Book cover for Intermediate Accounting

Intermediate Accounting

Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield

ISBN #9780470374948

13th Edition

695 Questions

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7,109 Students Helped

Homework Questions

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Summary
Learning Objectives
Key Concepts
Example Problems
Explanations
Common Mistakes

Summary

This chapter offers an in-depth examination of long-term liabilities and stockholders’ equity. It covers the procedures for issuing debt, including bonds and notes, and details the valuation and amortization processes essential for accurate financial reporting. Additionally, the chapter explains various aspects of stockholders’ equity management such as stock issuance, repurchase, dividend policies, and corporate actions like stock dividends and splits. Mastery of these topics ensures effective financial analysis and sound decision-making in corporate finance.

Learning Objectives

1

Explain the formal procedures for issuing long-term debt, including bonds and notes.

2

Describe the methods used for valuing and amortizing debt instruments.

3

Analyze the accounting treatments for debt extinguishment and off–balance–sheet financing.

4

Understand the issuance, repurchase, and classification of stock, including various classes and dividend policies.

5

Evaluate the impact of corporate actions such as stock dividends and splits on stockholders’ equity.

Key Concepts

CONCEPT

DEFINITION

Long-Term Liabilities

Obligations not due within the next year, including bonds and notes payable, which require specialized valuation and amortization methods.

Debt Issuance

The formal process of raising funds by issuing bonds or notes to investors, involving compliance with regulatory and procedural requirements.

Bonds

Debt instruments issued by corporations or governments with fixed or variable interest rates, representing a promise to repay the principal along with interest.

Notes

Shorter-term debt instruments often used in conjunction with longer-term financing, usually featuring specific payment schedules and interest terms.

Amortization

The process of gradually writing off the initial cost of a financial instrument over its useful life or term, including both the premium/discount on bonds and interest expense.

Debt Extinguishment

The process of removing a debt obligation from the balance sheet, typically when a company repurchases or restructures its debt.

Off–Balance–Sheet Financing

Financing methods where obligations are not recorded on the balance sheet, often to improve financial ratios or achieve regulatory compliance.

Stockholders’ Equity

The residual interest in the assets of a corporation after deducting liabilities, including common and preferred stock, retained earnings, and additional paid-in capital.

Stock Issuance and Repurchase

Corporate actions involving the selling of new shares to raise capital or buying back existing shares to manage capital structure and control ownership percentages.

Dividend Policies

Guidelines a company follows to determine the size and timing of dividend payments to its stockholders.

Stock Dividends and Splits

Corporate actions that alter the distribution and number of shares outstanding without changing the overall value of stockholders’ equity.

Example Problems

Example 1

(a) From what sources might a corporation obtain funds through long-term debt? (b) What is a bond indenture? What does it contain? (c) What is a mortgage?

Example 2

Potlatch Corporation has issued various types of bonds such as term bonds, income bonds, and debentures. Differentiate between term bonds, mortgage bonds, collateral trust bonds, debenture bonds, income bonds, callable bonds, registered bonds, bearer or coupon bonds, convertible bonds, commodity-backed bonds, and deep discount bonds.

Example 3

Distinguish between the following interest rates for bonds payable: (a) yield rate (b) nominal rate (c) stated rate (d) market rate (e) effective rate

Example 4

Distinguish between the following values relative to bonds payable: (a) maturity value (b) face value (c) market value (d) par value

Example 5

Under what conditions of bond issuance does a discount on bonds payable arise? Under what conditions of bond issuance does a premium on bonds payable arise?
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Step-by-Step Explanations

QUESTION

How do you calculate the bond amortization expense using the effective interest method?

STEP-BY-STEP ANSWER:

Step 1: Identify the carrying amount (book value) of the bond at the beginning of the period.
Step 2: Multiply the carrying amount by the effective interest rate to compute the interest expense for the period.
Step 3: Determine the coupon interest paid to investors during the same period.
Step 4: Calculate the amortization of the premium or discount by subtracting the coupon interest paid from the computed interest expense.
Step 5: Adjust the carrying amount of the bond by adding (if discount) or subtracting (if premium) the amortization amount.
Final Answer: The bond amortization expense is the difference between the interest expense calculated using the effective interest rate and the coupon interest paid.

Bond Amortization

QUESTION

What are the key steps involved in issuing new stock?

STEP-BY-STEP ANSWER:

Step 1: Obtain board approval and necessary resolutions authorizing the stock issuance.
Step 2: Determine the number of shares to be issued and the price per share based on market conditions and company needs.
Step 3: Prepare and file the required regulatory documentation and disclosures with the appropriate financial authorities.
Step 4: Execute the issuance process, which may include an initial public offering, private placement, or rights offering.
Step 5: Record the transaction in the company's financial statements, including any additional paid-in capital and changes in stockholders’ equity.
Final Answer: The stock issuance process involves board approval, determining issuance details, regulatory compliance, executing the issuance, and proper financial reporting.

Stock Issuance Process

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Common Mistakes

  • Failing to distinguish between the effective interest method and the straight-line method in bond amortization.
  • Misinterpreting debt extinguishment as merely removing an obligation without recognizing any associated gains or losses.
  • Overlooking the nuances of off–balance–sheet financing and its impact on assessing a company’s financial liabilities.
  • Confusing stock dividends with cash dividends, leading to errors in stockholders’ equity reporting.
  • Neglecting the procedural and regulatory requirements in both debt issuance and stock issuance processes.