Chapter 14 Long Term Financial Liabilities Essay

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LONG-TERM FINANCIAL LIABILITIES

Preview
Understanding Debt Instruments
Measurement
Recognition and Derecognition
Presentation, Disclosure, and Analysis
IFRS/ASPE Comparison

UNDERSTANDING DEBT INSTRUMENTS
LT Debts are obligations not payable within a year, or the operating cycle of the business, whichever is longer
Usually subject to formal creation  BoD & SH approval, legal contracts, restrictive covenants

BONDS & NOTES PAYABLE
Purpose is to borrow for long term when amount of capital needed is too large for one lender to supply & indebtedness can be divided
Created by bond indenture contract AKA promise to repay (1) principal at maturity, and (2) periodic interest at specified rate on face value
Typically accompanied by paper certificate, have $1K face value, and have semi-annual interest payments (but expressed as APR)
Selling agents AKA underwriters may guarantee certain sum of bond sales to the corporation, thus taking the risk for the given price. May also perform best efforts underwriting, or private placement.
TYPES OF LT DEBT
Registered and Bearer (Coupon) Bonds
Registered means issued in owner`s name
To sell, current certificate must be surrendered, and new certificate issued
Bearer/coupon is not recorded in owner's name, and may be transferred simply by delivery
Secured and Unsecured Debt
Secured is backed by pledge of collateral e.g. mortgage
Unsecured is not backed by collateral, risky, and high interest e.g. Junk bonds, LBO offerings
Term, Serial, and Perpetual Bonds or Notes
Term Bonds/Notes mature on a single date
Serial Bonds/Notes mature in instalments
Perpetual Bonds/Notes have unusually long terms, or do not mature
Income, Revenue, and Deep Discount Bonds
Income Bonds pay no interest unless issuing entity is profitable
Revenue Bonds pay interest from a specified revenue source
Deep Discount Bonds/Notes are sold at large discount that provide "total interest payoff" (at market rates) at maturity AKA zero-interest bonds
Commodity-Backed Bonds
Redeemable in amounts of a commodity, AKA asset-linked debt
Callable, Convertible Bonds and Notes, and Debt with Various Settlement and Other Options
Callable means right to retire debt before maturity (similar to demand loans)
Convertible means right to convert to other securities
Miscellaneous bonds/instruments provide payments tied to esoteric items, e.g. weather, catastrophes

CREDIT RATINGS
Assigned by independent credit rating agencies
Reflects company's credit quality (ability to meet debt obligations)
Quality is constantly monitored, so rating can be changed during issue's outstanding life
Many insurance companies, pension funds, and institutional investors are required to invest in investment grade securities (pressure to attain and stay at this level)

DEFEASANCE
Early repayment penalties may stop companies from paying off debt early
Companies may instead set aside money in a trust and allow the trust to repay the original debt (P&I) as it becomes due
Defeasance is the act of setting aside sufficient funds (PV of amount due under loan agreement) to pay the creditor
Legal Defeasance is when the original creditor looks to the trust for repayment and gives up its claim on the company; trust becomes debtor & new legal agreement made

TYPES OF COMPANIES THAT HAVE SIGNIFICANT DEBT FINANCING
3 general sources of financing  debt, equity, internally generated funds
Debt/leverage increase liquidity and solvency risk, but increases profits if return on invested proceeds is higher than interest payments
Issuing shares dilutes ownership
Internally generated funds is only do-able when there are excess funds, and requires an alternatives assessment (e.g. dividends)
Capital intensive industries (i.e. high tangible assets e.g. transportation, hotel) have greater ability to borrow funds because debt can be secured
Too much LT Debt means company is overextended, has higher cost of capital, and may be unable to access additional debt; ratios are important

MEASUREMENT…