Reading 28: Non-Current (Long-Term Liabilities)
Reading 28: Non-Current (Long-Term Liabilities)
Reading 28: Non-Current (Long-Term Liabilities)
• Not Covered
• 28j
Bond Terminology—I
• Par value: amount payable to the bondholders at maturity; also called face value, principal,
stated value, maturity value
• Coupon rate: interest rate used to calculate periodic interest payments; also called nominal
rate, stated rate
• Coupon payment: coupon rate times par value
• Market rate of interest: interest rate demanded by investors given the risks of an investment
• Effective interest rate: the market rate of interest when bonds are issued; used to compute
interest expense
• If the effective interest rate > coupon rate, bonds are issued at a discount (price < par)
• If the effective interest rate = coupon rate, bonds are issued at par (price = par)
• If the effective interest rate < coupon rate, bonds are issued at a premium (price > par)
• Interest expense: coupon payments plus amortization of any premium/discount; there are
two methods of amortization—effective interest method and straight-line
Bond Terminology—II
Example: Lynx Industries issues one thousand $1,000 par, 6% coupon, 5-year, annual-pay bonds for a
total of $958,998.
• Straight-line method
• Amortization of premium/discount = initial premium/discount ÷ original
years to maturity
• Interest expense = coupon payment + amortization of premium/discount
• Allowed by U.S. GAAP
Amortization of Premium/Discount—II
Example (cont.): Lynx Industries issues one thousand $1,000 par, 6% coupon, 5-year, annual-pay
bonds for a total of $958,998. The effective rate is 7%.
Smokey’s purchases half of the bonds on the open market at 98.25. Compute the gain/loss (if any)
that Smokey’s will report on their income statement.
A. Decrease.
B. Remain unchanged.
C. Increase.
Presentation/Disclosures
• Long-term liabilities are aggregated as a single amount
• Liabilities due within one year: current liabilities
• Footnotes
• Stated and effective interest rates
• Maturity dates
• Pledged collateral
• Scheduled repayments over the next 5 years
• Covenants
Timely principal and interest payments
Maintenance of pledged collateral
Dividend restrictions
Maximum leverage levels
Minimum liquidity ratios
Motivations for Leasing
• Fixed interest rates
• No down payment
U.S. GAAP
• Lessee will report depreciation expense and interest expense only in for finance leases.
• For operating leases, lessee reports a single lease expense.
Further, on the statement of cash flows, IFRS allows companies to classify interest paid under
operating, investing, or financing activities. U.S. GAAP requires companies to classify interest paid
under operating activities.
Lessor Accounting—IFRS
A lessor may classify a lease as (1) a finance lease or (2) an operating lease.
For a finance lease:
• At inception, lessor removes underlying leased asset from balance sheet.
• Instead, recognizes a lease asset composed of lease receivables and the asset’s expected
salvage value.
• If lessor is a manufacturer or dealer, selling profit may arise. Over the lease term, lessor
recognizes finance income.
For an operating lease:
• Lessor recognizes lease receipts as income and related costs (e.g., deprecation of the
leased asset) as expenses.
Lessor Accounting—U.S. GAAP
Under U.S. GAAP, a lessor may classify a lease as a (1) sales-type, (2) operating,
or (3) direct financing lease.
• If benefits and risks of ownership have been transferred to lessee, lessor will classify
the lease as a sales-type lease.
• If above conditions not met, the lease will be classified as an operating lease or
direct financing lease.
• For an operating lease, lessor accounting under U.S. GAAP is similar to the IFRS treatment.
• A lease is considered a direct financing lease under U.S. GAAP if the lease contract provides
for a third-party guaranteed residual value, which, combined with the future lease
payments by lessee, will equal or exceed the fair value of the leased asset.
Defined Contribution Plans
• Company contributes money to the plan, has no further obligation
• Accounting
• Income statement
Pension expense equals required contribution
• Balance sheet
Decrease in cash equal to actual contribution
Liability if actual contribution < required contribution
Asset if actual contribution > required contribution
Answer: A
For a premium, the amortization under the effective rate method is higher in the early years and lower in
the later years; in year 2 of 10, the amortization would be higher than the straight-line amortization.
A. Decrease
B. Remain unchanged
C. Increase
Answer: A
Canfield & Miller’s profitability suggests positive equity, so its liabilities are less than its assets;
furthermore, its debt is likely less than its liabilities, so its debt is less than its assets, and its
existing debt-to-asset ratio is less than 1. When the same amount is subtracted from the numerator
and the denominator, the ratio will decrease.