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Intermediate Accounting II: Understanding Debt, Bonds, SPE

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1 - You are planning to invest $10,000 in ABC's bonds. Right now the stated rate of the bonds is seven percent, and the market rate is eight percent. The Federal Reserve System (FRS) is considering lowering the interest rate by two percent to help stimulate the economy sometime next year, but the final decision has not been made (or at least publicly announced).

Should you invest in the bonds now or wait until the FRS makes its announcement? What is your reasoning behind your decision? What affect will this have on ABC's financial statements? How long should you hold the bonds if you choose to invest?

2 - Morrison Company has created SPE. None of the executives of Morrison Company is associated with the SPE as it has its own new president and chief executive officer (CEO). The SPE will hold the bonds issued by Morrison Company in return for shares of Morrison Company stock of equal amount, including the present value of the interest payments, and will pay off the debt when it comes due.

In your opinion, are the actions of Morrison Company and the SPE ethical? Why or why not? Should Morrison Company report the debt on the balance sheet? Why or why not?

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Solution Preview

1 - You are planning to invest $10,000 in ABC's bonds. Right now the stated rate of the bonds is seven percent, and the market rate is eight percent. The Federal Reserve System (FRS) is considering lowering the interest rate by two percent to help stimulate the economy sometime next year, but the final decision has not been made (or at least publically announced).
Should you invest in the bonds now or wait until the FRS makes its announcement? What is your reasoning behind your decision? What affect will this have on ABC's financial statements? How long should you hold the bonds if you choose ...

Solution Summary

Three paragraphs discuss the impact of interest rates on the issuer and the investor and the SPE issue.

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Similar Posting

Intermediate Financial Accounting: Variable Interest Entity

Discussion Question 1: Veritae, Inc. maintains an investment portfolio for liquidity and to enhance earnings. Included in the investment portfolio is $500,000 in bonds of D'Elegant Home Construction. The company's chief financial officer (CFO), Gaylord Kwame read in yesterday's Wall Street Journal that Moody's just downgraded D'Elegant's bonds because of the slowdown in the housing market. Gaylord wants you to research the current accounting requirements related to declines in the value of investment securities.

Research about accounting requirements of investment securities. Based on your research and understanding, answer the following questions:
- How would you account for the decline of the value of the investment securities required by GAAP?
- Does the treatment of the decline in value differ depending on whether the investment is accounted for as held-to-maturity, available-for-sale, or trading securities? Why or why not?
- If the investment was an equity investment in D'Elegant, how would your answer change?

Discussion Question 2: The decline and fall of Enron and its auditors were well publicized. Enron used special purpose entities (SPEs) to keep from reporting certain liabilities on their balance sheet. You may be surprised to know that their reporting of these entities was consistent with GAAP at that time.

Subsequently, Financial Accounting Standards Board (FASB) Interpretation Number 46 (revised December 2003), or FIN 46(R), was issued to address reporting of these types of entities, which are now referred to by the more general name of variable-interest entities (VIEs). This standard requires companies to consolidate VIEs based on risks and rewards rather than percentage ownership.

Research about Enron. Based on your research and understanding, respond to the following:
- Analyze and evaluate whether these guidelines will increase the quality of information investors receive about risks related to VIEs.
- Rationalize and justify your position using Enron or any other company—that either uses or has used SPEs or VIEs—as an example.

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