Textbook Notes (363,090)
Canada (158,185)
Commerce (1,634)
Chapter 11

Chapter 11

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McMaster University
Emad Mohammad

Accounting – Chapter 11 Non-current liabilities: are all of the entity’s obligations not classified as current liabilities. The use of long-term debt offers significant advantages to companies: • Shareholder maintain control- debt down not dilute ownership because debtholders participate netiher in the management of operations or in the eventual distribution of retained earnings. • Interest expense is tax deductible- this reduces the net cost of borrowing. • The impact on earnings is positive Financial leverage: is the use of borrowed funds to increase the rate of return on owner’s equity; it occurs when the after-tax interest rate on debt is lower than the rate of return on total assets. However, LT debt carries higher risk than equity: • Risk of bankruptcy • Negative impact on cash flows Characteristics of Long-Term Notes and Bonds Payable LT debt can be raised from banks, insurance companies and pension fund companies – this is known as private placement. It is often called note payable, which is a written promise to pay a stated sum of money at one or more specified dates. If a company’s need for debt capital exceeds the capability of a creditor, the company can issue publicly traded debt – bonds. Bond principle: the amount payable at the maturity of the bond. It is also the basis for computing periodic cash interest payments. Par value and face amount are other names for bond principal or the maturity value of a bond. (Par value is usually $1000) Stated rate – the rate of interest per period specified in the bond contract. Debenture – an unsecured bond Callable bonds – may be called for early retirement at the option of the issuer. Convertible bonds – may be converted to other securities of the issuer (usually common shares) Indenture – (bond indenture) is a bond contract that specifies the legal provisions of a bond issue. Trustee – an independent part appointed to represent the bondholders. Firm commitment underwriter – buys the entire issue of bonds and then resells them to individual creditors. Best efforts underwriter – sells the bonds or notes without any obligation to purchase them. Reporting Bond Transactions 1. Principal – this is usually a single payment made when the bond matures. It is also known as the par or face value. 2. Cash interest payments – payments computed by multiplying the principal amount times the interest rate. This is called the contract, stated or coupon rate of interest. Coupon rate – the stated rate of interest on bonds. Neither the company nor the underwriter determines the price at which the bonds sell. To determine the present value of the bond, you compute the present value of the principal (a single payment) and the present value of the interest payments (an annuity) and add the two amounts. Market interest rate: the current rate of interest on a debt when incurred, also called the yield or effective interest rate. The present value of a bond may be the same as par, above par (premium) or below par (discount). Bond premium: the difference between the selling
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