Chapter 13: Long-Term Liabilities

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Have you ever looked at a company's, you know, their financial reports and just wondered

how do they fund these huge multi -year projects or even just keep things running smoothly for decades?

And how can we, you know, trying to learn or maybe invest quickly get a handle on their long -term financial stability?

Today we're doing a deep dive into exactly that, the world of long -term liabilities.

It's really the backbone of a company's financial structure.

Yeah, absolutely.

And our mission here is to distill some core ideas, particularly drawing from great resources like Intermediate Accounting by Kiso, Wagen, and Warfield.

We want to break down the what, the how, and importantly the why of long -term debt.

We'll focus on how it actually works in practice.

Think journal entries, financial statement presentation, giving you really actionable insights.

Right.

So by the end of this deep dive, you should feel much more confident looking at a balance sheet and really understanding what's going on behind the numbers.

Okay, so let's unpack this.

What exactly are long -term liabilities and how are they different from the short -term current ones we hear about more often?

Well, fundamentally, long -term liabilities are obligations, debts, that a company doesn't expect to sell within one year or within its normal operating cycle if that happens to be longer.

Think of them as the debts stretching out into the future.

Current liabilities, on the other hand, those are the ones due pretty soon within that year.

So if it's not current, it generally gets classified as long -term.

There isn't a super explicit gap definition, it's often a residual thing.

Got it.

And what are the most common types we'd see on a company's books, the big ones?

The big players, yeah, are definitely bonds payable and long -term notes payable.

These are really the main ways companies get significant long -lasting financing.

Okay, bonds and notes, both ways to borrow money long -term.

So what's the key difference between them?

It mostly comes down to scale and structure.

A note payable is often like a direct loan from a single lender.

Think one bank lending a company, say, a million dollars.

It's a specific legal document, pretty straightforward.

Bonds payable, though, that's usually for much larger amounts, too big for one lender.

So the company breaks the total loan into smaller standardized chunks, usually a thousand dollars each, and sells these pieces to lots of different investors.

Ah, okay, so one lender versus potentially thousands.

Exactly.

Imagine needing maybe a billion dollars.

You'd issue a million bonds at a thousand dollars face value, and the whole thing is governed by this really detailed contract called a bond indenture.

It's like the rule book for that specific bond issue.

That makes sense.

But why should we, you know, as people looking at these companies, really care so much about these long -term debts?

What's the big deal?

Well, this goes right to the heart of a company's long -run financial health.

It's solvency.

Lenders, stockholders, they all want to know, can this company actually afford to pay the

And,

crucially, can it pay back the principal amount when the debt finally comes due?

The balance sheet, and especially the notes that come with it, provide exactly that information.

It's a window into their commitments years, even decades, out.

Let's make this real.

Target Corporation, for example, their recent report showed liabilities around 31 billion dollars against assets of roughly 43 billion dollars.

If you run the numbers, that's a debt -to -assets ratio of about 72 percent.

Yeah, 72 percent.

That's pretty significant, right?

It means liabilities are funding almost three -quarters of Target's assets.

Now, that number by itself, well, it needs context.

You want to compare it to Target's past performance or see how it stacks up against competitors like Walmart.

A high ratio isn't automatically bad if cash flow is strong, but it definitely shows a reliance on borrowing.

Okay, let's focus on bonds for a bit.

When a company issues a bond, what's the actual promise being made to the investor who buys it?

It's essentially a two -part promise.

First, they promise to repay a specific amount, the face value also called par value or principal on a set date in the future, the maturity date.

Usually that's a thousand dollars per bond.

Second, they promise to pay periodic interest, usually twice a year, based on a specified stated rate applied to that face value.

The whole point is raising significant capital for big, long -term things like building factories or major acquisitions.

Right.

And how do they get these bonds out there?

Is it like an IPO for stock?

Kind of similar, yeah, but using specific channels.

Often they'll use investment banks.

One way is from underwriting, where the bank buys the whole bond issue and takes the risk of reselling it.

Or they might do best efforts underwriting, where the bank just acts as an agent, sells what it can and gets a commission.

Sometimes for really large issues or specific needs, they might do a private placement, selling directly to big institutions like pension funds or insurance companies, bypassing the public market.

Gotcha.

And the source material mentions a whole bunch of different bond types.

This is where it gets interesting.

Can you hit some highlights?

Absolutely.

There's quite a variety.

You've got secured bonds, which are backed by specific collateral, maybe property or equipment.

That gives investors extra security if the company struggles.

Like a mortgage on a house.

Exactly like that concept.

Then you have unsecured bonds, often called debenture bonds or sometimes junk bonds, if the company's credit is really low.

These rely purely on the company's general credit worthiness.

Think of a giant like Apple issuing debt versus maybe a smaller, riskier company.

There are also term bonds, where the whole principle is due on one single date versus serial bonds, which mature in installments over several years.

Okay.

What about things like callability?

Right.

Callable bonds.

These give the issuer, the company, the right to buy back the bonds before maturity.

They'd usually do this if interest rates fall significantly, so they can refinance at a lower rate.

And then there are convertible bonds, which give the investor the option to swap the bond for a certain number of the company's common shares.

That's attractive if the company's stock price takes off.

Lots of variations.

And there are even things like deep discount or zero interest bonds.

Yeah.

Deep discount bonds, sometimes called zero interest debentures.

They're sold at a significant discount to face value and don't pay periodic cash interest.

The entire interest component is just the difference between the discounted purchase price and the full face value paid back at maturity.

Okay.

So with all these features, how do we actually figure out what a bond is worth when it's first issued?

What's the price?

The price, or the value, is determined by the present value of all the future cash flows the bond is expected to generate.

That means you take all the future periodic interest payments, plus that final principal repayment at maturity, and you discount all of those future amounts back to their value today using the current market rate of interest for similar bonds.

Okay.

Market rate.

You also mentioned the stated rate earlier.

Can you clarify those two?

They seem crucial?

Absolutely critical distinction.

The stated rate, sometimes called the coupon rate or nominal rate, is the interest rate printed on the bond itself.

It's fixed and determines the amount of cash interest the company actually pays out periodically.

The market rate, on the other hand, also called the effective rate or effective yield, is the rate investors are demanding in the market at the time the bond is issued for bonds of similar risk and maturity.

This rate is driven by the economy, inflation expectations, the company's specific risk, etc.

This is the rate investors actually earn if they hold the bond to maturity.

Right.

And the relationship between these two rates determines whether the bond sells at face value or...

Exactly.

If the stated rate equals the market rate, the bond sells at par face value.

Simple.

But what if the stated rate is, say, 4%, but the market demands 5 %?

Then, the bond has to sell at a discount less than its $1 ,000 face value.

Why?

Because investors can get 5 % elsewhere.

To entice them to buy this 4 % bond, the company sells it for less upfront.

That discount effectively boosts the investor's total return.

They pay less than $1 ,000, get the 4 % cash interest, and get the full $1 ,000 back in maturity.

That difference, the discount, brings their overall yield up to the 5 % market rate.

Makes sense.

And the flip side.

If the stated rate is 4%, but the market rate is only 3%.

Then the bond sells at a premium more than its $1 ,000 face value.

Investors are eager for that higher 4 % cash interest payment when the market's only offering 3%, so they're willing to pay extra upfront.

They know they'll only get $1 ,000 back at maturity, so paying that premium effectively reduces their overall yield down to the prevailing 3 % market rate.

Let's walk through an example.

Say, Realtek issues $100 ,000 of 5 -year bonds with a 9 % stated rate, but the market rate is 11%.

Discount or premium?

Definitely a discount.

Stated rate, 9 % is less than the market rate, 11%.

To price it, we need present value tables or a calculator.

First, the present value of the principal.

$100 ,000 due in 5 years, discounted at the 11 % market rate, using a PV factor of, say,

.59345, that's $59 ,345.

Then the present value of the interest payments, that's $9 ,000 per year, 9 % of 100K for 5 years, discounted at 11%.

Using an annuity PV factor of, say, 3 .69590, that's $33 ,263 .10.

So the total selling price is the sum of those two.

Exactly.

$59 ,345 plus $33 ,263 .10 gives you $92 ,390 .10.

That's the issue price.

And the discount is the difference from face value.

Right.

$100 ,000 face value minus the $92 ,608 change in rate, even after issuance.

Absolutely.

While bonds are initially recorded based on the market rate at issuance, their fair value fluctuates constantly as market interest rates change.

If rates go up, the value of existing, lower -rate bonds goes down, and vice versa.

You can see this in real corporate bond listings, like for Walmart or Apple.

You might see a bond with a certain coupon rate trading at a price like 108 % of face value, a premium, because its coupon is higher than current market yields for a company without

Or maybe below $100, a discount, if rates have risen since it was issued.

And long -term bonds are more sensitive to these rate changes.

Much more sensitive.

A small change in interest rates, like 1%, can have a much bigger percentage impact on the price of a 30 -year bond compared to a two -year note.

It's about the duration of those future cash flows being discounted.

OK, now for the accounting.

How do we actually put these on the books?

Let's start simple.

Issued at par.

Issued at par is the easiest.

Say Green Tea issues $800 ,000 of bonds at par.

The journal entry is just.

Debit cash, $800 ,000.

Credit bonds payable, $800 ,000.

Done.

And when they pay semiannual interest, say it's $40 ,000, the entry is.

Debit interest expense, $40 ,000.

Credit cash, $40 ,000.

Straightforward.

But what about when they're issued at a discount or premium?

You mentioned separate accounts.

Right.

The bonds payable account always gets credited for the face amount.

$800 ,000 in our Green Tea example.

The difference goes into a separate account.

So if Green Tea issued those $800 ,000 bonds for, say, $776 ,000 a discount, the entry would be.

Debit cash, $776 ,000.

Debit discount on bonds payable, $24 ,000.

And credit bonds payable, $800 ,000.

And that discount account sits on the balance sheet.

Yes.

Discount on bonds payable is a contra liability account.

It sits right below bonds payable and reduces its carrying value.

So initially, the net liability shown is $776 ,000, $800 to K24K.

Okay, which brings us to amortization.

Spreading that $24 ,000 discount over the life of the bond.

What are the methods?

There are two main methods, straight line and effective interest.

Straight line is simpler.

You just take the total discount, $24 ,000, and divide it by the number of interest periods.

Say 10 years, semiannual payments equals 20 periods.

So $24 ,000, 20 equals $1 ,200 per period.

And how does that affect the interest expense entry?

Good question.

The PASH interest paid is still based on the stated rate, $40 ,000 in our example.

But the interest expense recognized each period is the cash paid plus the discount amortization.

So the entry would be debit interest expense, $41 ,200, 40K cash plus $1 .2K amortization.

Credit discount on bonds payable, $1 ,200, reducing the discount balance.

And credit cash or interest payable, $40 ,000.

So amortizing a discount increases the reported interest expense compared to the cash paid.

Exactly.

And with a premium, it's the opposite.

Amortizing a premium decreases the reported interest expense.

The premium on bonds payable count is an adjunct account it adds to the bonds payable carrying value.

But you mentioned another method, effective interest.

Yes.

The effective interest method is preferred under GAP if it's material different from straight line.

And it's required under IFRS.

It's considered conceptually superior because it reflects a constant rate of interest expense over the bond's life based on the carrying value.

How does that calculation work?

It sounds more complex.

It involves two steps each period.

One, calculate bond interest expense.

Take the carrying value of the bond at the beginning of the period and multiply it by the effective market rate per period.

Two, calculate amortization.

Find the difference between the bond interest expense from step one and the cash interest paid, which is always face value at stated rate per period.

OK, let's try an example.

Evermaster issues $100 ,000 five -year bonds, 8 % stated rate paid semi -annually.

The market rate is 10%.

We calculated earlier this sells at a discount price $92 ,278.

Discount is $7 ,722.

Right.

And remember, rates and periods need to be adjusted for semi -annual.

Stated rate is 4 % per period, 8%.

Effective rate is 5 % per period, 10%.

And 10 periods, so the issuance entry.

Debit cash, $92 ,278.

Debit discount on bonds payable $7 ,722.

Credit bonds payable $100 ,000.

Now for the first interest payment and amortization using the effective interest method.

Step one, interest expense, carrying value effective rate.

Carrying value is $92 ,278.

Effective rate is 5%.

So $92 ,278, that's 0 .05, is $4 ,613 .90.

Let's round to $4 ,614.

Step two, cash interest paid equals face value at stated rate.

$100 ,000, your point is 0 .04, is $4 ,000.

Step three, amortization, interest expense, cash paid.

$4 ,614, $4 ,614.

This is the amount of discount amortized.

So the journal entry for the first payment is?

Debit interest expense, $4 ,614.

Credit discount on bonds payable, $614.

Credit cash, $4 ,000.

And the carrying value increases, right?

Yes.

The carrying value for the next period calculation is the old carrying value, $92 ,278, plus the amortization, $645.

And the amortization will also be slightly higher, $4 ,645.

Oh, I see.

The expense increases as the carrying value gets closer to $100 ,000.

How would this look on the balance sheet, say, after that second payment?

The bonds payable stays at $100 ,000 face value.

The discount balance started at $7 ,722, then we reduced it by $614, then by $645.

So $7 ,722, $645 equals $6 ,463 remaining discount.

The balance sheet would show bonds payable $100 ,000 less, discount on bonds payable $6 ,463 for a net carrying amount of $93 ,537.

OK, and if it were a premium, same bond, $100K, 8 % stated, but maybe a 6 % market rate, sells for $108 ,530, premium $8 ,530.

Same logic, just reversed.

Issuance, debit cash, $108 ,530, credit premium on bonds payable, $156.

First payment, using 3 % effective semi -annual rate, interest expense, $108 ,130.

Pay was $3 ,256.

This reduces the premium balance.

So the entry is debit interest expense, $3 ,256, $3 ,256, credit cash, $4 ,000.

Exactly.

Notice interest expense is less than cash paid.

The carrying value decreases each period, $108 ,530, $744, $786 for the next period, moving down toward $100 ,000.

And the balance sheet presentation would show the premium added.

Correct.

Maybe after a few periods, the premium balance is $7 ,020.

It would show bonds payable $100 ,000 plus premium on bonds payable $7 ,020 for a carrying amount of $107 ,020.

You know, this relates back to that point about the hot, hot, hot corporate debt market.

Since around 2008, with interest rates so low, companies like Boeing, Apple, Nike have issued tons of bonds.

It's often cheaper than bank loans.

And they lock in those low rates for years, funding R &D acquisitions or even buying back stock.

It's generally smart, but it does add risk, especially for companies whose earnings might be less stable.

Quick question.

What if bonds are sold between the regular interest payment dates?

Ah, yes.

Happens often.

Say, bonds pay interest January 1st and July 1st, but the company sells them on March 1st.

The buyer pays the seller, the company, the accrued interest from January 1st to March 1, in addition to the bond's price.

So the company collects cash for the bond itself plus two months of interest.

Then, on July 1st, the company pays the full six months of interest to whoever holds the bond, the buyer.

The net effect is the buyer is only out of pocket for the interest covering the four months they actually held the bond, March 1st and July 1st.

The initial entry for the company selling the bond would include a credit to interest expense or interest payable for the accrued interest received from the buyer.

Okay, got it.

Now, what about paying off debt, specifically paying it off early?

Extinguishment, right.

Right, extinguishment of debt.

If debt is paid off at maturity, it's simple.

Bonds payable is debited.

Cash is credited.

Any discount or premium should be fully amortized by then, so no gain or loss.

But early extinguishment is different.

The company might call the bonds back or buy them on the open market.

The key is comparing the reacquisition price, what they actually pay to get the debt back with the debt's carrying value, face value adjusted for any unamortized discount or premium at that specific date.

So you have to update the amortization first.

Crucial step.

Yes, you must amortize any discount or premium right up to the reacquisition date before you can calculate the gain or loss.

Then, if the reacquisition price is less than the carrying value, the company has a gain.

They paid less than what the liability was carried out on their books.

If the reacquisition price is more than the carrying value, it's a loss.

They paid more than the book value to get rid of the debt.

Can we see an example?

Say General Bell has $800 ,000 face value bonds outstanding.

They were issued at a discount, and now the unamortized discount is $24 ,000.

The bonds are callable at 101, they call them.

Okay.

First, the reacquisition price.

101 % of face value.

So $800 ,000 when 1 .01 equals $808 ,000.

That's the cash they pay.

Next, the net carrying amount.

Face value, $800 ,000 minus the unamortized discount.

$24 ,000 equals $776 ,000.

Now compare.

Reacquisition price, $808 ,000 is greater than the carrying amount, $776 ,000.

So it's a loss.

How much loss?

The difference.

$808 ,000, $776 ,000, equals $32 ,000 loss on redemption.

And the journal entry.

You need to clear the related accounts off the books.

Debit bonds payable, $800 ,000 to remove face value.

Debit loss on redemption of bonds, $32 ,000.

Credit discount on bonds payable, $24 ,000 to remove the remaining discount.

Credit cash, $808 ,000 for the payment.

Sometimes companies do this as part of refunding, issuing new debt, often at lower rates to pay off the old, more expensive debt.

And going back to bond types, are they all really created equal?

Our source measures 100 -year bonds and ESG bonds.

Yeah, that's a fascinating point.

You have these ultra long -term 100 -year bonds issued occasionally by stable governments or iconic companies like Disney or Coca -Cola.

They appeal to specific investors, like pension funds needing very long -duration assets.

And then there's the really growing trend of ESG bonds, environmental social governance.

Think green bonds funding renewable energy projects, or like Anheuser -Busch InBev sustainability -linked debt, where the interest rate might actually go down if they meet specific environmental targets.

It shows the bond market evolving beyond just pure finance.

Interesting.

Okay, let's shift gears slightly from bonds to long -term notes payable.

How similar is the accounting?

Very similar in principle.

Notes are also valued at the present value of their future principal and interest payments discounted at the market -rated issuance.

Any discount or premium is amortized over the note's life, preferably using the effective interest method.

So if a note is issued at face value, say Scandinavian Imports gets a $10 ,000 loan at the market rate, it's simple recording.

Yep, just like bonds at par.

Debit cash, credit notes payable, interest expense equals cash interest paid.

What about notes not issued at face value, like those zero -interest bearing notes?

Right.

With a zero -interest note, the company receives cash less than the face value.

Say Turtle Cove issues a three -year $10 ,000 zero -interest note when the market rate is 9%.

The cash they receive is the present value.

Using PV factors, $10 ,000 discounted back three years at 9 % is $7 ,721 .80.

So the difference is a discount.

Exactly.

The difference, $10 ,721 .80 is recorded as discount on notes payable.

The entry, debit cash, $7 ,721 .80, debit discount on notes payable, $2 ,278 .20, credit notes payable, $10 ,000.

And that discount gets amortized to interest expense over the three years.

Correct.

Using the effective interest method, In year one, interest expense carrying value, $7 ,791 .80.

Market rate, 9%, $694 .96.

Credit discount on notes payable, $694 .96.

No cash changes hands for interest, but expense is recognized and the carrying value increases.

Okay.

And what about regular interest bearing notes where the stated rate differs from the market rate, like Ruriko's $10 ,000 three -year note with a 10 % stated rate, but a 12 % market rate?

Again, find the present value using the market rate, 12%.

PV of principle plus PV of interest payments equals $9 ,520 using 12 % discount rate.

This means there's a discount of $480.

$10K, $9 ,520.

Issue its entry.

Debit cash, $9 ,520.

Debit discount on notes payable, $480.

Credit notes payable, $10 ,000.

And the amortization, how does that work when cash interest is being paid?

Same effective interest steps.

Year one, interest expense carrying value, $9 ,520 at same core.

Market rate, 12%, $1 ,1542.

Cash interest paid, face value, $10.

Stated rate, 10%, $1 ,000.

Amortization interest expense, $1 ,142.

Cash paid, $1 ,000.

So the entry is debit interest expense, $1 ,142.

Credit discount on notes payable, $142.

Credit cash, $1 ,000.

You got it.

The carrying value increases by $142.

What if a note is exchanged for something other than cash, like property or services?

Good question.

This happens frequently.

The rule is, the stated interest rate on the note is presumed fair unless there's no rate stated, the rate is clearly unreasonable, or the face amount of the note is materially different from the fair value of the property services or the fair value of the note itself.

If the fair value of the property or services is known, you use that value to record the asset and establish the note's present value.

Any difference from the note's face amount is a discount or premium.

Like the scenic development example, land with a known cash price of $200 ,000 is exchanged for a $293 ,866 or zero interest note.

Exactly.

The buyer, Health Spa, records the land at its fair value, $200 ,000.

They record notes payable at face value, $293 ,866.

The difference, $93 ,866, is debited to discount on notes payable.

And if the fair value of the property isn't clear?

Then you have to impute an interest rate.

You look at what rate the company would typically pay for similar financing, or what rate is appropriate for the specific transaction given the risks involved.

This imputed rate is then used to find the present value of the note, which becomes the basis for recording the asset received.

Like the Wunderlich co -example, architectural services exchange for a $550 ,000 note with a low 2 % stated rate, when an 8 % rate seems more appropriate.

Right, you'd calculate the present value of that $550 ,000 note principle and the small 2 %

using the imputed 8 % market rate.

Let's say that comes out to $418 ,239.

That $418 ,239 becomes the value recorded for the buildings or services.

Notes payable is still $550 ,000 face value.

The difference, $550 ,418 ,239 is $131 ,761 is the discount on notes payable.

The entry, debit buildings $418 ,239, debit discount $131 ,761, credit notes payable $550 ,000.

Makes sense.

One more time, mortgage notes payable.

How are they special?

They're basically just promissory notes secured by specific property, usually real estate.

The key feature is typically level installment payments over time.

Each payment includes both interest on the outstanding balance and a portion that reduces the principal.

An important accounting point is classifying the liability.

The amount of principal reduction scheduled for the next year or operating cycle is shown as a current liability.

The remaining unpaid principal balance is classified as long -term.

Sometimes lenders charge points upfront, which are essentially prepaid interest that increases the effective interest rate on the loan.

Okay, bringing this all together.

How does this debt get presented on the financial statements and how do analysts use this info?

Well, presentation -wise, companies often report large amounts of debt as a single line item on the balance sheet, like long -term debt.

But the crucial details, maturity dates, interest rates, collateral, call provisions, future payment schedules for the next five years, those are disclosed in the notes to the financial statements.

You have to read the notes.

Companies also have the fair value option.

They can choose to report most financial instruments, including bonds and notes, at their current fair market value on the balance sheet.

And changes in fair value go through income?

It depends.

If the fair value of a company's own debt changes due solely to changes in general market interest rates, like if rates rise, the value of their fixed rate debt falls, the resulting unrealized gain or loss typically does go into net income.

So if Edmonds Co.'s bonds drop in value from $500K to $480K because market rates went up, they record a gain?

Counterintuitive, yes.

Debit bonds payable $20 ,000 and credit unrealized holding gain or loss income $20 ,000.

Their liability is effectively less burdensome in current market terms.

But what if the value drops because the company's own credit worthiness gets worse?

Different treatment.

If the fair value decline is due to the company's specific credit risk increasing,

investors demand a higher yield because the company looks whiskier, the resulting unrealized holding gain is reported in other comprehensive income, OCI, part of equity, not net income.

Neither difference.

To avoid the perverse incentive of recognizing income simply because the company's financial health is deteriorating.

So same $20K value drop for Edmonds due to credit rating change,

debit bonds payable $20 ,000, credit unrealized holding gain or loss equity $20 ,000.

You mentioned reading the notes.

Are there specific things companies have to disclose?

Yes.

They need to disclose the nature of the liabilities, maturity dates, interest rates, call provisions, any assets pledged as security, and importantly, the aggregate amount of maturities and sinking fund requirements for each of the next five years.

Examples like Best Buy or Target's notes in the source material show how detailed these disclosures are.

What about ways companies might try to hide debt off balance sheet financing?

That used to be a bigger issue, famously with Enron.

The idea was to structure transactions, often using non -consolidated subsidiaries, where the parent owns less than 50%, or special purpose entities, SPEs, so that the debt associated with the project wouldn't appear on the main company's balance sheet.

Oh, I do that.

Reasons varied.

To make the balance sheet look less leveraged, maybe to avoid violating terms in other loan agreements, loan covenants, or sometimes because they felt assets were understated elsewhere.

Regulators like the FASB and SEC have really cracked down on this.

Sarbanes -Oxley increased disclosure requirements, and newer rules, like the Lease Accounting Standard, ASU 2016 -2, now require almost all leases over one year to be reported as liabilities on the balance sheet.

It's much harder to keep significant obligations truly off balance sheet now.

So with all this debt information properly disclosed, hopefully, how do we analyze a company's long -term solvency?

We use key ratios.

Two big ones are, one, debt to assets ratio, calculated as total liabilities divided by total assets.

This shows what percentage of the company's assets are financed by debt versus equity.

A higher ratio means more leverage, more risk.

Two, times interest earned, TIE ratio, calculated as net income plus interest expense plus income tax expense divided by interest expense.

This measures how many times a company's operating earnings can cover its annual interest payments.

A higher number is better, indicating a stronger ability to meet interest obligations.

Let's apply those to Target again.

We said debt to assets is about 72%.

What about TIE?

The example shows it was around 9 .8 times.

Right.

So while 72 % debt to assets seems high, the fact that Target's earnings cover its interest expense almost 10 times over, TIE of 9 .8, suggests they can comfortably handle their debt payments.

You have to look at these ratios together.

And the analytics and action point reinforces this total debt amounts very hugely between companies like Apple and Kroger, but the ratios provide better comparability.

Exactly.

Apple might have massive dollar amounts of debt, but relative to its enormous assets and earnings, its ratios might look very healthy.

Debt isn't inherently bad.

It's a tool.

Companies use it strategically, especially when rates are low, to fund growth, innovation, or return cash to shareholders via buybacks.

It's about whether the level of debt is manageable given the company's operating performance.

Okay.

One last major area from the appendix.

Troubled debt restructuring.

What happens when a borrower gets into serious financial trouble?

This is when a creditor, because the debtor is facing financial difficulties, grants concessions that they wouldn't normally consider.

It's not just refinancing for a better market rate.

It's specifically because the borrower is struggling.

And there are two main ways this happens.

Settlement or modification.

Correct.

Settlement of debt involves actually paying off the debt, but perhaps for less than owed.

This could involve transferring cash, non -cash assets like land or equipment, or even issuing the debtor's stock to the creditor.

The accounting gets interesting here.

The creditor records any assets received at their fair value and recognizes a loss for the difference, usually charged against their allowance for doubtful accounts.

The debtor, however, recognizes a gain on restructuring equal to the excess of the debt's carrying amount over the fair value of what they gave up.

Assets or equity.

If they transferred assets, they also have to recognize a gain or loss on the disposition of those assets based on the difference between the asset's book value and its fair value.

So the debtor could have two gains losses.

One on the asset disposal, one on the debt restructuring itself.

Precisely.

For example, if union mortgage owes $20 and settles by giving land with a fair value of $16 plus, but a book value of 21 mouncers.

Union debtor has a $5 mile of loss on disposal of land, 21 miller, book $16 fair.

They also have a $4 mile gain on restructuring, $20 debt forgiven, $16 fair value given.

Wow.

Okay.

And if they settle by giving stock instead, say stock with a fair value of $16 moan for that $20 debt.

Similar outcome for the gain.

Debtor reduces notes payable by $20,

records common stock at par value and paid in capital, the excess over par totaling the $16 remit fair value and recognizes the same $4 med game on restructuring.

$20 debt, $16 merged stock, FEA.

What's the other type?

Modification.

Modification of terms.

Here, the debt isn't settled outright, but the terms are changed.

Maybe reducing the interest rate, extending the maturity date, maybe even forgiving some of the principal or accrued interest.

The really key thing here is the potential for non -symmetrical accounting between the debtor and creditor.

Non -symmetrical.

How so?

The creditor usually measures their loss based on the present value of the modified future cash flows discounted back at the loan's original historical effective interest rate.

The debtor, however, compares the total future undiscounted cash flows under the new terms to the current carrying amount of the debt.

Undiscounted.

That seems odd.

It is a bit strange.

If the total undiscounted future payments under the new terms are still

or equal to the current debt carrying amount,

the debtor recognizes no gain at the time of restructuring.

They just calculate a new lower effective interest rate going forward.

So even if the present value is much lower, the debtor might record no gain.

Correct.

In example one, Resorts Development, the total undiscounted future payments, $11 .88, exceeded the current debt, $10 .05.

So the debtor recorded no gain, even though the creditor calculated a significant loss based on present value.

But if the total undiscounted future payments are less than the current debt?

Then the debtor recognizes a gain for the difference.

And in this case, all future cash payments made by the debtor are treated purely as principal reduction, with no interest expense recognized going forward.

The effective rate becomes 0 % for the debtor.

This happened in example two for Resorts Development.

The creditor, meanwhile, still calculates their loss based on present value using the original rate in both scenarios.

It highlights a complexity and perhaps an inconsistency in accounting standards, pushing some towards arguing for a broader fair value model.

Phew.

Okay, that was definitely a deep dive into long -term liabilities.

We've gone from the basics of bonds and notes, through valuation, discounts, premiums, amortization, all the way to extinguishment and troubled debt.

Yeah, we covered a lot of ground.

But hopefully you can see how understanding these concepts, the present value calculations, the journal entries, the different ways debt is structured and reported, really gives you the tools to look at a company's balance sheet and assess its long -term solvency, its financial health.

Absolutely.

So what does this all mean for you listening?

We hope this deep dive makes you feel, you know, a bit more empowered when you look at those financial statements, that you can start to decode the stories hidden in those liability numbers.

Hopefully it sparks even more curiosity about this whole world of accounting and finance.

Definitely.

Keep asking those why questions.

Keep digging deeper.

Because understanding how companies finance themselves is fundamental to understanding business.

There's always more to learn.

Well said.

Thank you for joining us on this deep dive.

Until next time.