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Intermediate Accounting

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12 Debt Financing Overview There are three primary ways in which a business can obtain assets. The most important means, in the long run, is through operations. Selling goods or services for more than it costs to make, procure, and/or administer the selling of them is essential for a company’s long-term stability. However, in the short term, especially when a business is new or is planning to expand, other means of financing become necessary. The two other primary ways in which a business can obtain assets is through debt and through equity financing. This chapter focuses on the first of those two, right-hand-side- of-the-balance-sheet financing methods. There are a wide variety of debt financing options available to businesses. The number of options seems to be increasing every day. These liabilities are generally listed on the balance sheet in the order in which they will come due. Items that will usually be paid back in the next month, such as Accounts Payable, are shown first. The last liabilities listed may be items that are not to be paid for ten years or more, such as Bonds Payable. Some “debt” doesn’t even show up on the balance sheet. Off-balance-sheet financing has become a hot topic in recent years—largely in part to abuses and scandals that have taken place with companies like Enron that used such tactics to make their financial position look better than it was. New accounting standards are now requiring additional disclosures when this kind of financing happens and fewer opportunities for off-balance-sheet financing to take place. The issue isn’t going to go away, however, so it is important to understand how off-balance-sheet financing happens, how to discover its existence in the disclosure notes, and how to interpret what it would mean should that “debt” actually show up on the face of the balance sheet. Financial ratios dealing with debt financing need to be examined with care. For instance, a business with no off-balance-sheet financing probably shouldn’t be compared straight across with a company which has billions of dollars of operating leases (not shown on the balance sheet) for which the leased assets will be used for, say, 74 percent of their useful lives by the business leasing the asset.
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12-2 Chapter 12 Learning Objectives Refer to the Review of Learning Objectives at the end of the chapter. It is crucial that this section of the chapter is second nature to you before you attempt the homework, a quiz, or exam. This important piece of the chapter serves as your CliffsNotes or “cheat sheet” to the basic concepts and principles that must be mastered. If after reading this section of this chapter you still don’t feel comfortable with all of the Learning Objectives covered, you will need to spend additional time and effort reviewing these concepts that you are struggling with.
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