Chapter 11 - Long-term liabilities: Notes, bonds, and leases. This chapter list three major long-term liability categories and identify key financial ratios relied upon to assess the importance of these liabilities as a form of financing; list three basic contractual forms that underlie long-term liabilities, and in each case show how the effective interest rate is computed. | 1 Chapter 11 Long-Term Liabilities Notes, Bonds, and Leases 2 2 Long-Term Liabilities Many companies finance their operations and growth opportunities through the use of long term debt instruments: Notes Payable – Formal borrowing agreement Bonds Payable – Issued to bondholders, smaller dollar amounts and larger amount of notes Leasehold Obligations – future cash payments for use of an asset 3 The Relative Size of Long-Term Liabilities 4 Figure 11-1 Long-term liabilities as a percentage of total assets, total liabilities, and shareholders’ equity Economic Consequences of Reporting Long-Term Liabilities 5 Improved credit ratings can lead to lower borrowing costs Management has strong incentive to manage the balance sheet by using “off-balance-sheet financing” Basic Definitions and Different Contractual Forms 6 Some contracts, called interest-bearing obligations, require periodic (annual or semiannual) cash payments (called interest) that are determined as a percentage of the face, principal, or maturity value, which must be paid at the end of the contract period. Non-interest-bearing obligations, on the other hand, require no periodic payments, but only a single cash payment at the end of the contract period. These contractual forms may contain additional terms that specify assets pledged as security or collateral in case the required cash payments are not met (default), as well as additional provisions (restrictive covenants). Basic Definitions and Different Contractual Forms 7 Figure 11-2 Six possible kinds of notes Long-term liabilities are recorded at the present value of the future cash flows. Two components determine the “time value” of money: interest (discount) rate number of periods of discounting Types of activities that require PV calculations: notes payable bonds payable and bond investments capital leases 8 Long-Term Liabilities Notes, Bonds, and Leases 8 Accounting for Long-Term Notes Payable 9 Figure 11-3 Accounting for non-interest-bearing note . | 1 Chapter 11 Long-Term Liabilities Notes, Bonds, and Leases 2 2 Long-Term Liabilities Many companies finance their operations and growth opportunities through the use of long term debt instruments: Notes Payable – Formal borrowing agreement Bonds Payable – Issued to bondholders, smaller dollar amounts and larger amount of notes Leasehold Obligations – future cash payments for use of an asset 3 The Relative Size of Long-Term Liabilities 4 Figure 11-1 Long-term liabilities as a percentage of total assets, total liabilities, and shareholders’ equity Economic Consequences of Reporting Long-Term Liabilities 5 Improved credit ratings can lead to lower borrowing costs Management has strong incentive to manage the balance sheet by using “off-balance-sheet financing” Basic Definitions and Different Contractual Forms 6 Some contracts, called interest-bearing obligations, require periodic (annual or semiannual) cash payments (called interest) that are determined as a percentage of the face,
