ACCTMIS 2200: Debt Financing

The obligation when a company borrows money from the bank for longer than a year

- long-term note payable

These liabilities are typically repaid in equal installments, part of which are repayment of _________ and part of which are ___________.

1. Principal
2. Interest

To spread the loan payments between interest and principal reduction use an ____________.

- amortization table

How do you calculate the interest?

= Principal x Rate X (n/12)

A _________ is a special type of note payable (borrowing from bank) that is secured by the pledging of certain assets, usually real estate, as collateral.

- mortgage

Subsequent entries are required for each installment payment (usually monthly payments), with each payment consisting of both _______ and _____________.

1. Interest
2. Principal Reduction

When first recording a mortgage payable...

DEBIT: Cash
CREDIT: Mortgage Payable

** amount initially received

What type of cash outflow is interest in?

- operating cash outflow

What type of cash outflow is principal of loans in?

- financing cash outflow

Lease

- a contract that specifies the terms under which the owner of an asset agrees to transfer the right to use an asset to another party

Lessee

- the party that is granted the right to use property under the terms of a lease

Lessor

- the owner of property that is leased to another party

Lessee Accounting

- records a leased asset and a lease liability on their balance sheet equal to the present value of the lease payments

- the leased asset is depreciated

- the lease liability is amortized (gradually reduced) over the lease term down to a zero balance

Depreciation of the Leased Asset

- the depreciated of the leased asset is referred to as amortization

- the amortization expense is typically calculated using the STRAIGHT-LINE bases. However, any method of depreciation can be used.

- assume the residual value is 0

To record the depreciation of the leased asset:

DEBIT: Amortization expense
CREDIT: Leased Asset

If the lease greenest calls for the asset to be returned to the lessor at the end of the lease, the lessee uses the _____________ as the asset's life.

- lease term

If the lease agreement calls for the ownership asset to be transferred to the lessee at the end of the lease, the lessee uses the ___________ as the asset's life.

- the economic life of the asset

Amortization of the Lease Liability

- reduces the liability each time a payment is made. At the end of the lease term, the liability balance must be zero.

- each payment is separated into two components: interest expense and principle reduction

- set up an amortization table

What are the financial statement ratios relating to debt?

1. Debt-To-Equity Ratio
2. Times Interest Earned Ratio

Debt-To-Equity Ratio

- measures the percentage of funds being provided by creditors versus stockholders

Debt-to-Equity Ratio Equation

= Total Liabilities/Total Stockholders Equity

What does a debt-to-equity ratio of 1.3 indicate?

- indicates liabilities are 30% larger than equity

Do you want a higher or lower number for the debt-to-equity ratio?

LOWER
- the higher the debt-to-equity ratio, the higher the risk to creditors

Times Interest Earned Ratio

- measures the companies' ability to meet its interest payments as they come due

Times Interest Earned Ratio Equation

= (Net Income + Income Tax Expense + Interest Expense) / Interest Expense

Do you want a higher or lower number with the Times Interest Earned Ratio?

HIGHER
- the higher the ratio, the more income the company has to pay its interest and the less likely the company is to default on these payments

EBIT

- earnings before interest and taxes

- refers to the numerator of the Times Interest Earned Ratio: (Net Income + Income Tax Expense + Interest Expense)

How do you find current lease liability?

- go to the year AFTER and its the reduction of principal

How do you find current note payable?

- look at the year AFTER and add together the reduction of principal

How do you find long-term lease liability?

- lease liability amount in year AFTER

How do you find long-term note payable?

- note payable balance in the year AFTER

How do you find the balance of the leased asset?

- take original value and subtract accumulated depreciation

How do you find cash paid for mortgage (operating)?

OPERATING = INTEREST
- add all the interest paid together

How do you find cash paid for lease (financing)?

FINANCING = PRINCIPAL
- add totals together from year you are looking for

The entry to record the annual lease payment on a lease includes...

Debit: Interest Expense
Debit: Lease Liability
Credit: Cash