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Chapter 14: 23Q (page 753)

What is off-balance sheet financing? Why might a company be interested in using off-balance sheet financing?

Short Answer

Expert verified

Off-balancesheet financing is a methodto lend funds in a manner in which the debts are not listed. The company shows interest in off-balance sheet financingbecause it appeals to more investors or in casethey (company) are burdened by debt but require additional capital to finance their business affairs.

Step by step solution

01

Meaning of off-balancesheet financing

Off-balance sheet financing is a financial method wherein firms list particular assets or liabilities so as to prevent them from displaying on their balance sheet.

02

Reasons behindoff-balance sheet financing

A companygenerally uses off-balance sheet financing because:

  • Eliminating debt improves the balance sheet quality and allows credit to be obtained easily at a minimal cost.
  • The asset side of the balance sheet is undervalued as fair value is not used in the case of various assets. Therefore, not listing certain debt transactions offsets the non-acceptance of fair values on definite assets.
  • Loans undertaken are unlikely to be contravened.

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Most popular questions from this chapter

On January 1, Martinez Inc. issued \(3,000,000, 11% bonds for \)3,195,000. The market rate of interest for these bonds is 10%. Interest is payable annually on December 31. Martinez uses the effective-interest method of amortizing bond premium. At the end of the first year, Martinez should report bonds payable of:

(a) \(3,185,130. (c) \)3,173,550.

(b) \(3,184,500. (d) \)3,165,000.

On April 1, 2017, Seminole Company sold 15,000 of its 11%, 15-year, \(1,000 face value bonds at 97. Interest payment dates are April 1 and October 1, and the company uses the straight-line method of bond discount amortization. On March 1, 2018, Seminole took advantage of favorable prices of its stock to extinguish 6,000 of the bonds by issuing 200,000 shares of its \)10 par value common stock. At this time, the accrued interest was paid in cash. The company’s stock was selling for $31 per share on March 1, 2018.

Instructions

Prepare the journal entries needed on the books of Seminole Company to record the following.

(a) April 1, 2017: issuance of the bonds.

(b) October 1, 2017: payment of semi-annual interest.

(c) December 31, 2017: accrual of interest expense.

(d) March 1, 2018: extinguishment of 6,000 bonds. (No reversing entries made.)

Question: Will the amortization of Discount on Bonds Payable increase or decrease Bond Interest Expense? Explain.

On June 30, 2009, County Company issued 12% bonds with a par value of \(800,000 due in 20 years. They were issued at 98 and were callable at 104 at any date after June 30, 2017. Because of lower interest rates and a significant change in the company’s credit rating, it was decided to call the entire issue on June 30, 2018, and to issue new bonds. New 10% bonds were sold in the amount of \)1,000,000 at 102; they mature in 20 years. County Company uses straight-line amortization. Interest payment dates are December 31 and June 30.

Instructions

  1. Prepare journal entries to record the redemption of the old issue and the sale of the new issue on June 30, 2018.
  2. Prepare the entry required on December 31, 2018, to record the payment of the first 6 months’ interest and the amortization of premium on the bonds.

What are the two methods of amortizing discount and premium on bonds payable? Explain each.
See all solutions

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