Financing Liabilities Lecture Review

Sixty vocabulary-style flashcards covering financing liabilities, notes payable, bonds, and credit risk analysis based on the lecture material.

Notes Payable

Formal credit arrangements between a creditor and a debtor that require the payment of a specified face amount at a fixed maturity date.

Principal

The face amount, par value, or maturity value of a note that must be repaid to the lender.

Short-Term Notes Payable

Obligations due and payable within $1$ year from the balance sheet date or operating cycle, whichever is longer.

Term Loans

A type of long-term note that requires the borrower to pay interest each period, with the principal due only at maturity.

Installment Loans

A type of long-term note that requires a fixed payment each period that includes both interest and principal.

PMT Formula (Excel)

Used to decide fixed payments: $PMT(i, n, PV, FV, 0or1)$, where $i$ is the periodic interest rate and $n$ is the number of periods.

Discount on Notes Payable

The difference between the face value and present value of a note when the stated interest rate is less than the market rate.

Effective Interest Method

A method used to amortize the discount or premium on notes and bonds to interest expense over the loan term.

Bond Payable

A debt instrument typically issued for a period greater than a year requiring repayment of the principal balance at a specified maturity date.

Bond Issuer

The debtor or borrower who issues the bond and receives the credit.

Bondholder

The creditor or lender who purchases the bond and expects a return on investment.

Secondary Market

A market where bonds can be traded among lenders after their initial issuance.

Credit Rating

An opinion on a company’s credit quality expressed as a letter grade, such as $AAA$ for strong repayment capacity.

Bond Indenture

A contract between the corporation and bondholders that outlines debt covenants, enforcement, and the terms of the bond.

Debt Covenants

Compliance agreements that place restrictions on the corporation to protect bondholders' interests and ensure cash for repayment.

Compensating Balances

Restricted deposits that a debtor is required to maintain to support existing lending arrangements.

Technical Default

Occurs when a debtor violates one or more terms of its debt covenants.

Actual Default

Occurs when a debtor misses interest and/or principal payments.

Secured Bonds

Bonds that use specific assets as collateral for the debt.

Debenture Bonds

Unsecured bonds that have no collateral backing.

Serial Bonds

Bonds that have multiple maturity dates.

Term Bonds

Bonds that have a single maturity date.

Callable Bonds

Bonds that can be called at the corporation's option at specified dates.

Convertible Bonds

Bonds that bondholders may convert into capital stock, such as common or preferred shares.

Face Value (Par Value)

The amount that the company will pay the bondholder at maturity, typically set at $1,000$ per bond.

Stated Interest Rate

The amount of interest the bond issuer will pay in cash expressed as an annual rate, also called the coupon or nominal rate.

Bond Price

The sum of the present value of the face value and the present value of interest payments based on the market interest rate at issuance.

Bond Discount

Occurs when the bond price is less than the face value because the stated rate is lower than the market rate.

Bond Premium

Occurs when the bond price is greater than the face value because the stated rate is higher than the market rate.

Market Rate (Yield)

The actual return investors receive, also known as the effective interest rate.

Discount on Bonds Payable Account

A contra-liability account that decreases the recorded value of bonds payable on the balance sheet.

Premium on Bonds Payable Account

A liability account that increases the recorded value of bonds payable on the balance sheet.

Carrying Value of Bonds (Discount)

Calculated as: $\text{Bonds Payable (Par Value)} - \text{Discount on Bonds Payable}$.

Carrying Value of Bonds (Premium)

Calculated as: $\text{Bonds Payable (Par Value)} + \text{Premium on Bonds Payable}$.

Effective Interest Expense Formula

$\text{Periodic Historical Market Interest Rate} \times \text{Carrying Value at Beginning of Period}$.

Cash Interest Payment Formula

$\text{Par Value of Bond} \times \text{Periodic Stated Interest Rate}$.

Zero-Coupon Bonds

Bonds that do not pay periodic cash interest and are typically issued at a significant discount.

Accrued Interest (Issuance)

The amount a buyer pays the issuer when bonds are sold between interest dates, representing interest from the prior date to the issue date.

Bond Issue Costs

Costs deducted from the carrying value of the bond by increasing the discount or decreasing the premium.

Debt Extinguishment

The retirement of bonds before their scheduled maturity date.

Gain on Early Extinguishment

Occurs when the retirement price is less than the net carrying value of the debt.

Loss on Early Extinguishment

Occurs when the retirement price is greater than the net carrying value of the debt.

Hybrid Security

A security, such as a convertible bond, that possesses characteristics of both debt and equity.

Stock Warrants

Long-term options to acquire a stated number of shares of common stock for a stated price.

Detachable Warrants

Stock warrants that can be removed by the holder and sold separately on the secondary market.

Nondetachable Warrants

Stock warrants that cannot be separated from the bond; total proceeds are typically assigned to the debt issue.

Proportional Method

A method of allocating proceeds based on the relative fair values of the bond and the warrants on a standalone basis.

Incremental Method

A method of allocating proceeds where one instrument receives its fair value and the residual is allocated to the other.

Current Maturity Adjustment

The reclassification of a long-term obligation as a short-term obligation when it becomes payable within next year.

Refinancing Criteria (ST to LT)

To reclassify short-term debt as long-term, management must show intent to refinance and the ability to consummate the refinancing.

Callable Obligations

Liabilities for which the creditors can require immediate payment if specified conditions or technical defaults exist.

Fair Value Option

An irrevocable election at the time of borrowing to value most types of financial obligations at fair value.

Instrument-Specific Credit Risk

The risk of the specific security as opposed to general market risk; related unrealized gains/losses are reported in OCI.

Sinking Fund

Cash or other assets held in a separate account specifically used to repay debt at maturity.

AAA Credit Rating

The highest rating given by agencies like Standard & Poor’s, indicating extremely strong capacity to meet financial commitments.

D Credit Rating

The rating assigned by Standard & Poor’s indicating a payment default on financial commitments.

Business Risk Assessment

Includes analyzing country risk, industry factors, competitive position, and profitability comparisons.

Financial Risk Assessment

Examination of governance, accounting, cash flow adequacy, capital structure, and liquidity.

Funds From Operations over Debt

A financial risk measure where a value greater than $60$ is categorized as minimal risk by S&P benchmarks.

Debt / EBITDA

A financial risk indicator used by agencies; a value less than $1.5$ is typically considered minimal risk.