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, callcd 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;
1. Write a paragraph presenting an analysis of the impact of the new standard on Roswell Manufacturing.
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Cornerstones of Financial Accounting
- Access the FASB Accounting Standards Codification at the FASB website ( www.fasb.org ). Determine the specific citation for accounting for each of the following items: 1. Disclosure requirements for maturities of long-term debt. 2. How to estimate the value of a note when a note having no ready market and no interest rate is exchanged for a noncash asset without a readily available fair value. 3. When the straight-line method can be used as an alternative to the interest method of determining interest.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 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_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_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_forwardTrue 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_forward
- Which of the following is not an example of commercial mortgage covenant: If the borrower sells a large portion of its assets, it must notify the lender tens day before the sale. A restriction on the amount of dividends the firm can pay its shareholders The borrower must file periodic GAAP reports with the lenders demonstrating compliance with the loan agreement. The borrower must notify the lender if it becomes involved in a lawsuit.arrow_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 not generally correct about recording a sale of a debt security before its maturity date? O An entry must be made to amortize a discount to the date of sale. O The entry to amortize a premium to the date of sale includes a credit to the Premium on Debt Investments account. O A gain or loss on the sale is reported as other revenue or expense. O Accrued interest will be received by the seller even though it is not an interest payment date.arrow_forward
- In 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 uses 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_forwardTRUE OR FALSE? (Based on the book.)The effect of a lender agreeing to give the borrowing entity a grace period within the reporting period will make a liability noncurrent.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
- Cornerstones of Financial AccountingAccountingISBN:9781337690881Author:Jay Rich, Jeff JonesPublisher:Cengage LearningPrinciples of Accounting Volume 1AccountingISBN:9781947172685Author:OpenStaxPublisher:OpenStax College