Chapter 10 Self Study Questions

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Jan 9, 2024

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Chapter 10 Self-Study Questions 1. Why would a company use an operating line of credit? - An operating line of credit is a pre-arranged agreement to borrow money at a bank, up to an agreed-upon amount - If the amount of cash a company has available is less than it requires, companies may borrow cash from banks using an operating line of credit to help them manage temporary cash flows 2. Identify the similarities and differences between bonds payable and instalment notes payable. Similarities: - Both are types of debt instruments used by businesses to raise capital - They involve a promise to repay the principal amount borrowed along with interest over a specified period - Interest expense is recognized on both bonds payable and instalment notes payable in a company's income statement - They typically have a fixed interest rate or a variable interest rate tied to a benchmark, like the prime rate Differences: - Bonds are usually issued to a larger number of investors in the form of bonds certificates and traded on the bond market o Instalment notes are typically issued to a single lender or a small group of lenders - Bonds have a longer maturity period, often ranging from several years to decades o Instalment notes have shorter maturities, often ranging from a few months to a few years - Bonds may be secured by specific assets or unsecured (debentures) o They are usually unsecured and do not involve the issuance of certificates Identify the similarities and differences between bonds payable and common shares. Similarities: - Both are ways for a company to raise capital to finance its operations and growth - Both represent financial claims on a company's assets and earnings - Both are recorded on a company's balance sheet as components of its capital structure Differences:

- Bonds represent debt financing, meaning the company owes a fixed amount of money to bondholders o Common shares represent equity financing, meaning shareholders are part owners of the company - Bondholders have a higher claim on company assets and income than common shareholders in the event of bankruptcy or liquidation o Common shareholders have a lower claim on company assets and income than bondholders in case of bankruptcy or liquidation 3. Doug Bareak Question. If Doug pays 1290 per month for 20 years with a 5% mortgage, he would be able to pay it off in 20 years. 4. Explain how an operating line of credit can help a company’s liquidity and why it is considered more flexible than most other bank loans such as mortgages. - An operating line of credit boosts a company's liquidity by providing quick access to funds for day-to-day operations - It's more flexible than traditional bank loans like mortgages because companies can borrow and repay as needed, up to the credit limit - This flexibility helps manage working capital efficiently, aligning borrowing with the company's immediate cash flow needs 5. Identify two advantages and two disadvantages of debt financing. Advantages: - Interest Tax Deductibility: Interest payments on debt are typically tax-deductible, reducing a company's taxable income and, therefore, its tax liability - Leverage and Amplified Returns: Debt allows a company to leverage its equity, potentially increasing returns on investment when the return on assets exceeds the cost of debt Disadvantages: - Interest Expense: Debt financing involves interest payments, which can be a significant financial burden and affect a company's profitability. - Financial Risk: Excessive debt can lead to financial distress, especially if a company struggles to meet its debt obligations, potentially leading to bankruptcy or insolvency 6. Is there a difference between the interest expense recorded in the statement of income and the interest paid during the year when a bold id sold at a discount? Yes, there is a difference

- Interest expense recorded in the income statement reflects the amortization of the bond discount over time, while interest paid during the year is the actual cash outflow for interest - The interest expense gradually increases to the bond's face value, while the interest paid occurs annually Is there a difference between the interest expense recorded in the statement of income and the interest paid during the year when a bond is sold at a premium? Yes, there is a difference - When a bond is sold at a premium, the interest expense recorded in the income statement is lower than the interest paid during the year - This is because the premium reduces the effective interest rate, resulting in lower interest expense compared to the actual interest paid 8. Are the Government of Canada are trading at a premium or a discount. The Government of Canada 1.00% bonds, trading at a price of 96.8, are trading at a discount. The face value of the bond is typically 100, so a price of 96.8 means it is trading for less than its face value. The Greater Toronto Airport Authorises bonds trading at a premium or a discount. The Greater Toronto Airport is trading at a premium. 9. What is the major reason for the change in the price of the bonds since they were issued? The major reason for the change in bond prices since issuance is fluctuations in market interest rates. When market rates increase above the coupon rate, bond prices tend to decrease, making existing bonds less attractive. Conversely, when market rates fall, bond prices tend to rise, reflecting the inverse relationship between bond prices and interest rates. 11. WestJet Airlines Ltd, leases aircraft and, when doing so, must perform scheduled maintenance on these aircraft. The company records a provision for aircraft maintenance when it acquires the aircraft. Why would the company recognize a provision at that time rather than when it performs the maintenance? WestJet recognizes a provision for aircraft maintenance when acquiring the aircraft to match expenses with revenue recognition principles. It aligns with the matching principle in accounting, ensuring that expenses are recognized in the same period as the related revenue, providing a more accurate representation of the company's financial performance and obligations. In what way does a provision for aircraft maintenance differ from an account payable?

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- Timing: A provision for aircraft maintenance is recorded in advance, usually when the aircraft is acquired, to anticipate future expenses. In contrast, an accounts payable is recognized when a company owes money for goods or services already received. - Nature: A provision represents an estimated future liability, often based on historical data and industry standards. An accounts payable is a specific, known liability for a bill that has been received and is due for payment.