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Unformatted text preview: 1 Chapter 3 Analyzing Financing Activities This chapter describes accounting analysis of financing activities both creditor and equity financing. Our analysis of creditor financing considers both operating liabilities and financing liabilities. Analysis of operating lia- bilities includes extensive study of post retirement benefits. Analysis of financing liabilities focuses on topics such as leasing and off-balance sheet financing, along with conventional forms of debt financing. We also analyze com- ponents of equity financing and the relevance of book value. Liabilities Current Liabilities Conceptually, companies should record the lia- bilities of the present value of the cash flow required to settle them. In practice, current liabilities are recorded at their maturity value, and not their present value, due to the short time period until the settlement. Current liabilities are of two types: These classifications are important because improper classification of liabilities can affect key ratios in fi- nancial analysis. Many borrowing agreements include covenants to protect creditors. In the evened of default, say in the maintenance of specified financial ratios such as that debt-to-equity ratio, the indebtedness becomes immediately due and payable. Any long term debt in default must, therefore, be reclassified as a current liability. A violation of a noncurrent debt covenant does not require reclassification of the noncurrent liability as current provided that the lender waives the right to demand repayment for more than a year from the balance sheet date. Noncurrent Liabilities They include loans , bonds , debentures , and notes . The noncurrent liabilities can take various forms, and their assessment and measurements requires disclosure of all restrictions and covenants. Disclosures include interest rates, maturity dates, conversion privileges, call features, and subordination provisions. They also include pledged 2 collaterals, sinking funds requirements, and a revolving credit provisions. Companies must disclose defaults on any liability provisions, including those for interest and principal repayments. A bond is a typical noncurrent liability. The bonds par (or face) value along with its coupon (contract) rate determines cash interest paid on the bond. Since the interest rate that will prevail in the bond market at the time of issuance of bonds can never be predetermined, bonds usually are sold in excess of par ( premium ) or below par ( dis- count ). This premium or discount represents, in effect, an adjustment of the coupon rate to the effective interest rate. The premium received is amortized over the life of the issue, thus reducing the coupon rate of interest to the effec- tive interest rate incurred. Conversely, the discount also is amortized, thus increasing the effective interest rate paid by the borrower....
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This note was uploaded on 06/11/2011 for the course ACCT 3607 taught by Professor Mike during the Spring '11 term at Assumption College.
- Spring '11