Class_content_13.4_Appendix__Special_Topics_Related_to_Long-Term_Liabilities_-_Principles_of_Account

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2/10/22, 10:04 PM13.4 Appendix: Special Topics Related to Long-Term Liabilities - Principles of Accounting, Volume 1: Financial Accounting | Ope…1/7Here we will address some special topics related to long-term liabilities.Brief Comparison between Equity and Debt FinancingAlthough we briefly addressed equity versus debt financing inExplain the Pricing of Long-Term Liabilities, we will now review the two options. Let’s consider Maria, who wants to buy abusiness. The venture is for sale for $1 million, but she only has $200,000. What are heroptions? In this situation, a business owner can use debt financing by borrowing money orequity financing by selling part of the company, or she can use a combination of both.Debt financingmeans borrowing money that will be repaid on a specific date in the future.Many companies have started by incurring debt. To decide whether this is a viable option, theowners need to determine whether they can afford the monthly payments to repay the debt.One positive to this scenario is that interest paid on the debt is tax deductible and can lowerthe company’s tax liability. On the other hand, businesses can struggle to make thesepayments every month, especially as they are starting out.Withequity financing, a business owner sells part of the business to obtain money to financebusiness operations. With this type of financing, the original owner gives up some portion ofownership in the company in return for cash. In Maria’s case, partners would supplement her$200,000 and would then own a share of the business. Each partner’s share is based on theirfinancial or other contributions.If a business owner forms a corporation, each owner will receive shares of stock. Typically,those making the largest financial investment have the largest say in decisions about businessoperations. The issuance of dividends should also be considered in this set-up. Payingdividends to shareholders is not tax deductible, but dividend payments are also not required.Additionally, a company does not have to buy back any stock it sells.ETHICAL CONSIDERATIONSDebt versus Equity FinancingMany start-ups and small companies with just one or two owners struggle to obtainthe cash to run their operations. Owners may want to use lending, or debt financing,to obtain the money to run operations, but have to turn to investors, or equityfinancing. Ethical and legal obligations to investors are typically greater than ethicaland legal obligations to lenders. This is because a company’s owners have an ethicaland legal responsibility to take investors’ interests into account when makingbusiness decisions, even if the decision is not in the founding owners’ best interest.

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Term
Fall
Professor
NoProfessor
Tags
Debt, Interest, Mortgage loan

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