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Financial leverage
increases when a company finances the assets it acquires with liabilities
Current operating liabilities
accounts payable
accrued liabilities
deferred performance liabilities
Current nonoperating liabilities
short-term interest-bearing debt
current maturities of long-term debt
Cash discount of 1/10, n/30
1% cash discount if payment is made in 10 days OR full purchase price due in 30
Net-of-discount method
when cash discounts are offered, inventory purchase is recorded at its cost; inventory is capitalized net of the discount
To figure out the cost of not paying in the discount period (interest rate)…
= [(Discount / Days beyond Discount Period) * 365] / Discount Price
Contingent liability
if an obligation is probable (more than 50% chance) AND amount is estimable, then it’s recognized
Warranty
commitment by manufacturer to repair or replace defective products within a specified period
recognized as Liability and Expense
When a repair or replacement is made: Warranty Liability/Payable is decreased
Contract liability
deferred/unearned revenue
Accrued Interest
= Principal x Annual Rate x Portion of the Year Outstanding
Bond sold at par
cost to the issuing company is cash interest paid
coupon rate = market rate
Bond sold at discount
1. Cash interest paid and 2. Discount incurred
Coupon rate < Market rate
Discount = Par - Lower Issue Price
Bond sold at a premium
1. Cash interest paid and 2. Cost reduction due to premium received
Coupon rate > Market rate
Interest/coupon payment
= Face value x Coupon rate
cash amount on FSET
Interest expense
= Amount owed x Market rate
Ending Net Bonds Payable for Discounts
= Beginning Net Bonds Payable + Discount Amortization
Bond Discount
Contra liability
Net Bonds Payable for Discount
= Bonds Payable - Bond Discount
Net Bonds Payable for Premium
= Bonds Payable + Bond Premium
Ending Net Bonds Payable for Premium
= Beginning Net Bonds Payable - Premium Amortization
Underestimated accruals
underestimated liabilities, underestimated expense, overestimated income
Overestimated accruals
overestimated liabilities, overestimated expense, underestimate income
If fair value of a bond increases…
+ Fair Value Adjustment in liabilities, + Unrealized Loss in expenses
Call provision
part of bond agreement that lets companies repurchase bonds in the open market before maturity by paying a small premium above face value
Gain or loss on bond repurchase
= Book value of the bond - Repurchase payment
Default
risk that the company won’t be able to pay its obligations when they’re due (insolvency)
Covenants
restrictions creditors put on companies’ activities to provide protection against default risk, put indirect costs on a company which increase as the company relies more on debt financing