On the balance sheet, bonds and notes payable are reported at the present value of future cash flows using the historical effective rate of interest at the issue date. Note that the effective interest amortization table provides the book values of the note at each year end. At December 31, 2017, the $100 million maturity value must be reclassified as a current liability because funds will be disbursed within one year of the balance sheet date (actually, the next day). A reclassification of a large note payable from long-term to current may have a material adverse impact on working capital (current assets minus current liabilities) and the current ratio (current assets divided by current liabilities). In practice, this potential adverse impact is alleviated two ways. First, a firm may set up a sinking fund in liquid assets (because of debt covenants or as part of the firm’s cash management policy) to be used to repay the debt. The sinking fund and debt classifications will have countervailing effects on working capital
Another means of avoiding the reclassification of long-term debt to a current liability is to enter into a refinancing agreement. If the firm has the intent and ability to refinance the debt on a long-term basis, U.S. GAAP allows the obligation to remain in the long-term classification at the balance sheet date (withappropriate footnote disclosure). Auditors will investigate whether the ability to refinance is present by searching for a refinancing agreement with a lender or for evidence that actual refinancing has taken place before the financial statements are issued.
The statement of cash flows reports the net proceeds of debt issues, interest payments, and maturity payments. Under both U.S. GAAP and IFRS, cash flows relating to principal amounts of debt are reported as financing activities. Under U.S. GAAP, the
The statement of cash flows reports the net proceeds of debt issues, interest payments, and maturity payments. Under both U.S. GAAP and IFRS, cash flows relating to principal amounts of debt are reported as financing activities. Under U.S. GAAP, the
cash flow portion of interest expense is included as an operating cash outflow because interest expense reduces net income, which is reported as a source of cash flow from operating activities under the indirect method. Under the indirect method, this is achieved by adjustments to net income for the portions of interest expense that are not cash flows. That is, interest payable increases must be added back in the operating cash flow section. Further, amortizations of bond discounts (premiums) increase (decrease) interest expense but are not cash outflows (inflows). Amortization of bond discounts (premiums) are added back (subtracted) in the operating section as well
Many companies disclose cash interest payments in the notes to the financial statements or in a supplementary schedule provided with the cash flow statement. PepsiCo discloses cash paid for interest in Note 14. Under IFRS, cash payments for interest can be reported as an operating or financing cash outflow. Under both U.S. GAAP and IFRS, the income statement reports interest expense as a nonoperating charge
Many companies disclose cash interest payments in the notes to the financial statements or in a supplementary schedule provided with the cash flow statement. PepsiCo discloses cash paid for interest in Note 14. Under IFRS, cash payments for interest can be reported as an operating or financing cash outflow. Under both U.S. GAAP and IFRS, the income statement reports interest expense as a nonoperating charge
Fair Value Disclosure and the Fair Value Option
Long-term notes and bonds are financial instruments; therefore, firms must disclose the fair values in the notes to the financial statements. In referring back to Exhibit 7.5, the December 31, 2015, book value of the note payable is $98.17 million. This amount is referred to as amortized cost because it represents the original ‘‘cost’’ of the debt, $95.79 million, adjusted for the amortization of the bank’s discount for 2013–2015. The amount also represents the present value of the remaining cash flows (two more $5 million interest payments and one final $100 million principal payment) at the historical 6% effective rate of interest.
Long-term notes and bonds are financial instruments; therefore, firms must disclose the fair values in the notes to the financial statements. In referring back to Exhibit 7.5, the December 31, 2015, book value of the note payable is $98.17 million. This amount is referred to as amortized cost because it represents the original ‘‘cost’’ of the debt, $95.79 million, adjusted for the amortization of the bank’s discount for 2013–2015. The amount also represents the present value of the remaining cash flows (two more $5 million interest payments and one final $100 million principal payment) at the historical 6% effective rate of interest.
If the market’s required rate of interest has changed since the original signing date of the note, the fair value of the debt will change as well. Suppose the market requires a 7% return on PepsiCo’s note at December 31, 2015. The fair value of the note would then be:
PepsiCo would report the amortized cost of $98.17 million on the face of the balance sheet (probably in a group with other long-term debt) and the fair value of $96.38 million in the notes to the financial statements. Recently, both the FASB and IASB passed a rule allowing firms the option of using fair value as the basis for balance sheet reporting of financial liabilities (and financial assets) instead of amortized cost.21 If PepsiCo were to adopt the fair value option for this
debt, it would report $96.38 million of notes payable on the face of the balance sheet and an unrealized gain on remeasurement of long-term debt equal to $1.79 million ($98.17 million – $96.38 million) on the income statement (see Exhibit 7.7). The standards are silent on how to recognize interest expense on this new long-term-debt basis. However, using the effective interest method (as described previously) with the new market rate and new book value would be consistent with current practice. Firm must choose whether to elect the fair value option or not with the inception of each new financing instrument, and be consistent over the life of the instrument. Firms do not have to be consistent from one instrument to the next, so some firms may have some financing instruments reported on the balance sheet at amortized cost and other instruments reported at fair value.
debt, it would report $96.38 million of notes payable on the face of the balance sheet and an unrealized gain on remeasurement of long-term debt equal to $1.79 million ($98.17 million – $96.38 million) on the income statement (see Exhibit 7.7). The standards are silent on how to recognize interest expense on this new long-term-debt basis. However, using the effective interest method (as described previously) with the new market rate and new book value would be consistent with current practice. Firm must choose whether to elect the fair value option or not with the inception of each new financing instrument, and be consistent over the life of the instrument. Firms do not have to be consistent from one instrument to the next, so some firms may have some financing instruments reported on the balance sheet at amortized cost and other instruments reported at fair value.
No comments:
Post a Comment