• Internal Code :
  • Subject Code : C521
  • University :
  • Subject Name : Managerial Accounting

Long-Term Debt (Bonds and Notes Payable)

Please review the class notes for Module 5 prior to beginning this mini case.

The purpose of this mini case is to provide you with a deeper understanding of long-term debt. The only long-term debt we cover in C521 is bonds and notes payable. You will continue using the company you selected for mini case 1. Please submit your mini case on Canvas and include your company’s name on the document that you submit.

Required:

1. Briefly discuss the impact of any accounting recent accounting pronouncements related to bonds or long-term notes payable. You can find this information in the footnotes (e.g., Recent Accounting Pronouncements).

I noted no new pronouncements related to bonds or long-term notes payable.

2. Review the Management Discussion and Analysis (MD&A) section and briefly note any discussion related to long-term debt and/or bonds for the past three years.

Note that information for 2019 from 2019 10-K, 2018 came from the 2018 10-K and information for 2017 came from the 2017 10-K.

During 2019, financing activities consisted primarily of net repayments on long term debt of $6.5 billion.

During 2018, financing activities consisted primarily of net repayments on long term debt of $3.5 billion.

During 2017, financing activities consisted primarily of repay of term debt of $3.5 billion, partially offset by issuing a term debt of $28.7 billion and proceeds from commercial paper of $3.9 billion.

3. List the amount of long-term debt (bonds and notes payable) as a percentage of total liabilities and shareholders’ equity for the past three years and briefly comment on its trend.

decrease in long-term debt in past 3 years
decrease in long-term debt in past 3 years

There was a sharp decrease in long-term debt. However, there was a sharp increase in its percentage of total liabilities and shareholders’ equity across the three years. This is consistent with the discussion in MD&A related to debt repayment.

4. List the amount of cash inflows and outflows related to long-term debt (bonds and notes payable) from the Financing Activities section of the Statement of Cash Flows for the past three years and briefly comment on this activity.

Statement of Cash Flows for the past three years

Over the past three years, Apple has issued and repaid long-term debt, indicating that it actively uses long-term debt to finance its business. The information from the Statement of Cash Flows is consistent with the balance sheet changes in long-term debt and with management’s discussion of financing activities.

5. Locate the footnote disclosure for long-term debt (bonds and notes payable):

a. Note any covenants related to debt-to-equity and interest coverage.

The company, Apple has entered into interest rate swaps to effectively manage its interest rate risk on some of its U.S. dollar-denominated fixed-floating rate notes. Moreover, it entered into foreign currency swaps to manage its foreign currency risk.

The Indenture (for the senior unsecured notes) contains certain covenants that, among other things, limit the Company's ability and the ability of its restricted subsidiaries to incur additional indebtedness, make certain dividends, repurchase Company stock or make other distributions, make certain investments, create liens, transfer or sell assets, merge or consolidate and enter into transactions with the Company's affiliates. Such covenants are subject to a number of exceptions and qualifications set forth in the Indenture. The Indenture also contains certain customary events of default, including failure to make payments in respect of the principal amount of the Notes, failure to make payments of interest on the Notes when due and payable, failure to comply with certain covenants and agreements and certain events of bankruptcy or insolvency. The Company was in compliance with all of its covenants under the Indenture on December 31, 2019.

b. Locate information about the fair value of long-term debt and compare it to the carrying value of the debt. What do you conclude about how the market rates changed since the debt was issued?

On December 31, 2019, the fair market value of the long term debt was $107.5 billion and the carrying value of this term debt was $101.7 billion. Since the fair value is greater than the carrying value, this implies that the market demanded a lower rate of return on these bonds since the issuance date.

On December 31, 2018, the fair market value of the long term debt was $103.2 billion and the carrying value of this term debt was $104.2 billion. Since the fair value is less than the carrying value, this implies that the market demanded a higher rate of return on these bonds since the issuance date.

At December 31, 2017, the fair market value of long term debt was $106.1 billion and the carrying value of this long term debt was $104 billion. Since the fair value is less than the carrying value, this implies that the market demanded a higher rate of return on these bonds since the issuance date.

The fair market value of all other debt as of December 31, 2019, 2018, and 2017 approximated the respective carrying amounts, implying no change in interest rates for those instruments.

6. Verify the calculation of the debt-to-equity ratio from the D&B Business Browser for the past three years and comment on any changes. Note that D&B typically calculates the debt-to-equity ratio using only long-term debt and the current portion of long-term debt. You should use total debt, as discussed in my class notes and the Libby text.

calculation of the debt-to-equity ratio

a. If the company noted a debt-to-equity ratio covenant from part (3a) above, comment on the risk of the company violating its covenant.

None noted.

b. Compare the ratio to its industry benchmark and comment on differences.

The debt-to-equity ratio of company Apple has increased. It is much higher than the industry average which has also shown the rising trend. Apple's increasing debt-to-equity ratio is consistent with the analysis above in which I noted an increase in debt levels.

c. What do the results suggest about your company’s risk of insolvency?

The risk of insolvency is rising with the debt to equity ratio.

d. Comment on your company’s capacity to increase its debt-to-equity ratio.

Given a high debt-to-equity ratio of Apple, I have doubts about its capability to undertake more debt, specifically if it does not have the competency to use the amount of debt in a profitable manner.

7. Verify the calculation of the times interest earned ratio from the D&B Business Browser for the past three years and comment on any changes. Note that D&B calls this ratio the interest coverage ratio.

calculation of the times interest earned ratio

a. If the company noted a times interest earned (interest coverage) ratio covenant from part (5a) above, comment on the risk of the company violating its covenant.

The debt covenant requires a minimum interest coverage ratio of 3. On the other hand, Apple's ratio is above this level, the ratio has steadily declined indicating that Apple's margin for paying its interest expense has fallen. If this trend continues, Apple risks being in violation of its covenant. If this occurs, then the market response will be negative, resulting in a dramatic drop in its stock price.

b. Compare the ratio to its industry benchmark and comment on differences.

Apple’s ratio is greater than that of the industry in all the three years. The ratio for both Apple and the industry has fallen, suggesting an issue with the industry as a whole.

c. Comment on your company’s capacity to pay more interest if it were to increase its debt.

With the rise in debt to equity ratio, the company seems to be struggling to maintain its interest coverage ratio, because of the decline in its net income from 2018 to 2019. This led me to make a conclusion that the capacity of the company to take more amount of debt is declining.

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Managerial Accounting Assignment Help

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