refers to assets that are set aside during dissolution to specifically satisfy a particular claim. A claim that is backed by collateral is called secured.
Debt Protections: Covenants (affirmative and negative)
Lenders establish covenants to safeguard their investments.
Affirmative covenants- specify actions that management needs to take to keep the debt in good standing (must file audited f/s in accordance with GAAP)
Negative Covenants - limit management behaviors that might be harmful to the lenders. Consist of two parts: 1) constraints and 2) penalties
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