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Chapter 14: Q22Q (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, 2017, Aumont Company sold 12% bonds having a maturity value of \(500,000 for \)537,907.37, which provides the bondholders with a 10% yield. The bonds are dated January 1, 2017, and mature January 1, 2022, with interest payable December 31 of each year. Aumont Company allocates interest and unamortized discount or premium on the effective-interest basis.

Instructions

(Round answers to the nearest cent.)

  1. Prepare the journal entry at the date of the bond issuance.
  2. Prepare a schedule of interest expense and bond amortization for 2017–2019.
  3. Prepare the journal entry to record the interest payment and the amortization for 2017.
  4. Prepare the journal entry to record the interest payment and the amortization for 2019.

Using the same information as in E14-22, answer the following questions related to American Bank (creditor).

Instructions

  1. What interest rate should American Bank use to calculate the loss on the debt restructuring?
  2. Compute the loss that American Bank will suffer from the debt restructuring. Prepare the journal entry to record the loss.
  3. Prepare the interest receipt schedule for American Bank after the debt restructuring.
  4. Prepare the interest receipt entry for American Bank on December 31, 2019.
  5. What entry should American Bank make on January 1, 2021?

BE14-1 (L01) Whiteside Corporation issues $500,000 of 9% bonds, due in 10 years, with interest payable semi-annually. At the time of issue, the market rate for such bonds is 10%. Compute the issue price of the bonds.

Question: Zopf Company sells its bonds at a premium and applies the effective-interest method in amortizing the premium. Will the annual interest expense increase or decrease over the life of the bonds? Explain.

Lady Gaga Co. recently made an investment in the bonds issued by Chili Peppers Inc. Lady Gaga’s business model for this investment is to profit from trading in response to changes in market interest rates. How should this investment be classified by Lady Gaga? Explain.
See all solutions

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