Chapter 12 Notes

Chapter 12 Notes - Chapter 12 notes The objective of debt...

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Chapter 12 notes The objective of debt instruments is to help a company raise needed funds for business. Off-balance sheet financing are methods a company uses to avoid disclosing debt on F/S. Obligations due in the future must be measured in PV terms. Excluding contractual obligations called executory contracts, a liability is not recognized until it is incurred. An obligation may be contingent upon a future event. When the occurrence of a future event becomes probable, the obligation becomes a liability. Revenue received in advance creates a liability for future goods or services. Liabilities are classified as current or non-current (long term). Working capital is calculated as current assets less current liabilities and is a measure of liquidity. The current ratio, current assets/current liabilities, is also a measure of liquidity (can a company meets is current obligation?). Traditionally, a current ratio of less that 2.0 indicated problems but technological improvements have made decreased this #. When debt that has been reported as non-current will mature within one year, the liability should be reported as current to reflect the drain on current assets. However, if the debt is to be repaid by the transfer of non-current assets that have been accumulated for the purpose of liquidating debt, the obligation continues to be non-current. Also, short term debt that is expected to be refinanced on a long term basis should not be reported as current, provided the financing is secure (FASB #6). Two conditions must be met: management must intend to refinance on a LT basis AND demonstrate the ability to refinance. Ability to refinance means actually refinancing during the period between the dates the BS & FS are issued, or procuring an agreement to refinance LT. If refinancing occurs before the BS is issued, the portion of ST debt that is to be excluded cannot exceed the proceeds issued from the new debt to retire the old debt. If the obligation is paid prior to the issuance of FS, then it must be classified as a current liability. For a bond sale, if the note is paid before the sale of bond, it is current; if payoff occurs after the sale, it is non-current. IASB does not allow for the variance in dates between BS & FS, nor do post- balance sheet events effect the classification of debt. If ST debt is not included in current liabilities, it must be disclosed in the notes. The fair value measurement for liabilities is typically the PV of future cash outflows used to settle the obligation. Current obligations that are a result of normal business operations are not discounted; they are reported as face value. Liabilities are divided into 3 categories for reporting purposes: ones that are definite in amount, ones that are estimated, and contingent. Normally desirable to classify current NP on the BS as trade or nontrade because
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Chapter 12 Notes - Chapter 12 notes The objective of debt...

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