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Chapter 14: Long-Term Financial Liabilities

  • Page ID
    97944
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    Leveraging and Debt – Can it be a Smart Move?

    In simple terms, leveraging is borrowing to invest, in the hopes that the investment will generate a higher rate of return than the interest rate of the debt. The investment that is financed by debt may be intended to increase a company's corporate wealth by expanding its market share, or adding new product lines to increase net income. It can also involve investing in other companies' shares to enhance a special relationship or receive share dividends and capital appreciation of the shares as a return on investment. No matter the reason, there are important aspects of leveraging that must be considered before entering into such an arrangement.

    1. Does the company currently generate enough net income and hold enough assets to service the proposed leveraging strategy?
    2. Is leveraging the best strategy, given alternative financing arrangements such as increasing equity by issuing more shares?
    3. Does management clearly understand the risks of taking on a leveraging strategy or is the decision driven more by emotions than by careful consideration?
    4. Since leveraging increases the debt burden, will this impact any existing restrictive debt covenants from other creditors?
    5. Does the company have sufficient business processes in place to adequately monitor and measure the return of the investment funded by the additional debt? This must be done to ensure that the return from the investment exceeds the interest rate of the debt itself.
    6. If the investment's return is less than expected, does the company have enough net income and other resources to keep the investment in hopes of an improvement in the future?
    7. Is the company diversified enough to achieve a balance between the leveraged investment and its other sources of funds and operations?

    (Source: HSBC, 2013)

    Learning Objectives

    After completing this chapter, you should be able to:

    • Describe long-term financial liabilities and their role in accounting and business.
    • Describe notes payable, and explain how they are classified and how they are initially and subsequently measured and reported.
    • Describe bonds payable, and explain how they are classified and how they are initially and subsequently measured and reported.
    • Define and describe other accounting and valuation issues such as the fair value option, defeasance, and off-balance sheet financing.
    • Explain how long-term debt is disclosed in the financial statements.
    • Identify the different methods used to analyze long-term liabilities; calculate and interpret three specific ratios used to analyze long-term liabilities.
    • Explain the similarities and differences between ASPE and IFRS regarding recognition, measurement, and reporting of long-term payables.

    Introduction

    This chapter will focus on the basics of long-term debt, such as bonds and long-term notes payable. Each of these will be discussed in terms of their use in business, their recognition, measurement, reporting and analysis. Other, more complex types of financial liabilities such as convertible debt, pension liabilities, and leasing obligations, will be discussed in future chapters.

    Chapter Organization

     


    Chapter 14: Long-Term Financial Liabilities is shared under a not declared license and was authored, remixed, and/or curated by LibreTexts.

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