Chapter 11

Chapter 11 - Chapter 11 Reporting and Interpreting...

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Financial Accounting, Third Canadian Edition 11-1 Chapter 11 Reporting and Interpreting Long-term Liabilities
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Financial Accounting, Third Canadian Edition 11-2 The acquisition of assets is financed from two sources: Debt - funds from creditors Equity - funds from owners Understanding the Business The mix of debt and equity for a company is called the capital structure .
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Financial Accounting, Third Canadian Edition 11-3 Significant debt needs of a company are often filled by issuing notes and bonds . Bonds Cash Understanding the Business: Capital Structure – Long-term Debt
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Financial Accounting, Third Canadian Edition 11-4 Understanding the Business Advantages of bonds: Bonds are debt , not equity, so the ownership and control of the company are not diluted. Cash payments to the debt holders are limited to the scheduled payments of interest principal. Interest expense is tax deductible . The impact on earnings is positive ( positive financial leverage ) because money can often be borrowed at a low interest rate and invested at a higher interest rate.
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Financial Accounting, Third Canadian Edition 11-5 Understanding the Business Disadvantages of bonds: Risk of bankruptcy exists because the interest and principal are legal obligations and must be paid back as scheduled or creditors will force legal action. A single, large principal paymen t is required at the maturity date. Negative impact on cash flows exists because interest and principal must be repaid in the future.
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Financial Accounting, Third Canadian Edition 11-6 Financial Leverage Financial Leverage Financial Leverage is the use of borrowed funds to increase the rate of return on owner’s equity; it occurs when the interest rate on debts is lower than the rate of return on total assets.
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Financial Accounting, Third Canadian Edition 11-7 Financial Leverage Capital Structure ________________________ Total assets = $600,000 50% Debt 100% Equity 50% Equity Income before interest and taxes $ 100,000 $ 100,000 Interest expense ($300,000 x 10%) -0- 30,000 100,000 70,000 Income tax expense (@40%) 40,000 28,000 Net income $ 60,000 $ 42,000 Long-term debt $ 0 $ 300,000 Owners’ equity $ 600,000 $ 300,000 Return on equity (Net income/Owners’ equity) 10% 14%
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Financial Accounting, Third Canadian Edition 11-8 Types of Long-Term Debt Long-term debt is available to companies in various forms: Bank loans Notes Mortgages Bonds and Debentures
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Financial Accounting, Third Canadian Edition 11-9 As liquidity increases . . . . . . Cost of borrowing decreases. Bonds can be Bonds can be traded on traded on established established exchanges that exchanges that provide provide liquidity liquidity to bondholders. to bondholders. Understanding the Business
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Financial Accounting, Third Canadian Edition 11-10 Characteristics of Bonds Payable $ Bond Issue Price $ Bond Certificate At Bond Issuance Date Bonds payable are long-term debt for the issuing company.
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Chapter 11 - Chapter 11 Reporting and Interpreting...

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