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Long-term Liabilities are obligations that are expected to be settled over more than one year or operating cycle e.g. bonds, long-term notes payable, long term 2.
loans, finance leases, deferred tax liabilities and pension liabilities.
Accounting for Bond Issuance
Par value Bond: If the market (effective) rate of interest is equal to the contractual (coupon) rate, the bonds will sell at its face/par value. • Discount Bond: If the market (effective) rate of interest is higher than the contractual (coupon) rate, the bonds will sell at less than face value, or at a discount. • Premium Bond: If the market rate of interest is less than the contractual rate on the bonds, the bonds will sell above face value, or at a premium.
Accounting Treatment: For issuer
Bonds are contractual promises made by a company (borrower) to lenders (bondholders) to pay cash in the future in exchange for receiving cash now.
• Details of terms of the bond are recorded in the bond document called indenture. • The bond indenture describes the maturity date, interest payment dates, interest rate, frequency of payments (i.e. annually, semi-annually etc.) and characteristics of the bonds. Types of future cash payments of bonds: 1. Face value of the bonds: The face value is the amount of principal due at the maturity date. It is also known as principal, par value, stated value or maturity value. 2. Periodic interest payments/coupon payments or coupon: These interest payments are based on the interest rate promised (contractual interest rate/stated rate) i.e. interest payment = face value × contractual rate. Definitions: Coupon rate: Contractual interest rate is referred to as Coupon rate, nominal rate or stated rate. For fixed rate bonds, coupon rate remains constant throughout the life of the bonds. Market value: The market value of a bond is equal to the present value of all future cash payments promised by the bond. Market interest rate: It is the rate demanded by buyers of bonds considering the risks associated with future cash payments of the particular bond issue. Effective Interest Rate/Borrowing Rate: It is the market rate of interest at the time of issuance of bond. • It is the discount rate that makes the present value of all the future cash payments promised by the bond equal to their selling price. • For the issuer, interest expense is calculated using effective interest rate. Carrying amount/Carrying value/Book value/Net book value: It refers to the amount at which bonds are reported on the balance sheet of an issuer.
• Cash received from issuing bonds is reported as Financing cash inflow. • Issuance of bonds results in increase in cash and increase in long-term liability. • On balance sheet, initially, bonds payable are reported at = face value – (+) discount (premium).
Practice: Example 1 & 2, Volume 3, Reading 32, P. 534 & 535.
Accounting for Bond Amortization, Interest Expense and Interest Payments
NOTE: Accounting treatment of bonds payable and notes payable is similar
On balance sheet, bonds can be recorded at:
a) Amortized historical cost: Historical cost +/cumulative amortization (or amortization cost) • Note that analyzing company’s underlying economic liabilities and solvency is more difficult for investors when debt is reported at amortized historical cost. b) Fair values Under IFRS: • Initially, bonds are reported as a liability on the balance sheet by the amount equal to sales proceeds – issuance costs. • All debt issuance costs are included i.e. printing, legal fees, commissions and other types of charges are included to measure the liability and are part
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Non-current (Long-term) Liabilities
500 Semiannual interest expense = 12. carrying amount (amortized cost) of the bonds increases to face value over time. carrying amount (amortized cost) of the bonds decreases to face value over time. 538 & 539. • Initially. NOTE: For zero-coupon bonds. • Initially.000 / 6 = 1. • At maturity.12 × (6/12) = 12. In indirect method of cash flow from operation: Bonds issued at discount: For bonds issued at discount. • Cash outflows related to bond issuance costs are classified as financing cash outflows. interest payments are not shown separately on the statement of cash flow. • The amount of periodic interest expense* < amount of periodic interest (coupon) payment to bondholders. • Interest payments are classified as operating cash outflow.1. a) Bond interest expense = Carrying value of the bonds at the beginning of the period × Effective interest rate b) Bond Interest Payment = Face value of the bonds × Contractual (coupon) rate c) Amortization of the discount (or premium) = Bond interest expense – Bond interest payment 2) Straight-line Method: The straight-line method of amortization of bond discount/premium allocates the same amount each period.000 Periodic premium amortization = 9. Volume 3. Under U.000 Periodic discount amortization = 9. • Debt issuance costs are recorded separately as an asset (deferred charge) and are amortized on a straight-line basis over the life of the bonds. *Interest expense = periodic interest payments + amortization of discount • Amortization of discount is added back to net income. • The amount of periodic interest expense = amount of periodic interest (coupon) payment to bondholders. but companies are required to disclose separately the amount of interest paid. • Amortization of premium is subtracted from net income.000 / 6 = 1.000 + 1. Reading 32.S.500 Important to note: Amortization of discount or premium is a non-cash item and thus it does not affect cash flow. carrying amount = face value. GAAP: • Initially.000 × 0. bonds are reported as a liability on the balance sheet at the amount of sales proceeds only. NOTE: Typically. accounting and reporting is the same as above except that there are no interest payments in zero-coupon bonds.S. amount of interest expense = amount of discount amortization.500 Amortization of Bond Premium: Number of periods = 3 × 2 = 6 Semiannual interest payment = 200.500 Semiannual interest expense = 12. Carrying amount >Face value.com of the carrying amount. P. 2 . *Interest expense = periodic interest payments . • As the discount is amortized.000 .500 = 13. • At maturity.000 × 0. Bond Discount/Premium Amortization = ୭୬ୢ ୈ୧ୱୡ୭୳୬୲ ୭୰ ୮୰ୣ୫୧୳୫ ୳୫ୠୣ୰ ୭ ୍୬୲ୣ୰ୣୱ୲ ୣ୰୧୭ୢୱ Bonds issued at par value: For bonds issued at face value. • Carrying amount = Face value. Carrying amount < face value.Reading 32 Non-current (Long-term) Liabilities FinQuiz. • This method better reflects the economic substance of the transaction. • Cash outflows related to bond issuance costs are classified as financing cash outflows.amortization of premium Example: Amortization of Bond Discount: Number of periods = 3 × 2 = 6 Semiannual interest payment = 200.500 = 10. • The amount of periodic interest expense* > amount of periodic interest (coupon) payment to bondholders. Practice: Example 3 & 4. Thus.12 × (6/12) = 12. • Interest payments can be classified either as operating cash outflow or financing cash outflow. • Bonds issued at discount reflect that some of the borrowing costs have been paid by the issuer at issuance. GAAP. carrying amount = face value. Bonds issued at premium: For bonds issued at premium. Two Methods for Amortizing the Premium or Discount of Bonds: 1) Effective Interest Rate Method: • It is required under IFRS but preferred to use under U. • As the premium is amortized.
• When financial liabilities are measured at other than fair value whereas financial assets are 2. • Bond repayment is treated as financing cash outflow. Covenants refer to terms and conditions of the lending agreement. They deal with limitations and restrictions on the borrower’s activities and play an important part in minimizing risk to creditors and in reducing the cost of borrowing. • Bond repayment is treated as financing cash outflow. When market interest rate decreases Practice: Example 5. b) If the bonds are redeemed before the maturity date: • On balance sheet. gain (loss) is reported.3 Current Market Rates and Fair Value Reporting Option measured at fair value. issuer can purchase bonds in the open market or can exercise a call option. companies are required to writeoff any unamortized debt issuance costs at the time of redemption. bonds payable is reduced by the carrying amount of redeemed bonds and cash is reduced by an equal amount. it leads to earnings volatility. companies are required to disclose fair value of their liabilities unless carrying amount is approximately equal to fair value or fair value cannot be reliably measured. Practice: Example 6. 542. debt-to-capital and leverage ratios are Overestimated. Volume 3. Reading 32. • On balance sheet. P. • Under both IFRS and U. • Financial liabilities when reported at fair value are designated as financial liabilities at fair value through profit or loss. loss is reported due to increase in the fair value of a liability. • In indirect method of statement of cash flows net income is adjusted for any gain/loss on early retirement of debt. • If the amount of gain or loss is material. • Carrying amount = Face value. 3 . Fair value of a Bond with fixed coupon rate increases 2. GAAP. face value) and cash is reduced by an equal amount. bonds payable is reduced by the carrying amount at maturity (i. • Under U. There are two types of covenants. Volume 3.Reading 32 Non-current (Long-term) Liabilities FinQuiz. privileges. gain is reported due to decrease in the fair value of a liability.S.* If amortized historical cost is used. • Discount/premium on the bond will be fully amortized at maturity. 544. • *Gain or loss resulting from changes in fair value is reported in profit or loss.e. it is reported separately as a line item on the Income statement. GAAP.com 2.S. P. If fair value is used. and limitations of the bondholders. a) If the bonds remain outstanding until the maturity date: • Issuer pays face value of bonds at maturity to bondholders. Reading 32. If amortized historical cost is used. These are included in the gain/loss. • When the cash paid to redeem the bond < (>) carrying amount of bonds.5 Debt Covenants A bond indenture defines the rights. debt-to-capital and leverage ratios are Underestimated.4 Derecognition of Debt Company's reported liabilities > reported debt at amortized historical cost To retire a bond early. When market interest rate Increases Fair value of a Bond with fixed coupon rate decreases Compnay's reported liabilities < debt reported at amortzied historical cost If fair value is used.
2 Finance (or Capital) Leases versus Operating Leases 1) Lease provides less expensive financing as it usually requires zero down payment. Additional information i. LEASES A lease is a contractual agreement in which financing is provided by the lessor (owner of an asset) to the lessee. On the balance sheet. • Warrants: They give the debt holder the right to buy shares of issuer’s common stock at a specified price. 3.6 Presentation and Disclosure Practice: Example 9.1 Advantages of Leasing leverage ratios as compared to borrowing.g. Volume 3. disposition to the lessee as the asset can be returned to lessor at the end of the lease. When any debt covenant is violated by a borrower.e. 3. 2. residual value. • To maintain all properties used in the borrower’s business in good conditions and working order. • To pay all taxes and other claims when due. 3) The negotiated lease contract may contain less restrictive provisions than other form of borrowing. 2) Leases are often based on fixed interest rates. 4 .com 1) Affirmative Covenants: These covenants require the debtor to do certain things that will improve the credit quality of the issuer. lessee makes periodic payments to the lessor. 548. 551. Notes provide information regarding: • • • • • Stated and effective interest rate Maturity dates Covenants Collateral pledged as security (if any) Amount of scheduled debt repayments for the next 5 years Practice: Example 8. timing of future cash outflows is provided in the notes to financial statements. 6) Lease also provides a tax reporting advantage e. debt-toequity i. Finance (or capital) Lease: Finance Lease is the purchase of some asset by the buyer (lessee) that is directly financed by the seller (lessor).e. lenders may: Portion of the long-term liabilities due within next 12 months is reported as part of the current liability on the balance sheet.Reading 32 Non-current (Long-term) Liabilities FinQuiz. For example: • To pay interest. if any on a timely basis. P. number of shares subscribed for = (aggregate principal amount of debt /par value of a lot) × shares subscribed per lot • • • • Waive the covenant Ask for penalty payment or higher interest rate Renegotiate with the borrower Call for the payment of entire debt Practice: Example 7. Volume 3. 547. it cannot be greater than the specified level. and premium. For example: • Limitations on the company’s ability to incur debt in the future. When warrants are exercised. 5) Operating leases (also known as off-balance sheet financing) do not require a liability to be reported on balance sheet. In exchange of receiving the right to use the asset. types & nature of debt. to pay dividends or to make other strategic decisions. total amount of long-term liabilities due after one year is reported as a single line item. It is similar to purchasing the asset where the purchase is financed by the seller (lessor). 2) Negative Covenants: Negative covenants are those which require the borrower not to take certain actions. Reading 32. 4) Leases reduce risk of obsolescence. P. a synthetic lease can be created which allows the lessee to deduct depreciation and interest expense for tax purposes and for financial purposes lease can be treated as an operating lease in which only rent expense is recorded and no lease liability is reported on the balance sheet. • Limitations on level of financial ratios e. • To maintain certain ratios above a specified amount. NOTE: Debt contracts may include: • Convertible debt: It gives the debt holder the right to exchange debt for equity. 3. principal.g. This improves Types of Lease: 1. Volume 3. P. to invest. Reading 32. Reading 32.
only lessee can use it without making any major changes.2. On the statement of cash flows: • Under U. while the portion of lease payment that reduces lease liability is reported as financing cash outflow. **Because. only the depreciation expense is treated as operating expense whereas in operating lease. paragraph 10). • On the statement of cash flows. 4) The PV of lease payments is 90% or more of the fair value of the leased asset. Higher return measures in early years. Classification of Lease: Under IFRS.e. Operating Lease: • On the balance sheet. • Under IFRS: Interest expense can be reported as operating cash outflow and/or financing cash outflow. the lease is classified as a finance lease and a lessee reports a leased asset and a lease liability on the balance sheet.Reading 32 Non-current (Long-term) Liabilities FinQuiz. The four requirements are as follows: 1) Ownership of the leased asset transfers to lessee at end of the lease. the lessee reports interest expense on the debt (lease liability) and the asset depreciation expense (if the asset acquired is depreciable). 2) The lease contains an option for the lessee to purchase the leased asset at a price less than fair market value of the asset at some future date (also known as bargain purchase option). Stronger solvency position (lower debt ratios). no asset or liability is recorded. Lower operating cash flows. • The initial value of both the lease asset and the lease payable is the lower of the fair value of the leased asset or the PV of future lease payments. in finance lease. • At the lease inception. • The lease asset is of a specified nature i. GAAP. ownership of an asset is transferred to the lessee. 5 . • On the income statement.S. NOTE: Total expense over the life of the lease will be identical for both operating and finance lease. the PV of the minimum lease payments represents at least substantially all the fair value of the leased asset. For example (IAS 17. a lease that meets any one of four specific requirements is classified as a finance lease. 3. a lease would be classified as finance lease when: • At the end of the lease. lessee reports leased asset and related liability (lease payable). 3) The lease term is 75% or more of the useful life of the leased asset. On the income statement. Summary of Financial Statement Impact of Lease Accounting Finance Lease Assets Liabilities (current & long-term) Net income (in the early years)* Net income (later years) Total Net income EBIT (operating income)** Cash flow from operations Cash flow from financing Total cash flow Higher Higher Lower Operating Lease Lower Lower Higher Lower Same Lower Lower Higher Same Higher Same Higher Higher Lower Same * Because depreciation & interest expense is higher in early years in finance lease relative to operating lease. It is similar to renting an asset. the lessee reports rent expense which is equal to lease payment only. the entire lease payment is treated as operating expense. Operating Lease: An Operating Lease is an agreement which allows the lessee to use the asset for a period of time. NOTE: A lease which does not meet any of these criteria is classified as an operating lease. if all risks and rewards related to ownership are transferred to the lessee. • The lease term represents a major part of economic life of the asset even if title is not transferred. lessee reports full lease payment (rent expense) as an operating cash outflow. Under U. a company reporting a lease as an operating lease as compared to an identical company reporting an identical lease as a finance lease will show: • • • • Higher profits in early years. • Interest expense = lease liability at the beginning of the period × interest rate (Interest rate used by the lessee is the lower of the lessee’s incremental borrowing rate and the lessor’s implicit rate).1) Accounting and Reporting by the Lessee Finance Lease: On balance sheet. GAAP: only the portion of the lease payment relating to interest expense is reported as operating cash outflow. • The lease contains an option for the lessee to purchase the leased asset at a price less than fair market value of the asset at some future date.S. In summary.com 2.
• Cost of sales = carrying amount of the leased asset – PV of the estimated unguaranteed residual value. For manufacturer or dealer lessor. Financial Statement Impact of Lease Accounting Practice: Example 10. And the lessor also reduces its assets by the carrying amount of the leased asset.com Ratio Impact of Lease Accounting Finance Lease Current ratio (CA/CL) * Working Capital (CA – CL) * Asset Turnover (Revenue/TA) Fixed Asset Turnover (Revenue/Net Fixed Assets) Return on Assets (NI/TA) in early years Lower Lower Lower Operating Lease Higher Higher Higher Under U. only the interest revenue portion of the lease payment is reported as operating cash inflow. GAAP: To classify the lease as finance (capital) lease.S. Volume 3. Lease Disclosures Requirements: Under IFRS: • Future lease payments (both capital/finance and operating leases) are disclosed for the first year. Any direct costs incurred initially by a lessor (except manufacturer or dealer lessor) are reported as part of receivable and reduce the amount of income recognized over the lease term. any initial direct costs are treated as expense and are deducted to determine selling profit. 11 & 12. otherwise lease would be classified as operating lease. Under U. the lessor reports interest revenue on the lease only. 3. the lessor continues to report the leased asset. Reading 32. On the Income Statement. * Revenue recognition requirements: Seller is reasonably certain to collect cash and he/she has performed substantially under the lease.S. • Sales revenue = lower of the fair value of the asset or PV of the minimum lease payments. Interest Revenue = Lease receivable at the beginning of the period × interest rate Repayment of principal is treated as reduction in lease receivable and financial income. • And then aggregated for all subsequent years. On the Income Statement.2) Accounting and Reporting by the Lessor Under IFRS: A lease is classified as finance lease if the lessor has substantially transferred all the risks and rewards.Reading 32 Non-current (Long-term) Liabilities FinQuiz. Higher Lower Higher Higher Lower Lower * The Principal payment due within next year is reported as a current liability on the lessee’s balance sheet. 557 &559. Finance Lease from the Lessor’s Perspective: Lower (due to higher fixed assets) Return on Assets (NI/TA) in subsequent years Return on equity (NI/shareholders’ equity) in early years Return on equity (NI/shareholders’ equity) in subsequent years Debt-to-Assets ratio Debt-to-Equity ratio Higher Lower Higher On the Balance Sheet. 555. income reported under finance lease > income reported under operating lease. GAAP: • Future lease payments (both capital/finance and operating leases) are disclosed for first five years on year by year basis. Over the total lease term. P.2. the lessor reports interest (lease) revenue and also continues to report depreciation expense related to the leased asset. • And then in aggregate for all subsequent years. On the statement of cash flows. Operating Lease from the Lessor’s Perspective: Lower Higher Higher (because NI is high and asset base is low) Lower On the Balance Sheet. 6 . the lessor reports a lease receivable based on the PV of future lease payments. the entire lease payment is reported as operating cash inflow. On the statement of cash flows. • Future lease payments (both capital/finance and operating leases) are disclosed in aggregate for Years 2-5. In the early years of the lease. This reduces the lessee’s current ratio and working capital. at least one of the four criteria and the revenue recognition requirements* must be met by the lessor. total lease revenue and total change in cash (total cash flows) is identical under both finance and operating leases. while the principal portion of lease payment is reported as investing cash inflow.
lessor removes the asset from the balance sheet and a lease receivable is created by the same amount. Accounting for defined contribution plan is relatively straight-forward. interest portion of the lease payment is reported as an operating cash inflow while the principal reduction is reported as investing cash inflow. 4. Volume 3. interest portion of the lease payment is reported as an operating cash inflow while the principal reduction is reported as investing cash inflow. Types of Finance Lease: Under U. lessor recognizes profit (loss) on the sale of the leased asset & interest revenue where. 7 . Interest Revenue = Lease receivable at the beginning of the period × interest rate On the statement of cash flows. In the Income statement. Reading 32. there is no distinction between a sales-type lease and a direct finance lease. liabilities (debt) and expenses and therefore higher ROA and lower leverage. Gross Profit (Loss) = Sales price – Cost of goods sold Profit on the transaction is reported at inception and interest revenue is reported over the lease term. On statement of cash flows. Operating cash flow is higher under operating lease since entire lease payment is reported as operating cash-inflow. INTRODUCTION TO PENSIONS AND OTHER POST-EMPLOYMENT BENEFITS Long-term liabilities also include pension and other post-employment benefits e. • In the Income statement.S. Lessor would prefer a finance lease because. • However. NOTE: Under IFRS. • Sale = PV of the lease payments • Cost of goods sold = carrying amount of the asset. 2) Sales-Type Lease: It results when PV of lease payments >Carrying amount of the leased asset Lessor earns both interest revenue and a profit (or loss) on the sale of the leased asset. • At the inception of the lease. amount paid is treated as operating cash outflow. Practice: Example 13 & 14. there are two types of Finance (Capital) lease from the lessor’s perspective: 1) Direct-Financing Lease: It results when PV of lease payments = Carrying amount of the leased asset • Lessor earns only interest revenue over the life of the lease. Thus.g. lessor removes the asset from the balance sheet and a lease receivable is created. At the inception of the lease. depreciation) on their balance sheet. 565 & 567. When some portion of the amount is not paid by fiscal year end. When amount is paid.e. lessor is not required to show the asset and its associated financing (i. Taxes paid are higher in early years in finance lease due to higher revenue in early years.com In the subsequent years. it is recorded as a liability on the balance sheet. Important: • Lessee often prefers operating leases to finance leases because of lower reported assets. under finance lease. income reported under finance lease < income reported under operating lease. Interest Revenue = Lease receivable at the beginning of the period × interest rate • On the statement of cash flows. GAAP. • Pension plans (they are the most significant postemployment benefits) • Health care plans • Medical insurance • Life insurance Types of Pension Plans: 1) Defined Contribution Plan: Under defined contribution plan • An employer (company) contributes an agreedupon amount in the plan and employer has no • • • • • obligation to make further payments beyond that amount. The agreed upon amount represents an expense for the employer. lessor recognizes interest revenue where. it is recorded as reduction in cash on the balance sheet.Reading 32 Non-current (Long-term) Liabilities FinQuiz. P.
• This pension obligation is treated as pension expense and is allocated over the employee’s employment. o Payments are made into the fund. • When the difference between actual return and expected return is large. Reading 32. o Interest expense is the increase in the liability due to the passage of time. • Pension expense for employees not directly related to production is treated as part of salaries and other administrative expenses. 571.e. Interest expense accrued on the beginning pension obligation. 2) Net pension obligation (or asset) can be measured by excluding the unrecognized smoothed amounts of actuarial gains/losses or past service costs from the balance sheet. • The pension benefit amount is defined on the basis of Plan Formula i. rather. compensation increases. • When expected returns are estimated accurately. then the long-run. can use expected instead of actual return on investments. EVALUATING SOLVENCY: LEVERAGE AND COVERAGE RATIOS Solvency refers to ability of a company to meet its long-term obligation i. interest payments & principal repayment. Practice: Example 15. Under IFRS: There are two ways to measure net pension obligation (or net pension asset) 1) Net pension obligation (or asset) can be measured as follows: Net pension obligation (or asset) = Pension obligation – Plan assets • When pension obligation > plan assets. Actuarial gains and losses: Actuarial gains & losses can occur when changes are made to the assumptions on which a company’s estimated pension obligation has been based e.com 2) Defined Benefit Plan: Under defined benefit plan • An employer (company) is obligated to pay future benefits to the employee during retirement. Smoothing reduces the volatility of pension expense and net income. companies must amortize a portion into pension expense. • Pension expense for employees directly related to production is added to inventory and expensed through cost of sales. v. • When pension obligation < plan assets. Expected return on plan assets • Typically.e. defined benefit plans are funded through a separate legal entity called a pension trust fund. net pension obligation is reported and plan is underfunded. P.Reading 32 Non-current (Long-term) Liabilities FinQuiz. o Retirees are paid from that fund. Prior service costs or past service costs: It is the cost or increase in the PV of a company’s estimated pension liability that results from changes to the terms of a pension plan applicable to employees’ service during previous periods. • Pension expense is composed of 5 common components: i. Treatment of pension expense related to production employees: Pension expense is not directly reported on the Income Statement. Both IFRS and U. employee turnover. iii. GAAP: Companies are required to measure net pension obligation (or asset) as pension obligation – plan assets.S. Under U.S. retirement ages. • Future amount to be paid are estimated and discounted to determine the PV of pension obligation. Volume 3. ii. number of years an employee is expected to live beyond retirement.g. iv. o These payments remain invested until they are paid.e. These include: 8 . Primary types of Solvency Ratios include: 1) Leverage Ratios Leverage ratios focus on balance sheet and are used to evaluate the degree of use of liabilities instead of equity to finance assets. GAAP allow companies to “smooth” the effects of actuarial gains/losses or past service costs over time by not recognizing them immediately as income or expense. o Years of service o Compensation (expected salary) etc. o Age i. Employees’ service costs incurred during the period o Service cost: It is the present value of new benefits earned by the employee for working another year. Reported pension expense = Pension costs – expected* earnings on investments (on Pension plan assets) NOTE: *In order to reduce the volatility of reported pension expense resulting from market fluctuations. companies 5. net pension asset is reported and plan is overfunded. actual return = expected return. Thus. mortality rates.
d) Financial Leverage Ratio (or Leverage Ratio) = ୴ୣ୰ୟୣ ୭୲ୟ୪ ୱୱୣ୲ୱ ୴ୣ୰ୟୣ ୭୲ୟ୪ ୗ୦ୟ୰ୣ୦୭୪ୢୣ୰ୱᇱ ୣ୯୳୧୲୷ Practice: Example 16.com a) Debt-Capital Ratio = 2) Coverage Ratios Coverage ratios focus on income statement and are used to evaluate the company’s ability to satisfy its debt-related payments. • Higher ratio indicates stronger solvency position. weaker solvency. the greater the financial risk of a company and weaker solvency position. • It measures the percentage of a company's capital (debt + equity) financed through debt. b) Fixed charge coverage = ୍ ା ୣୟୱୣ ୮ୟ୷୫ୣ୬୲ୱ ୍୬୲ୣ୰ୣୱ୲ ୟ୷୫ୣ୬୲ୱାୣୟୱୣ ୮ୟ୷୫ୣ୬୲ୱ • It measures the amount of debt capital relative to equity capital. NOTE: Lease payments are added to numerator because they were deducted to calculate operating profits. • Higher ratio indicates stronger solvency. 575. taxes and lease payments). Reading 32. greater the financial risk of a company and weaker solvency position. c) Debt-Equity Ratio = ୭୲ୟ୪ ୈୣୠ୲ ୭୲ୟ୪ ୗ୦ୟ୰ୣ୦୭୪ୢୣ୰ୱᇱ ୣ୯୳୧୲୷ • It reflects the number of times a company is able to pay off its interest payments (service its debt) with its EBIT (operating income). Volume 3.Reading 32 Non-current (Long-term) Liabilities ୭୲ୟ୪ ୈୣୠ୲∗ ୭୲ୟ୪ ୈୣୠ୲ ା ୭୲ୟ୪ ୗ୦ୟ୰ୣ୦୭୪ୢୣ୰ୱᇱ ୯୳୧୲୷ FinQuiz. Practice: End of Chapter Practice Problems for Reading 32 9 . • Higher ratio indicates greater amount of debt and thus.Assets (or Total Debt) Ratio = ୭୲ୟ୪ ୈୣୠ୲ ୭୲ୟ୪ ୟୱୱୣ୲ୱ a) Interest Coverage (or Times interest earned) = ୮ୣ୰ୟ୲୧୬ ୮୰୭ϐ୧୲ ሺ୍ሻ ୍୬୲ୣ୰ୣୱ୲ ୮ୟ୷୫ୣ୬୲ୱ • It reflects the percentage of total assets financed with debt. the higher the debt. P. b) Debt . NOTE: Debt-to-equity ratio of 1 = Debt-to-capital ratio of 50%. • Generally. excluding liabilities such as accrued expenses and accounts payable • It reflects the number of times a company is able to pay off its interest and lease payments with its earnings (before interest. • It measures the amount of total assets supported by one money unit of equity. * Total Debt = interest-bearing short-term + long-term debt. • Higher the ratio. the greater the financial risk of a company and weaker solvency position. • The higher the ratio.
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