Analyzing Financing Activities CHAPTER
3 CHAPTER Analyzing Financing Activities
Liabilities Definition A liability is a probable future payment of assets or services that a company is presently obligated to make as a result of past transactions or events the company Because of a has a for future past event. present sacrifices obligation Past Present Future
A liability is a probable future payment of assets or services that a company is presently obligated to make as a result of past transactions or events. Definition Liabilities Past Present Future Because of a past event... ...for future sacrifices. … the company has a present obligation
Liabilities Classification Current (short-term) Noncurrent ( Long- Liabilities Term) Liabilities Obligations whose settlement requires use of Obligations not current assets or the payable within one incurrence of another year or the operating current liability within one cycle, whichever is year or the operating longer cycle, whichever is longer
Current (short-term) Liabilities Noncurrent (LongTerm) Liabilities Obligations whose settlement requires use of current assets or the incurrence of another current liability within one year or the operating cycle, whichever is longer. Obligations not payable within one year or the operating cycle, whichever is longer. Liabilities Classification
Liabilities Alternative Classification Obligations that arise from Operating operating activities--examples Liabilities are accounts payable, unearned revenue, advance payments, taxes payable, postretirement liabilities, and other accruals of operating expenses Obligations that arise from financing activities--examples Financing are short- and long-term debt, Liabilities bonds, notes, leases, and the current portion of long-term debt
Operating Liabilities Financing Liabilities Obligations that arise from operating activities--examples are accounts payable, unearned revenue, advance payments, taxes payable, postretirement liabilities, and other accruals of operating expenses Obligations that arise from financing activities--examples are short- and long-term debt, bonds, notes, leases, and the current portion of long-term debt Liabilities Alternative Classification
Liabilities Disclosures for Current (Financing) Liabilities Compensating balance arrangements, including those not required by law Balance sheet segregation of (1)legally restricted compensating balances and(2) unrestricted compensating balances related to long-term borrowing arrangements if balances are computable at a fixed amount Short-term bank and commercial paper borrowings, including: Commercial paper borrowings separately listed in balance sheet Weighted-average interest rate and terms separately stated for short-term bank and commercial paper borrowings Weighted-average interest rate, average outstanding borrowings, and maximum month-end outstanding borrowings for short-term bank debt and commercial paper combined for the period Disclosure of amounts and terms of unused lines of credit for short-term borrowing arrangements (with amounts supporting commercial paper separately stated) and of unused commitments for long-term financing arrangements
Liabilities Disclosures for Current (Financing) Liabilities n Compensating balance arrangements, including those not required by law n Balance sheet segregation of (1) legally restricted compensating balances and (2) unrestricted compensating balances related to long-term borrowing arrangements if balances are computable at a fixed amount n Short-term bank and commercial paper borrowings, including: • Commercial paper borrowings separately listed in balance sheet • Weighted-average interest rate and terms separately stated for short-term bank and commercial paper borrowings • Weighted-average interest rate, average outstanding borrowings, and maximum month-end outstanding borrowings for short-term bank debt and commercial paper combined for the period n Disclosure of amounts and terms of unused lines of credit for short-term borrowing arrangements (with amounts supporting commercial paper separately stated) and of unused commitments for long-term financing arrangements
Liabilities Accounting-Based Liability Restrictions(Covenants) Aim: Safequard creditors' investments Common restrictions include: Dividend distribution restrictions Working capital restrictions Debt-to-equity ratio restrictions Seniority of asset claim restrictions Acquisition and divestment restrictions Liability issuance restrictions Potential information sources: Liability prospectus, annual report, SEC filings, and creditor information services(e.g, Moody's)
Liabilities Accounting-Based Liability Restrictions (Covenants) Aim: Safeguard creditors’ investments Common restrictions include: n Dividend distribution restrictions n Working capital restrictions n Debt-to-equity ratio restrictions n Seniority of asset claim restrictions n Acquisition and divestment restrictions n Liability issuance restrictions Potential information sources: Liability prospectus, annual report, SEC filings, and creditor information services (e.g., Moody’s)
Leases Leasing Facts Lease- contractual agreement between a lessor (owner) and a lessee(user or renter) that gives the lessee the right to use an asset owned by the lessor for the lease term MLP- minimum lease payments (MLP) of the lessee to the lessor according to the lease contract
Leases Leasing Facts Lease – contractual agreement between a lessor (owner) and a lessee (user or renter) that gives the lessee the right to use an asset owned by the lessor for the lease term MLP – minimum lease payments (MLP) of the lessee to the lessor according to the lease contract
Leases Lease Accounting and Reporting (1)Capital Lease Accounting For leases that transfer substantially all benefits and risks of ownership-accounted for as an asset acquisition and a liability incurrence by the lessee, and as a sale and financing transaction by the lessor A lessee classifies and accounts for a lease as a capital lease if at its inception, the lease meets any of four criteria lease transfers ownership of property to lessee by end of the lease term (t lease contains an option to purchase the property at a bargain price (iti) lease term is 75% or more of estimated economic life of the property (iv) present value of rentals and other minimum lease payments at beginning of lease term is 90% or more of the fair value of leased property less any related investment tax credit retained by lessor (2)Operating Lease Accounting For leases other than capital leases-the lessee (lessor) accounts for the minimum lease payment as a rental expense(income)
Leases Lease Accounting and Reporting (1) Capital Lease Accounting For leases that transfer substantially all benefits and risks of ownership—accounted for as an asset acquisition and a liability incurrence by the lessee, and as a sale and financing transaction by the lessor A lessee classifies and accounts for a lease as a capital lease if, at its inception, the lease meets any of four criteria: (i) lease transfers ownership of property to lessee by end of the lease term (ii) lease contains an option to purchase the property at a bargain price (iii) lease term is 75% or more of estimated economic life of the property (iv) present value of rentals and other minimum lease payments at beginning of lease term is 90% or more of the fair value of leased property less any related investment tax credit retained by lessor (2) Operating Lease Accounting For leases other than capital leases—the lessee (lessor) accounts for the minimum lease payment as a rental expense (income)
Leases Lease Disclosure and Off-Balance-Sheet Financing Lease Disclosure Lessee must disclose: (1) future MLPs separately for capital leases and operating leases--for each of five succeeding years and the total amount thereafter, and(2 )rental expense for each period an income statement is reported Off-Balance-Sheet Financing Off-Balance-Sheet financing is when a lessee structures a lease so it is accounted for as an operating lease when the economic characteristics of the lease are more in line with a capital lease-neither the leased asset nor its corresponding liability are recorded on the balance sheet
Leases Lease Disclosure and Off-Balance-Sheet Financing Lease Disclosure Lessee must disclose: (1) future MLPs separately for capital leases and operating leases—for each of five succeeding years and the total amount thereafter, and (2) rental expense for each period an income statement is reported Off-Balance-Sheet Financing Off-Balance-Sheet financing is when a lessee structures a lease so it is accounted for as an operating lease when the economic characteristics of the lease are more in line with a capital lease—neither the leased asset nor its corresponding liability are recorded on the balance sheet
Leases Frequency of Capital and Operating Leases Operating Only 43% Capital Only 3% Both Capital Operating Neither 44% 10%
Leases Frequency of Capital and Operating Leases Capital Only 3% Operating Only 43% Both Capital & Operating Neither 44% 10%