Chapter 10 - Accounting

Front 1

How are assets financed?

Back 1

They are financed from 2 sources: debt from creditors and equity from funds from owners

Front 2

Current cash equivalent

Back 2

The amount a creditor would accept to cancel the debt.

Front 3

Working capital

Back 3

[Current Assets]-[Current Liabilities]

Changes in working capital have a direct impact on cash flows

Front 4

Compute Interest

Back 4

[Principal] x [Interest Rate] x [Time]

Front 5

Contingent Liability

Back 5

Potential liability that has arisen as the result of a past even. Not an effective liability until a future event occurs.

When it occurs, it causes a contingent loss.

Front 6

Probabilities of occurrences

Back 6

a) probable (noted on balance sheet)

b) reasonably probable (noted on financial statements)

c) remote (not disclosed)

Front 7

SSecured Debt

Back 7

This type of liability means that if the debt isn't paid, then the borrower can take ownership of a asset.

Front 8

Private placement

Back 8

Raising debt from institutions such as banks, insurance companies, pension plans.

This is written in as a note payable which specifies a maturity date and interest rate.

Front 9

Bonds

Back 9

They are publicly traded debt.

Current ratio and working capital works the same way.

Front 10

Operating lease

Back 10

Things such as renting out assets. They are recorded when the rent is used, not when the contract is created.

Front 11

Capital lease

Back 11

This is more long term, renting out assets.

a) 75% of economic life

b) ownership is transferred at end of lease

Reporting something as operating lease means there there less debt expense, so it is more preferred.

Front 12

Present Value

Back 12

Current value of an amount to be received in the future.

Front 13

Present Value of a Single Amount

Back 13

( [1]/[1+i]n ) x amount

Front 14

Advantages of Bonds

Back 14

1)Bondholders don't have vote or share in company's earnings, so the power is still with stockholders

2) Interest expense is tax detectable (reduces cost of borrowing).

3) Earnings can be positive if it is borrowed at a lower interest rate and invested in a higher interest rate.

Front 15

Market Interest Rate

Back 15

It's the interest rate demanded by creditors.

Also used to calculate "Present Value" computations to discount future cash flows.

Front 16

Coupon Interest Rate

Back 16

It is the stated interest rate on the bond.

Front 17

Another word for "Coupon Interest Rate"

Back 17

a) Stated Rate

b) Contract Rate

Front 18

Bond Discount

Back 18

This happens when the "Coupon Interest Rate" is lower than the "Market Interest Rate".

So it is sold at a discount, less than par.

Front 19

Bond Premium

Back 19

This happens when the "Coupon Interest Rate" is higher than the "Market Interest Rate".

So it sold more than the par.

Front 20

Another word for "Market Interest Rate"

Back 20

a) Yield

b) Effective-Interest Rate

Front 21

Times Interest Earned

Back 21

[Net income + Interest Expense + Income Tax Expense] / [Interest Expense]

The higher the ratio, the better. It shows the amount of resources generated for each interest expense dollar.

Front 22

Discount

Back 22

Use "Market Rate of Interest".

The discount amount is a "Contra-Liability" account. And it is recorded as a DEBT

Front 23

Amortize interest Expense

Back 23

Interest Expense must be adjusted when bonds are sold at "Discount".

2 methods used:
a) Straight-line

b) Effective Interest

Front 24

Straight Line Method

Back 24

[Discount Amount]/[# of periods]


The Discount Amount is what was lost during the transaction. So it must be allocated each period.

So the amount is then added to "Interest to be Paid".

The interest to be calculated is done so using (Par Value x Interest Rate on Bond/Periods in year).

Front 25

Journal Entry for Amoritization of Interest Expense

Back 25

Interest Expense [+E, SE-]
Discount on Bonds Payable [-XL,-L]
Bonds Payable [-L]