Bonds Payable and Off-BS Financing, Exams of Business Accounting

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ACCY 304 Test 1 Bonds Payable -         - if doesn't meet def. of CL, must be LTL - principle based on terms and cond. of contract - long-term debt (BP) & long-term NP - long-term debt has various covenants and restrictions protecting both lenders and borrowers; inc. amt. authorized to be issued, int. rate, due date, call provisions, property pledged as securities, sinking fund req., WC & Div. restrictions, limitations on consumption of additional debt Issuing Bonds -         - bond arises from bond indenture - represents promise to pay sum of $ @ maturity date and periodic int. @ specified rate on maturity (face) amt. - indv. bonds = paper certificate - int. pmts. usually semi-annually - main purpose to borrow for long-term when amt. capital needed too large for one lender to supply - firm underwriting = guarantee sum to co., take risk of selling - best-effort underwriting = sell for commission - private placement = issuing co. sell directly Types of Bonds -         - Secured - unsecured - term - serial - callable - convertible - commodity-backed - deep-disc. - registered - bearer (coupon) - income - revenue Secured Bonds -         backed by pledge of collateral; mortgage, trust Unsecured Bonds -         not backed by collateral; debenture/junk; risky, high int.; use to fin. leveraged buyouts Term Bonds -         mature on single date Serial Bonds -         mature in installments Callable Bonds -         give issuer right to call and redeem prior to maturity Convertible Bonds -         convert. to securities of corp. for specified time after issuance Commodity-Backed (Asset-Linked) Bonds -         redeemable in measures of commodity Deep-Discount Bonds (Zero-Int. Debenture) -         sold at disc. that prov. buyer's tot. int. payoff at maturity Registered Bonds -         issued in name of owner and req. surrender of certificate and issuance of new to complete sale Bearer (Coupon) Bonds -         not recorded in name of owner and may be transferred from one owner to another Income Bonds -         pay no int. unless issuing co. profitable Revenue Bonds -         int. on them paid from specified rev. sources Valuation and Acct. for BP -         - selling price set by supply and demand of buyers/sellers, relative risk, mkt. cond., state of economy - investment community values bond @ PV of expected FCF, consisting of int. and principal - if rate employed by buyers differs from stated, PV of bonds differ from face; diff. determines actual price paid - Disc. = bond sells < face, mkt. rate > stated - Prem. = bond sells > face, mkt. rate < stated Issuance and Mktg. of Bonds to Public -         weeks/months; arrange underwriters to help mkt. and sell; obtain SEC's approval, undergo audits, issue prospectus; have certificates printed Stated, Coupon, Nominal Rate -         written in terms of indenture; issuer sets rate; percentage of face, par, principal, maturity val. Market, Effective-Yield, Discount Rate -         int. rate actually earned by bondholders Off-BS Fin. -- Diff. Forms -         - Non-Consolidating Subsidiary = not req. to consolidate if < 50% owned - Special-Purpose Entity (SPE) = created to perform special project; project financing arrangement; SPE fin. and build, co. guarantees it or other co. purch. all products produced; take- or-pay contract Off-BS Fin. -- Rationale -         - removing debt enhances qual. of BS and permits credit to be obtained more readily at less cost - loan covenants often limit amt. of debt co. can have; these types of commitments might not be considered in computing debt limitations - some argue asset side of BS severely understated - increased note disclosure - SEC req. (1) all contractual obl. in tabular format, (2) contingent liab. and commitments in either textual/tabular format Presentation of LTD -         - 1 amt. with comments and schedule in notes - note disclosures gen. indicate nature of liab., maturity dates, int. rates, call provisions, conversion privileges, restrictions imposed by creditors, assets designated/pledged as security - fair val. of LTD disclosed - must disclose fut. pmts. for sinking fund req. and maturity amts. of LTD during each of next 5 yrs. Analysis of LTD -         interest in co. long-term solvency, ability to pay int. and repay face val. at maturity Debt-to-Assets Ratio -         - measures % of TA prov. by creditors - D-A = TL/TA - greater = greater risk co. can't meet obl. Times Interest Earned -         - indicates co.'s ability to meet int. pmts. as they come due - TIE = (NI + Int. Exp. + Income Tax Exp.) / Int. Exp. Troubled-Debt Restructuring -         - occurs when a creditor "for economic or legal reasons related to the debtor's financial difficulties grants a concession to the debtor that it would not otherwise consider" - 2 transactions: (1) settlement of debt at less than carry. amt., (2) continuation of debt with modification of terms Settlement of Debt -         - can involve either transfer of noncash assets or issuance of debtor's stock - creditor should acct. for noncash assets or eq. interest rec. at their fair val. - debtor determine excess of carry amt. of payable over fair val. of assets or eq. transferred (gain) - creditor determine excess of rec. over fair val. of same assets or eq. interests transferred (loss) - debtor recog. gain equal to excess ; creditor normally charge excess (loss) against Allow. for DA - debtor recog. gain or loss on disposition of assets to extent that fair val. of assets differs from carry amt. (BV) Modification of Terms -         - debtor's serious short-run CF problems will lead it to request one or combo. of modifications: (1) reduction of stated int. rate, (2) extension of maturity date of face amt. of debt, (3) reduction of face amt. of debt, (4) reduction/deferral of any accrued int. - creditor's loss based on expected CFs disc. @ hist. effective rate of loan; debtor's calc. based on undisc. amts. - gain recorded by debtor does not equal loss recorded by creditor under many circumstances - 2 ex.: (1) no gain for debtor = tot. FCF exceeds tot. pre-structuring carry. amt. of debt, so debtor records no gain nor makes adj. to carry. amt. of payable; compute new effective int. rate to record int. exp. in fut. & (2) gain for debtor = pre-restructure carry. amt. exceed tot. FCF as result of mod. 3 Primary forms of Bus. Org. -         - proprietorship - partnership - corporation Corp. Form Special Characteristics -         - influence of state corp. law - use of capital stock or share system - development of variety of ownership interests State Corp. Law -         - to establish corp., must submit articles of incorp. to state where incorp. desired - state issues corp. charter, recog. co. a legal entity subject to state law - incorp. in only 1 state - co. advantage to incorp. in state w/ laws favoring corp. form - acct. for SHs' eq. follows each state's provisions of bus. incorp. act Capital Stack/Share System -         - within class, each share equal; number of shares determines interest - in absence of restrictive provisions, each share has rights: (1) to share proportionately in profits/losses, (2) to share proportionately in input/vote, (3) to share proportionately in corp. assets upon liquidation, (4) to share proportionately in new issues of stock of same class (preemptive right) - share system easily allows one indv. to transfer interest to other; each share personal property of owner - corps. often use registrars and transfer agents who specialize in prov. erv. for recording and transferring stocks; USTA and UCC govern negotiability of stock certificates Preemptive Right -         - protects existing SH from invol. dilution of ownership interest; protect proportionality - many co. have elim. bc. hard to issue large amts. of add. stock (in acquiring other co.) Variety of Ownership Interests -         common and preferred stock Common Stock -         - represents basic ownership interest - residual corp. interest that bears ultimate risk of loss and receives benefits of success - CSHs not guaranteed div. or assets upon dissolution - gen. control mgmt. of corp. and tend to profit most if co. successful Preferred Stock -         - special classes of stock; special class of shares that possesses certain pref./feat. not possessed by CS - SHs sacrifice certain rights in return for other special rights/privileges by contract - common preference is div. priority/priority on earnings - issue pref. stk. w/ par val., expressing div. pref. as % of par; no-par pref. stk., express div. pref. as $ amt. per share - pref. to div. assures corp. must pay stated div. rate or amt. applicable to pref. stk. before any on CS Components of SHs' Eq. -         - 4 categories: (1) capital stock, (2) additional paid-in capital, (3) RE, (4) other comprehensive income - SHs' eq. diff. btwn. A & L of co., residual interest - SHs' eq. = cumulative net contributions by SHs + RE; no existence apart from A & L; equals net assets; claim against potion of tot. A; amt. not specified or fixed Contributed (Paid-In) Capital -         - tot. amt. paid in on cap. stock - amt. prov. by SHs to corp. for bus. use - cap. stk. and add. PIC - includes par val. of outstanding stk. and prem. less disc. on issuance Earned Capital -         - capital that develops from profitable operations - consists of all undist. income remaining invested in co. RE -         earned capital of co. Accumulated Other Comprehensive Income -         - aggregate amt. of OCI items - unreal. gains/losses on avail.-for-sale debt investments/certain derivative transactions         - pref. stk. and add. PIC - pref.; SHs' eq. bc. no legal obl. to pay - convertible = SHs' eq.; no gain/loss; employ BV method (Dr. Pref. Stk., Add. PIC - Pref.; Cr. CS, PIC in Excess - CS) - pref. at par as 1st item; disclose rights Corporations Purchase Outstanding Stock to: -         - provide tax-efficient dist. of excess cash to SHs = cap. gain rates on sale of stk. to co. approx. 1/2 ordinary tax rate - increase earnings per share and return on eq. - provide stock for emp. stk. compensation contracts or to meet potential merger needs - thwart takeover attempts or reduce number of SHs - make mkt. in stock Leveraged Buyout (LBO) -         eliminate public ownership entirely by purchasing all outstanding stock, borrows money to fin. stk. repurchase Treasury Stock -         - corp. own stock, reacquired after having been issued and fully paid - not asset; reduces net assets - no right to vote, exercise preemptive rights, rec. cash div., rec. assets upon liquidation - essentially same as unissued cap. stock - contra eq. acct. Purchase of Treasury Stock - 2 methods -         - Cost - Par (stated) Val. Cost Method -         Debiting the Treasury Stock account for the reacquisition cost and in reporting this account as a deduction from the total paid-in capital and retained earnings on the balance sheet; more widespread Par (Stated) Value Method -         records all transactions in treasury shares at their par value and reports the treasury stock as a deduction from capital stock only Outstanding Stock -         the number of shares of issued stock that stockholders own Sale of Treasury Stock -         - sale price = cost - Dr. Cash, Cr. TS - after elim. Cr. bal. in PIC-TS, corp. Dr. additional excess of cost over SP to RE Sale of Treasury Stock Below Cost -         Dr. excess of cost over SP to PIC from TS Sale of Treasury Stock Above Cost -         - Cr. difference to PIC from TS - not gain bc. (1) gains on sales occur when selling assets, (2) gain/loss not recog. from stk. transactions w/ own SHs Retiring Treasury Stock -         - cancellation of treasury stock and reduction in number of shares of issued stk. - status of authorized and unissued - corp. Dr. PIC accts. applicable to retired shares Reasons Very Few Companies Pay Div. in Amt. Equal to Legally Avail. RE -         - maintain agreements w/ creditors, retain all/portion of earnings, in form of assets, to build up additional protection against possible loss - meet state corp. req., that earnings equivalent to cost of TS purch. be restricted against div. declaration - retain assets that would otherwise be paid out as div., to finance growth/expansion; internal fin., RE, "plowing" profits back into bus. - smooth out div. pmt. from yr. to yr. by accum. earnings in good yrs. and using such as basis for div. in bad yrs. - build up cushion/buffer against possible losses/errors in calc. of profits *co. should not pay div. unless both present and fut. fin. position warrant dist. Financial Condition and Dividend Distribution -         - consider liquidity, curr. liab., avail. of funds to pay div. - disclose div. policy especially if (1) have earnings but fail to pay div., (2) don't expect to pay div. in foreseeable fut. Types of Dividends -         - cash, property (div. in kind), liquidating div. - all div. except stk. div. reduce tot. SHs' equity - stk. div. = no asset payout, incurs no liab., add. shares Cash Dividends -         - BoD votes on declaration; declares; prepare current list of SHs - 3 dates: date of declaration, record, pmt. - declared cash div. is a liab. bc. pmt. gen. req. very soon (CL) - div. declared (closed to RE at yr. end) or RE - do not declare or pay div. on TS Property Dividends -         - div. pay. in assets of corp. other than cash - div. in kind; may be merch., real estate, investments - usually in form of securities of other corp. that distributing co. holds - when declaring, corp. should restate at fair val. the property it will dist., recog. any gain/loss as diff. btwn. property's fair val. and carry val. at declaration - Dr. to RE/Prop. Div. Declared, Cr. to Prop. Div. Pay. at amt. equal to fair val. of property dist. - Distribution = Dr. Prop. Div. Pay., Cr. Acct. containing dist. asset (restated at fair val.) Liquidating Dividends -         - based on other than RE - implies such div. return of SHs' investment rather than profits; any div. not based on earnings reduces corp. PIC. and to that extent is liquidating div. - portion of div. in excess of acc. income represents return of part of SHs' investment - clear stmt. of source of div. should accompany - Dr. RE, PIC; Cr. D/P - Dr. D/P, Cr. Cash Stock Dividends -         - issuance by corp. of own stk. to SHs on pro rata basis, w/o rec. any consideration - "capitalize" part of earnings and RE in bus. on permanent basis - co. dist. no assets; SH proportionate int. & tot. BV same; BV/Share down - some believe transfer par val. of stk. as div. from RE to cap. stk.; others believe transfer fair val. of stk. issued from RE to cap. stk. and add. PIC - merely reclassification of SHs' eq. Small (ordinary) Stock Div. -         - stock div. < 20-25% of comm. shares outstanding at declaration, co. req. transfer fair val. of stk. issued from RE - Declaration: Dr. RE; Cr. CS Div. Dist., PIC Excess Par - Dist.: Dr. CS Div. Dist.; Cr. CS Stock Splits -         - mgmt. believe better public relations = wider ownership of stock - tgt. mkt price sufficiently low within range of investors -reduce mkt. price of shares - no entry, memo note to indicate changed par val. (dec.) and increased shares Stock Splits and Stock Div. Differentiated -         - Split = inc. # of shares outstanding and dec. par/std. val. per share - Div. = inc. # of shares outstanding, inc. tot. par val. of shares (publicity gesture, retain profits in bus.) Large Stock Dividend -         - whenever corp. issue add. shares for purpose of reducing unit mkt. price, then dist. more closely resembles stock split than stk. div. - this effect usually results only if number of shares issued > 20-25% of shares prev. outstanding - "split-up effected in form of div."/"stock split-up" - transfer par. val. of stk. issued from RE to cap. stk. - declaration: Dr. RE; Cr. CS Div. Dist. Stock Warrants Issued with Other Securities -         - basically long-term options to buy CS @ fixed price - generally life 5 yrs., occasionally 10 yrs., seldom perpetual - detachable stock warrant = can be separated from stk. and traded as separate security - allocate proceeds from sale of debt plus detachable warrant btwn. 2 securities - 2 separable pieces allows for determination of fair val. Proportional Method - Warrants w/ Other Securities -         - acct. for proceeds from offering by placing val. on 2 securities: (1) val. of bonds w/o warrants, (2) val. of warrants - allocate proceeds using proportion of 2 values based on their fair values - PIC - Stk. Warrants Acct. Incremental Method - Warrants w/ Other Securities -         - instances where co. can't determine fair val. of warrants or bonds - co. uses security for which it can determine fair val. and allocates remainder of purch. price to security for which doesn't know fair val. Conceptual Questions - Warrants -         - features of conv. securities inseparable in sense choices are mutually exclusive; holder converts bonds or redeems for cash, but not both; no basis to recog. conv. val. - issuance of bonds w/ detachable warrants involves 2 securities; @ issuance separable instruments and justifies separate treatment - nondetachable warrants don't req. allocation of proceeds btwn. bonds and warrants; record entirety as debt Stock Right -         - old SHs gen. have right (preemptive priv.) to purch. newly issued shares in proportion to their holdings - saves existing SHs from suffering dilution of voting rights w/o their consent or may allow for purch. somewhat below fair val. - warrants issued for stk. rights of short duration - certificate states # shares may purch. (1:1), price at which purch. (norm. less than curr. mkt. price) - co. make only memorandum entry when issue rights to existing SHs; indicates # rights issued to ensure co. has add. unissued stk. registered for issuance Effective Compensation Programs... -         - base comp. on emp. and co. performance - motivate emp. to high lvls. of performance - help retain executives and allow for recruitment of new talent - max. emp.'s after-tax benefit and min. employer's after-tax cost - use performance criteria over which emp. has control Straight-Cash Compensation -         - typically salary plus bonus - short-run Stk.-Based Compensation Plans -         - long-term compensation plans attempting to develop co. loyalty among key employees by giving "piece of action" (eq. interest) - largest single component for exec. officers' pay for co.'s in S&P 500 Stock Option -         - gives key employees option to purchase CS at given price over extended period of time - provides emp. w/ opportunity to receive stk. if performance of co. satisfactory - typical performance measures focus on long-term improvements that are readily measurable and benefit co. as whole (inc. EPS, rev., stk. $, mkt. share) Intrinsic Value Method for Measuring Stk. Comp. -         - measure comp. cost by excess of mkt. price of stk. over exercise price at grant date - measures what holder receive today if option immediately exercised Fair Value Method for Measuring Stk. Comp. -         - bases cost of emp. stk. options on fair val. of stk. options granted - co. use acceptable option-pricing models to val. options @ grant date (take into acct. many factors that determine option's underlying val.) - GAAP requires; co. should base acct. for cost of emp. services on fair val. of comp. paid; amt. presumed to be measure of val. of services received Grant Date -         the date you receive the options Recognition - Stk. Comp. - 2 main acct. issues -         - how determine comp. exp. - over what periods to allocate comp. exp. Recognition - Stk. Comp. - Determining Exp. -         - compute tot. comp. exp. based on fair val. of options expected to vest on date they grant options to emp. - no adjustments after grant date in response to subsequent changes in stk. price (up or down) Recognition - Stk. Comp. - Allocating Comp. Exp. -         - Service Period = co. recog. comp. exp. in periods in which emp. perform service; vesting period unless otherwise specified - co. determine tot. cost at grant date and allocates to periods benefited by emp. services Stk. Comp. Example - Basic Entries -         - date of grant : no entry - record comp. exp. : Dr. Comp. Exp.; Cr. PIC - Stk. Options Stk. Comp. Example - Exercise -         - Dr. Cash (# exercised * option $) - Dr. PIC - Stk. Options (% exercised * tot.) - Cr. CS (shares * par) - Cr. PIC - Excess Par - CS (remainder) Stk. Comp. Example - Expiration -         - Dr. PIC - Stk. Options - Cr. PIC - Expired Stk. Options Stk. Comp. Example - Adjustment -         - unexercised doesn't nullify need to record cost of serv. received and attributable to plan; co. therefore doesn't adj. comp. exp. upon expiration of options - if emp. forfeits option bc. fails to satisfy serv. req., co. adj. est. of comp. exp. recorded in curr. period (Dr. PIC - Stk. Options; Cr. Comp. Exp.) Restricted-Stock Plans -         - transfer shares of stock to emp., subject to agreement that shares can't be sold, transferred, pledged until vesting occurs - subject to forfeiture if cond. for vesting not met Major Advantages of Restricted Stock -         - never becomes completely worthless - generally results in less dilution to existing SHs; usually one-half to one-third size of options bc. will have end val. - better aligns emp. incentives w/ co. incentives; essentially SH and should have interest in long- term objectives Restricted Stock Ex. - Grant Date -         - Dr. Unearned Comp. - Cr. CS, PIC - Excess Par Unearned Compensation Account -         - Deferred Comp. Exp. - cost of services yet to be performed - not asset - contra eq. acct. Restricted Stock Ex. - Comp. Exp. -         - Dr. Comp. Exp. - Cr. Unearned Comp. Restricted Stock Ex. - Forfeit -         - Dr. CS, PIC - Excess Par - Cr. Comp. Exp., Unearned Comp.