Hey Guys, was hoping you could provide some clarification on the following which i’m finding a little confussing: Taken Analyst Notes: “Debt reported on the balance sheet is equal to the present value of future cash payments discounted at the market value rate on the date of issuance. Increases (decreases) in the current market value rate decrease (increase) the market value of the debt. This economic gain or loss is NOT reflected in either the income statement or balance sheet” however they later state that: "When interest rates increase, and the market value of the debt decreases, this will decrease the liabilities that the company has. As the liabilities will be lower, the debt-to-equity ratio will be more favorable. " What i find confussing is in the first paragraph it states that gains and losses are not reported of the IS or BS, however in the second paragraph it states that LIABILITIES will be lower when interest rates Increase, I though from paragraph one that gains or losses where not reflectesd on the BS or IS. Have i understood some thing incorrectly ? Thanks/
Yes you are right those changes in market value of the debt are not reflected in IS or BS but when you analyze the company it is more appropriate to use market values of assets and liabilities and the market value of the company’s debt is lower (however it is not reflected anywhere in FS).
Alright, excelllent!!! Thanks for the confirmation.
Can we assume like: When interest rate goes up; value of the bond (debt) comes down. Likewise, when interest rate comes down; value of the bond issued (debt) goes up.
correct me if i’m wrong any explanation on this…?
You are right but probably financial liabilities are measured in BS at amortized cost and therefore any changes in market value are not reflected anyway (same as in case of financial assets HTM).
rockstar_131 Wrote: ------------------------------------------------------- > Can we assume like: When interest rate goes up; > value of the bond (debt) comes down. Likewise, > when interest rate comes down; value of the bond > issued (debt) goes up. Did you understand tgrycner’s answer? The idea here is that in CFA studies there are two things going on - understanding the financial statements and then using those statements to value a company (or some security of the company). The financial statements are put together following some set of rules that may not reflect the economic reality of the company. As an analyst, your job is to fix that up. One of the easiest things to do is to fix up straight debt. E.g., Let’s say there is a company that does nothing except sell bonds and invest the proceeds in short-term risk free rates. The company sells $1M 100-yr bonds at 4% and then 100-yr interest rates shoot up to 10%. The company’s balance sheet would show that there is no contribution to equity from this interest rate move; it borrowed $1M and invested $1M in short-term deposits. As an analyst, you need to look at this situation and say that this company is worth a ton because it’s essentially buying a short position in a 4% 100-yr bond when interest rates are at 10%.
PLEASE HELP!!! I’m really starting to get confused, Accounting principles or (mark to market rules) state that companies carrying assets (Bonds/MBS) mark these instruments to market and carry these instruments on their market value and reflect any gain or loss on the BS But the below extract seems to contradict that? I know….I’m really missing something here…your assistance please…thanks guys. Taken Analyst Notes: "Debt reported on the balance sheet is equal to the present value of future cash payments discounted at the market value rate on the date of issuance. Increases (decreases) in the current market value rate decrease (increase) the market value of the debt. This economic gain or loss is NOT reflected in either the income statement or balance sheet.
“International” test and all aside, in the US most things are carried on the balance sheet at historical cost. Securities are bit different because depending on the accounting classification (Held to Maturity or Available for Sale). HTM are carried on the BS at cost and AFS are marked to market.
If it is Available for Sale (AFS assets) then it must be carried at mark to market value and any gain losses reported directly in equity. If it is held to maturity (HTM) then it must be carried at amortised cost and market value is not relevant for Balance sheet purposes. However you may have to disclose their MV in the notes to the fin. statements. There are strict catergory for classification for financial Assets which are critical to ascertain their value for BS purposes.: FV at Profit and Loss: generally these are held for trading and/or derivatives (unless designated as an effective hedging instrument) —Carried at MV and gains/losses recongnised in income statement). Bonds rarely fall in this category unless it is held for trading. Loans and Receivables (amortised cost, Market value not relevant) Held to Maturity(amortised cost, Market value not relevant). Bonds genrerally fall in this category and therefore carried at amortised cost. Available for Sale( carried at MV and gains/losses recongnised in equtiy and recycled to income statment on their sale): This is also a defaulty category. For eg: common stock . There are also other strict rules on derecognition and switching from one category to another. For eg: If an instrument is classified as HTM , then it cannot be moved to FV at profit or loss , or AFS. The company may face penalties and would not be allowed to use this category for another 2 years. Cheers Sumo
Yikes! Paul and sumo - read that more carefully. “Debt reported on the balance sheet is equal to the present value of future cash payments discounted at the market value rate on the date of issuance. Increases (decreases) in the current market value rate decrease (increase) the market value of the debt. This economic gain or loss is NOT reflected in either the income statement or balance sheet” The preceding is about debt that you have issued, i.e., bonds that you have sold to borrow money from other people. “Accounting principles or (mark to market rules) state that companies carrying assets (Bonds/MBS) mark these instruments to market and carry these instruments on their market value and reflect any gain or loss on the BS” … and the two comments above are about bonds that you own, i.e., bonds that other people issued and you bought.
Most financial liabilities other than trading and derivatives are also recorded at amortized cost so not at market value…
Financial Liabilities held for trading are carried at mark to market value. Other financial liabilites including bond are carried at amortized cost. This is a default category. Any economic gain is not reported in any of the statements. However they may e revalued to mark to market value in the case of acquistion to determine the Fair value of Net assets and therefore Goodwill for consolidation purposes. Cheers Sumo
I’ll bet Reineir is hopelessly confused. Sumo, read above and stop confusing stuff.