Financial Accounting 21010033

Farhan Khan

CP Session # 06:

In this chapter, we learned the different forms of financing i.e. Equity and Liabilities, also as to
how companies account and report these financing needs. Our main focus is towards their
implications for analysis of financial statements.
Following are some of the key take always:
1. Financial liabilities are also called interest-bearing liabilities, whereas Operating
liabilities can then be termed as free debt i.e. Payables, accruals etc.
2. Although short-term borrowings bear lower interest rates as compared to long-term
debts, but they are riskier as it has to repaid in the near term, and firms have to make
sure that an agreement to provide revolving credit is already arranged before term ends
if requirements persist.
3. Few important terms regarding the accounting of long-term debt :
a. Amortized cost: reflect the present value of the debt, discounted at interest
rates at the time of issue of debt.
b. Fair value: also reflect present value of the debt, but can diverge from amortized
cost because it is discounted at current (prevailing) interest rates.
4. Face value does not diverge significantly from amortized cost as long as coupon rates
and effective market interest rates are similar.
5. Also, Debt is usually reported on Balance Sheet at amortized cost, and currently Fair
value accounting for Debt is not required.
6. An analyst should examine the future debt payment schedule, this will give insights into
when the future debts will mature and whether the company is healthy enough to meet
those requirements. Also, just because a firm has significant amount of unutilized credit
available doesn’t guarantee that it will be refinance the maturing debt, because the
nature of the available credit line could be for short-term (working capital)
requirements.
7. The three forms of protections for lenders are:
a. Seniority: Order in which the different parties get paid if the company dissolves.
b. Collateral: securing the claim against certain specific assets to hedge risk in case
of dissolution.
c. Covenants: limitations and restrictions on the firm to safeguard the lenders,
these serve as early warnings for lenders, so that they can protect their
investments, also these usually protect entire class of lenders.
8. An analyst needs to consider protections available to creditors because these decide the
relative riskiness of the different class of creditors’ i.e. junior bear more risk as
compared to senior, secured debt is less risky as compared to unsecured debt.
Financial Accounting 21010033
Farhan Khan

9. In case of collateralized debt, an analyst needs to consider the nature and value of that
specific asset when firm gets bankrupt i.e. what if the asset is rendered useless and has
no demand in the marker e.g. A special asset for a company.
10. One way to obtain the use of facilities and equipment is to buy them, but an alternative
is to lease them, which can be either Operating lease (or) a Capital lease, in the latter
case the benefits and risks are transferred to the lessee.
11. An analyst must exercise care in accepting management’s estimates for Contingent
liabilities.
12. As per the definition of liabilities, a firm cannot recognize Commitments on a financial
statement as these are future oriented contracts, but it is important that information
about commitments is disclosed in Notes.
13. Special Purpose Entity: Where a company establishes a separate legal subsidiary to
isolate financial risk, then use it to secure funding, (or) maybe the company intends to
undertake a very risky project but doesn’t want to put the parent company at risk.
14. SPE is also a form of Off-balance sheet financing, this way by reaping the benefits of an
SPE its operating performance ratios improve significantly.
15. A financial instrument will be a financial liability, as opposed to being an equity
instrument, where it contains an obligation to repay
16. Capital stock is the number of common and preferred shares that a company is
authorized to issue, according to its corporate charter.
17. Preferred stock entitles the holder to a fixed dividend, whose payment takes priority
over that of common stock holders.
18. Minority interest is basically ownership (or) equity interest of less than 50% of an
enterprise.