Concept explainers
Debtholders receive note contracts, one for each note, that describe the payments promised by the issuer of the debt. In addition, the issuing corporation frequently enters a supplementary agreement, called a note indenture, with a trustee who represents the debtholders. The provisions or covenants of the indenture may place restrictions on the issuer for the benefit of the debtholders. For example, an indenture may require that the issuer’s debt to equity ratio never rise above a specified level or that periodic payments be made to the trustee who administers a “sinking fund" to provide for the retirement of debt.
Consider Roswell Manufacturing’s debt indenture, which requires that Roswell’s debt to equity ratio never exceed 2:1. If Roswell violates this requirement, the debt indenture specifies very costly penalties, and if the violation continues, the entire debt issue must be retired at a disadvantageous price and refinanced. In recent years, Roswell’s ratio has averaged about 1.5:1 ($15 million in total liabilities and $10 million in total stockholders’ equity). However, Roswell has an opportunity to purchase one of its major competitors, Ashland Products. The acquisition will require $4.5 million in additional liabilities, but it will double Roswell’s net income. Roswell does not believe that a stock issue is feasible in the current environment. The Financial Accounting Standards Board issued a new standard concerning accounting for post employment benefits, which is strongly supported by the Securities and Exchange Commission. Implementation of the new standard will add about S2 million to Roswell’s long-term liabilities. Roswell’s CEO. Martha Cooper, has written a strong letter of objection to the FASB. The FASB received similar letters from over 300 companies.
Required;
2. If you were a member of the FASB and met Martha Cooper at a professional meeting, how would you respond to her objection?
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Cornerstones of Financial Accounting
- Which is an incorrect scenario on covenants?a. The issuing firms pursued revenue generating projects to ensure payment of the interest and theprincipal on a timely basis.b. The issuing firm disposes a mortgage on a bond to settle other creditors’ claims to prevent insolvency.c. The issuing firm submitted periodic reports to the trustee bank to fulfill the loan agreement.d. The issuing firm disposed the collateral to settle the agreement with the bondholders.e. B & Df. All of the aboveg. None of the abovearrow_forwardWhen an entity breaches a covenant under a long-term loan agreement on or before the end of the reporting periodwith the effect that the liability becomes payable on demand, the liability is classified as noncurrent whenI. The lender has agreed after the end if the reporting period and before the financial statements areauthorized for issue not to demand payment as a consequence of the breach.II. The lender has agreed on or before the end of the reporting period to provide a grace period ending atleast twelve months after that date. a. Both I and IIb. Neither I and IIc. I onlyd. II onlyarrow_forwardWhen the original terms of a debt agreement are changed because of financial difficulties experienced by the debtor (borrower), the new arrangement is referred to as a troubled debt restructuring. Such a restructuring can take a variety of forms. For accounting purposes, these possibilities are categorized. What are the accounting classifications of troubled debt restructurings?arrow_forward
- When a debtor is in financial difficulty and a current londer grants concessions to the debtor to refinance an existing debt arrangement, this is referred to as a O a. Troubled debt restructuring. O b. Debt extinguishment. O c. Debt modification. O d. Debt pay-off.arrow_forwardIn accounting for short-term debt expected to be refinanced to long-term debt: a. GAAP uses the authorization date to determine classification of short-term debt to be refinanced. b. IFRS uses the authorization date to determine classification of short-term debt to be refinanced. c. IFRS and GAAP use the financial statement date to determine classification of short-term debt to be refinanced. d. GAAP uses the date of issue, but only for secured debt, to determine classification of short-term debt to be refinanced.arrow_forwardWhen a customer is delinquent on paying a notes receivable, your company has the option to continue to attempt collection or sell the debt to a collection agency. Research the benefits and challenges with each of these options and in a short essay, answer the following questions. A. What are the benefits and challenges of continuing to attempt collection yourself? B. What are the benefits and challenges of selling debt to a collection agency? C. If you had a dishonored notes receivable, which option would you select and why? D. Would you weight certain benefits or challenges differently when making your selection? How?arrow_forward
- True or False. 1. Maturity value is the amount collectible on the agreed date of payment. 2. The creditor has no right to authorize anybody to collect from the debtor. 3. A creditor may authorize anybody to accept payment from the debtor on his behalf. 4.arrow_forwardWays that a lender may respond to a defaulted loan without resorting to foreclosure include all of the following except Multiple Choice defer or forgive some of the past-due payments. accept a deed in lieu of foreclosure. allow short sale to a third party. accelerate the debt. offer credit counselina.arrow_forwardRevenue bonds, compared with general obligation bonds, generally A.) Are paid out of property or sales tax revenues. B.) Bear lower interest rates. C.) Are subject to the same debt limitations. D.) Are not backed by the full faith and credit of the issuing government.arrow_forward
- Which one of the following is NOT the standard covenants in loan contracts? a. Audit fee b. Actions in case of default c. Government charges d. Fees and interest ratesarrow_forward6. When unspecified receivables are used to secure for a loan, which accounting treatment is required? Only a note to financial statement is required The borrower notifies the debtor that their receivables were assigned the borrower should not notify the debtor that their receivables were assigned Notify the debtor that their receivable was soldarrow_forwardWhich of the following is an example of nonrecourse debt? (a) A personal loan secured by collateral where the borrower's liability is limited to the collateral. (b) Any business debt that is secured by collateral. (c) A home mortgage where the buyer is personally liable for any deficiency after foreclosure. (d) An automobile lease.arrow_forward
- Cornerstones of Financial AccountingAccountingISBN:9781337690881Author:Jay Rich, Jeff JonesPublisher:Cengage LearningPrinciples of Accounting Volume 1AccountingISBN:9781947172685Author:OpenStaxPublisher:OpenStax College