TAMU ACCT 229 Exam 3 - Arnosky

What are probable debts or obligations that result from PAST transactions, which will be paid with assets or services?

Liabilities

What is a liability with a maturity of 1 year or less?

Current Liability

What is riskier between debt or equity?

Debt is riskier than equity

What is a legal obligation that MUST be repaid?

Interest

What are liabilities measured at?

Their current cash equivalent

What is a current cash equivalent?

What the creditor would accept to cancel the debt immediately (Carrying Value)

What is another term for current cash equivalent?

Carrying Value

What is the Working Capital formula?

current assets - current liabilities

What is the current ratio formula?

current assets / current liabilities

What are the 2 distinctions for current liabilities?

1.) using a current asset (usually cash) or service

2.) within one year or operating cycle, whichever is longer

What are examples of current liabilities?

Accounts Payable, Accrued Liabilities (Wages payable etc.), Unearned Revenue, Current Maturities of Long-Term Debt

What is a portion of long term debt that will be due within the next year which should be classified as a current liability?

Current Maturity of Long Term Debt

What are examples of Contingent (Estimated) Liabilities?

Warranties, Guarantees, Box Tops, Lawsuits

What has to happen for an Estimated Liability to be recorded?

Probably and can be estimated (Journal Entry)

What has to happen for an Estimated Liability to be contingent?

Probable and can NOT be estimated; possible (add to footnotes, don't do journal entry)

What is it called to do nothing about an Estimated Liability

Remote (Do Nothing)

What is the journal entry for Recording Estimated Liability?

Debit Expense, Credit Estimated Liability

What type of note has the principle and interest due at maturity?

Interest-Bearing Note

What is the Short-Term Interest Calculation formula?

Principle x Int% x (Months Passed/12)

What is the formula to determine effective interest rate?

Interest Expense / Cash Proceeds

What type of note has interest deducted in advance?

Non-Interest Bearing Note

What type of note has the higher effective interest rate?

Non-Interest Bearing Note

What is the cash proceeds formula?

Face Value - Interest

What is the part of the note that is being paid back in the future?

Face Value

What do you pay at the end of a Non-interest bearing note?

Face Value (Interest was discounted out initially which is why you receive a lower amount as cash proceeds at beginning)

What do you pay at the end of an interest bearing note?

Face Value + Interest

What type of account is the discount on Note Payable?

Contra-Liability

What is the formula for carrying value?

Note Payable - Discount

What is the important rule to remember about discounts on notes?

Discounts of Long-term debt are classified as long term debt, and discounts of short-term debt are classified as short term debt

What are the advantages of debt?

1. Interest Expense is tax deductible (NI down, Taxes down)

2. Debt will not dilute ownership

What are the disadvantages of debt?

1. Interest expense is a legal obligation to pay

2. Must have cash flows to make payments on debt

What type of note is where all the cash is paid back at the end of the note's life?

Lump Sum Note

What type of note requires equal payments at specific intervals as you progress through the life of the note?

Annuities

Almost all long term notes are what?

Non-interest bearing

What is interest accrued over time on principle only?

Simple Interest

What is the type of interest that includes the Principle + Accumulated interest that earns/incurs interest in the future?

Compound Interest

What is the equivalent value of a future amount "discounted" back to the present time (eliminates the compounding of interest over that time period)?

Present Value

What is the important rule about calculating interest?

Interest is usually expressed as an Annual Percentage Rate (APR) so if the interest is being compounded semiannually, quarterly, or monthly, you must adjust the interest rate and pro rate to match the compounding periods

How do you pro rate the interest rates?

Example (Semiannual)

10% APR -> 5%

10n -> 20n

What are other terms for FV and PV?

FV = "Contract Price"

PV = "List Price"

What can a lump sum note not have?

Multiple payments

What does the carrying value always work towards?

Face Value

How do you calculate the discount on a note payable?

FV - PV

What is the formula for calculating interest expense on a long term note?

Carrying Value x Int%

What is the formula to calculate new carrying value for a lump sum note?

Old Carrying Value + Year Int Exp

What is the Single Sum PV formula?

PV = Future Value x PV$1(%,n)

What is the Annuity PVOA Formula?

PVOA = pmt x PVOA (%,n)

What is the payment or receipt made at the end of each period?

Ordinary Annuity

What is an amount that if invested at a compound interest now, would provide for a series of equal payments at the end of each period in the future?

Present Value of Ordinary Annuity

What are the headings for the Amortization Schedule?

Date, Cash Pmt, Interest Exp (CV x Int%), Principle Reduction (Difference between pmt and int exp), Carrying Value

What is the formula for total cost of borrowing for a long term note?

Cash out (Cash Pmt x periods)

- (Financed Portion of Cost; amount received from loan)

Which rate do you use to solve for the cash interest payment for bonds?

Stated Rate

What rate do you use to solve for the PV or PVOA for bonds?

Market Rate

What is a long-term debt sold to creditors?

Bonds

Who sells the bond and gets cash in return (issue price)?

Borrower/Issuer/Seller

Who receives the bond and gives cash in return?

Lender/Buyer

During the life of the bond, what does the borrower have to do?

Make periodic cash interest payments to the lender

At the end of the life of the bond, what does the borrower have to do?

Pay the face value of the bond to the lender

What is the cash the borrower receives at the beginning of the bond?

Issue Price

What is the amount of cash the borrower agrees to pay back at the end of the bond's life?

Face Value

What are the 2 promises a bond makes?

1. Repayment of the bond principal at maturity (the face value)

2. Periodic interest payments based on the face value (usually annually or semi-annually)

What is the cash interest payment formula for bonds?

Fave Value x Stated Int%

What is a fixed rate of interest paid on face value of the bond; always used when determining interest payment?

Stated Rate (Coupon Rate)

What is the going rate of interest that borrowers & lenders are willing to accept on the day the bond is sold; will determine the selling price of the bond?

Market Rate (Effective Rate or Yield)

Who sets the stated rate?

Borrower

Who sets the market rate?

Bond Market

What is the bond contract that specifies all legal provisions of the bond?

Bond Indenture

What does the bond indenture state?

both the stated rate and market rate are locked in at issuance and the company is now legally required to make all interest payments and repay the principal at maturity; after this point market rates do not affect the accounting for the bond on the company's book

What are the 3 types of bonds?

Debenture, Callable, Convertible

What type of bonds are unsecured; not backed with the pledge of a specific asset (collateral) and are simply based on a promise?

Debenture Bonds

What type of bonds are where the corporation reserves the right to buy bonds back early (called) at a stated price?

Callable Bonds

What type of bond can be exchanged for a stated number of shares of stock in the borrowing organization?

Convertible Bond

What will the bond sell at if the Market Rate is greater than the Stated rate?

Discount

What will the bond sell at if the market rate is equal to the stated rate?

Face Value

What will the bond sell at if the market rate is less than the stated rate?

Premium

What must you find in order to determine the selling/issue price of a bond?

The PV$1 and the PVOA

What are the 4 steps for computing the issue price of bonds?

1. Find Interest Payments: FV x Stated Rate %

2. Find PV of Face Value: PV = FV x PV$1 (Mkt%,n)

3. Find PV of Interest Pmts: PVOA = pmt x PVOA (Mkt%,n)

4. Add PV of Face Value and PV of Interest Pmts to find the selling price of the bond (cash proceeds of the company)

If the bond sells at face value, what is the carrying value of the bond?

The face value and the interest expense will equal the cash int pmts

What must you do if the bonds sell at either a premium or discount?

Use the Effective Interest Method to amortize the premium/discount

What is the carrying value formula for a discount bond?

Bond payable - Discount = Carrying Value

What is the initial carrying value of a bond?

The issue price

What are the headings for the Amortization Table used for bonds?

Date, Cash Pmt, Int Exp (CV x Market Rate%), Discount/Premium Amortization (Difference between Cash pmt and Int exp), Carrying Value

What is the journal entry for a discount bond on a specific interest payment date?

Debit Int Exp, Credit Discount Amortization and Cash Pmt

How do you calculate the total cost of borrowing for a bond?

Cash Out: (Total Interest Payments + Face Value)

- (Issue Price)

What is the journal entry at the date of issuance for a discount bond?

Debit Cash (@issue price) and Discount, Credit Bond Payable (@FV)

What is the journal entry at the date of issuance for a premium bond?

Debit cash (@issue price) and Credit Premium and Bond Payable (@FV)

What are discounts and premiums classified as in relation to bonds?

Adjunct Accounts (attached to the parent account of bond payable)

What is the journal entry for a premium bond at a specific interest payment date?

Debit Int Exp and Premium Amortization, Credit Cash Pmt

What is the journal entry if you retire a bond at maturity (when FV = CV)?

Debit Bond Payable, Credit Cash (@FV)

How do you find the price if you retire a bond early that is a callable bond?

Cash to Retire = Face Value x Call Price (% of FV)

How do you find the price if you retire a bond early that has no call feature?

Cash to Retire = FV x Market Price %

What is the journal entry if you make a gain when retiring a PREMIUM bond?

Debit Bond Payable (@FV) and Premium (@unamortized amt) and Credit Gain (@CV-Cash to Retire) and Cash (@cash to retire)

What is the journal entry if you make a gain when retiring a DISCOUNT bond?

Debit Bond Payable (@FV) and Credit Discount (@unamortized amt) and Gain (@CV-Cash to Retire) and Cash (@cash to retire)

What is the journal entry if you make a loss when retiring a DISCOUNT bond?

Debit Bond Payable(@FV) and Loss(@CV-Cash to Retire) and Credit Discount (@unamortized amt) and Cash(@cash to retire)

What is the journal entry if you make a loss when retiring a PREMIUM bond?

Debit Bond Payable(@FV), Premium(@unamortized amt), and Loss(@CV-Cash to Retire) and Credit Cash(@cash to retire)

How do you determine carrying value of Bonds at a given time?

Face Value - Unamortized Discount OR Face Value + Unamortized Premium

How do you determine if you make a gain or a loss when retiring a bond?

If Cash to Retire > CV then Loss

If Cash to Retire < CV then Gain

What are the aspects of a corporation?

1. Separate legal entity (own assets, incur liabilities, enter into contracts, sue and be sued)

2. Stockholders elect Board of Directors; Board appoints CEO, CFO, etc.

3. Stockholders have the right to vote and receive dividends (depending on type of stock they own)

What are the 2 ways a company can finance operations?

Issue stock (Equity) or issue debt (liability)

What are the advantages of issuing equity?

1. Ease of raising capital (great number of potential investors)

2. Dividend flexibility (NOT liabilities until declared by board)

3. ROI is higher on stocks than bonds