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CHAPTER F9: FINANCING ACTIVITIES I. Types of Obligations A. Organizations engage in activities that obligate them to make future payments of cash or to provide goods and services. 1. Most obligations are reported as liabilities on a company’s balance sheet. 2. Three attributes define a liability for an organization: (1) a present responsibility exists to transfer resources to another entity at some future time, (2) the organization cannot choose to avoid the transfer, and (3) the event creating the responsibility has already occurred. 3. Exhibit 1 presents the liabilities reported on the balance sheet of Mom’s Cookie Company. II. Debt Obligations A. Short-Term Debt 1. An organization has an obligation to repay short-term debt during the coming fiscal period. 2. This includes any portion of long-term debt that will come due during the coming fiscal period. B. Long-Term Debt 1. Long-term debt consists of notes and bonds payable which are contracts between borrowers and creditors. a. Debt obligations that are secured by specific assets are referred to as secured debt or secured loans. b. Other types of debt are unsecured. For example, major corporations often issue debentures, which are unsecured bonds. 2. Debt obligations have many different characteristics. a. Serial bonds are bond issues that require a portion of the bonds to be repaid each year. b. Callable bonds are bonds that a company can reacquire after the bonds have been outstanding for a specific period. c. Convertible bonds can be converted into company stock for a price. C. Debt Transactions 1. The maturity value or face value of bonds is the amount that the company must pay creditors at the end of the bond term. a. Bonds are often sold to yield a return to creditors that is greater or less than the stated rate or nominal rate. b. The annual interest paid on the debt is the stated rate of interest. c. The actual rate of return earned by creditors is the real rate or effective rate. d. Exhibit 2 demonstrates the effect when the effective rate is greater than the stated rate of return. 2. The present value of bonds is calculated by adding the present value of an annuity (the interest payments) plus the present value of a single amount (repayment of the face value). a.
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The present value of the interest payments (annuity) and the present value of the maturity value (single amount) used the yield rate as the discount rate. b. Exhibit 3 illustrates the relationship of future cash flows of a bond obligation and its current (present) value. 3. Real and stated interest rates have an effect on the sales price of bonds. a. When the real rate of interest on the bonds is higher than the stated rate, bonds sell at a discount (at less than maturity value). A sample bond amortization table is provided in Exhibit 4 . b.
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