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Module 8. Reporting and Analyzing Nonowner Financing Activities. Accounting Equation: Another Look. Current Liabilities. Current operating liabilities
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Module 8 Reporting and Analyzing Nonowner Financing Activities
Current Liabilities • Current operating liabilities • Accounts payable - obligations to other companies for amounts owed on purchases of goods and services. These are usually non-interest-bearing. • Accrued liabilities - obligations for which there is no related external transaction in the current period. These accruals are made to properly reflect the liabilities owed and expenses incurred by the company as of the statement date.
Current Liabilities (cont’d) • Current non-operating liabilities • Short-term interest-bearing loans: short-term bank borrowings expected to mature in whole or in part during the upcoming year, together with accrued interest. • Current maturities of long-term debt: long-term liabilities that are scheduled to mature in whole or in part during the upcoming year.
Wages Accrual Example • Failure to recognize this liability and associated expense would understate liabilities on the balance sheet and overstate income. • Payment does not result in expense because the expense was recognized in the prior period when incurred.
Uncertain Accruals • If the obligation is probable and the amount estimable, then a company will recognize this obligation, called a contingent liability. • If only one of the criteria is met, the contingent liability is disclosed in the footnotes.
Current Non-Operating Liabilities • Short-term bank loans (including the accrual of interest) • Current maturities of long-term debt – long-term liabilities that are scheduled to mature on whole or in part during the upcoming 12 months are reported as a current liability.
Short-term Interest-Bearing Loans • Companies generally finance seasonal swings in working capital with a bank line of credit.
Bond Pricing – 2 Important Rates • Coupon (contract or stated) rate - the coupon rate of interest is stated in the bond contract; it is used to compute the dollar amount of (semiannual) interest payments that are paid to bondholders during the life of the bond issue. • Market (yield or effective) rate - this is the interest rate that investors expect to earn on the investment for this debt security; this rate is used to price the bond.
Cash Flows from Bonds • Assume that investors wish to price a bond with a face amount of $10 million, an annual coupon rate of 6% payable semiannually (3% semiannual rate), and a maturity of 10 years. • Investors purchasing this issue will receive the following cash flows:
Bond Pricing:Coupon Rate = Market Rate (Par) • Assuming that investors desire a 6% annual market rate of interest (yield), the bond sells for $10 million:
Bond Pricing:Coupon Rate < Market Rate (Discount) • Assume that investors expect an 8% annual yield (4% semi-annual yield). • Given this new discount rate, the bond will sell for $8,640,999:
Bond Pricing:Coupon Rate > Market Rate (Premium) • Assume that investors expect only a 4% annual yield (2% semiannual yield). • Given this new discount rate, the bond sells for $11,635,129:
Effective Cost of Debt • Sale atpar - the effective cost to the company is the cash interest paid. • Sale at a discount - the effective cost to the company includes both the cash interest paid and the discount. • Sale at apremium - the effective cost to the company, then, is the cash interest paid less the premium amortization.
Accounting for Bonds: Balance Sheet • Sale at par:
Accounting for Bonds: Income Statement Interest expense in the income statement is the sum of two components:
Verizon’s L-T Debt Footnote Companies are required to present a schedule of debt maturities for each of the next 5 years:
