Chapter 9

Chapter 9 - Chapter9 9-1

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Chapter 9 9-1 Current liabilities are obligations that fall due within the coming year (or within one operating cycle, if longer than a year). Long-term liabilities fall due beyond one year from the balance sheet date. 9-2 Accounts payable are obligations arising from purchasing goods and services on credit. Notes payable are promises to repay principal plus interest at specific future dates. Salaries and wages payable are amounts earned by employees but not yet paid. Income taxes payable are taxes yet to be paid to the government on recorded income. Current portion of long-term debt is the amount of principal due within the next year on long-term debt. Interest and rent are additional accruals. 9-3 Except for additional clerical costs, withholding taxes do not add to employer costs. It is true that social security taxes have two parts – a portion withheld from the employee and an equal portion paid by the employer. 9-4 No. Warranty obligations should be accrued at the time of sale. Such recognition requires an estimate of warranty claims, but a best estimate is better than ignoring the obligation for warranty services. 9-5 A mortgage bond is secured by the pledge of specific property. A debenture is a general claim against the total assets of the firm. If the same company issues both mortgage bonds and debentures, the mortgage bond is safer because mortgage bondholders have first claim on funds from liquidation of the pledged asset or assets. 1
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9-6 If no lien exists against specific assets, the bond is called a debenture . Holders of debentures have no specific claim against the assets beyond their general claim against the total assets -- a claim shared with other general creditors, such as trade creditors. Subordinated debentures give bondholders a claim that is junior to other general creditors' claims against the total assets. If the debentures are unsubordinated , the holders would have the same priority as general creditors. 9-7 No. Protective covenants generally protect bondholders . 9-8 Covenants benefit the lender or investor. They restrict the issuer's behavior. This is important because without such a restriction, the issuer could do things detrimental to the investor's interest. For example, in KKR's buyout of RJR Nabisco substantial new debt was issued that increased RJR Nabisco's debt/equity ratio. Existing debt became more risky and its price fell significantly. 9-9 The call provision benefits the issuer who obtains a choice in managing future financial affairs. The call premium compensates the investor for the investor's risk that the issuer will choose to redeem the bond early, to the investor's detriment. 9-10 The face amount is the payment due at maturity. If market interest rates for similar bonds are above the coupon interest rate of a particular bond, the market price of this bond would be less than the face amount, and vice versa. 9-11 The bond markets compound interest semi-annually. Therefore, a 12 percent rate really means 6 percent interest for every 6 month period, compounded.
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Chapter 9 - Chapter9 9-1

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