Corporate Financial Accounting Study Set 3

Business

Quiz 11 :
Liabilities

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Quiz 11 :
Liabilities

Times Interest earned: It measures the interest amount which has to pay to the creditors. It is the ratio of income before interest and income taxes to interest expenses. It is also known as interest coverage ratio. It is calculated by following formula: img Or img The two large companies of company AC and WS have given the interest expenses and income or loss before income tax expenses for two years. a.It is required to compute the times interest earned ratio for companies AC and WS that are shown below: Step1: The EXCEL formulas are shown in below table: img The ratio of times interest earned is computed with the help of formula that is shown below: img Step2: The outcome of above table is shown below: img Thus, the time interest earned ratios of company AC are img , img and of company WS are img , img for respective year of 2 and year 1.As the company WS has best performance as the time interest earned ratio is higher as compare to the company AC. The company WS generates the more revenue to pay its interest expenses. b.Interest Coverage Ratio or Times Interest earned ratio: It is the ratio which shows how easily a company pays interest on outstanding debt. It is the measure of the ability of the company to pay off its debt on a timely manner. As seen from the table above, Company AC has a low time interest earned ratio at year 1. This means that during year 1, the company AC has loss in year 1 so it has difficulty to pay off the debt or interest expense from its income. But gradually in the year 2, Company AC has relatively high interest coverage ratio or time interest earned ratio of 2.9. As the company generate revenue of 2.9 times of its interest expenses. This means that the ability to repay the loan has been increased.c.When the interest coverage ratio or time interest earned ratio is less than 1, then it means that the company has not enough money to pay off its creditors. It does not mean that the creditors will not be repaid the debt. But it means that a company has a difficulty to pay interest on the debt to its creditors. The company has not generated sufficient revenue in that particular period. And the efficiency and production of company is reduced.d.The interest coverage ratio or time interest earned ratio of company WS shows that in year 1, the company WS has enough revenue to pay the interest to the creditors as the time interest earned ratio is 11.1. The company WS generates the revenue of 11.1 of its interest expenses. In year 2, the company has best performance as the time interest earned ratio is highest in this year of 11.6. Again it has a far higher interest coverage ratio of approximately 12. This means that company WS has a high ability to pay off its debt out of its income or revenue. E. The time interest earned ratio of company WS has higher as compare to company Ac.Thus, the company WS appears to have a greater protection to the creditors. This is because that the creditors of company WS get timely interest and principal payment of the debt. With a high time interest earned ratio or interest coverage ratio, the company WS can repay off its loan at a timely manner to the creditors.

Journal Entry: The process of accounting a transaction by logging it in accounts journal is known as entering a journal entry. General journal is called as book of original entry because events are first recorded in the general journal. Bond : It is debt-security where an investor lends funds to a corporate or government, and earn interest on this loan. The corporate entities and the government become the borrower and pay interest on the borrowed funds. The period for which the bonds are issued is predetermined along with the stipulated interest rate. Bonds can be issued by variety of entities such as government, municipalities, corporate houses, sovereign governments and states. The company D issue the bond at $5,000,000 (face value), coupon rate of 6% and maturity period of 10 years. The bond paid $ 150,000 as semiannual interest. The company received the cash amount of $5,000,000. (A) It is required to prepare the journal entry of issue of bond on January 1 that is as shown below: img The cash amount which the company raises from the issue of bond is $5,000,000 and the repayment amount to the debt holders at maturity is also $5,000,000. Thus, the issue amount and repayment amount is equal and the bond is to be issued at face value amount. Thus, the cash which the company raises is $5,000,000 so it is debited and repayment amount of $5,000,000 is treated as credit. (B) It is required to prepare the journal entry of interest payment on bond by company on June 30 that is as shown below: img As the interest amount is paid by company so interest expense account is debited and cash account of company D is reduced by $150,000 as it is credited.(C) It is required to prepare the journal entry of payment of principal amount at maturity date on December 31 that is as shown below: img The principal amount is paid by company at maturity as bond payable account debited and cash account of company is credited as it is decreased by same amount.

When issuing a bond a company has two obligations that are incurred from its issuance. (a) Interest payments- usually paid semi-annually (b) Principal payment- paid at maturity

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