ACCOUNTING THEORIES

 Running Head: ACCOUNTING THEORIES 1
Accounting Theories
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ACCOUNTING THEORIES 2
Nine 'nearly broke covenants' over debt deal
Summary
The management of Nine Entertainment reports that they sealed a deal with Apollo and
Oaktree hedge funds rescuing the entertainment firm from breaching a debt covenant earlier
agreed with creditors. The deal came after Nine Entertainment recorded a loss of $971.7million
in the year 2011-2012, falling operating profit and shrinking revenues, situations that put the
firm’s financial situation in a precarious position. The two major lenders agreed to swap their
debt for equity easing Nine Entertainment financial woes. Owners of nine hedge funds bowed to
pressure from the original lenders who were seeking to salvage Nine Entertainment from
imminent insolvency. The arrangement was reached that allowed lenders to convert their senior
loans into equity stakes.
Accounting Theory
Positive accounting theory is an accounting theory that explains debt covenants
agreements. The positive accounting theory is segregated into three hypotheses namely bonus
plan hypotheses, debt covenant hypothesis and political cost hypothesis. However, two theories
deal with debt restructuring mechanisms, and they include debt covenant hypothesis and political
cost hypothesis. According to Deegan (2009), positive accounting theory debt covenant
hypothesis proposes that the primary objective of the management of a firm is to minimize
lending problems with lenders and creditors during the times when the company is facing
challenges. Deegan (2009) further continues to state that debt covenant hypothesis propose
shifting future earnings for the current period to minimize the violation of debt covenants. On the
other hand, the political cost hypothesis opines that the management can shift current earnings to
future periods to minimize the violation of debt covenants.
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Application of Accounting Theory
The debt covenant hypothesis implies that the management has an obligation to rescue a
company from breaching debt covenants. Among the measures that management of a firm can
use to minimize cases of debt covenant violation, include negotiating with lenders and creditors
to ease debt covenants, making necessary arrangements to pay back the debt and shifting
reported profits from future to current reporting periods. The management of Nine Entertainment
in keeping with the suppositions of the debt covenant hypothesis, engaging creditors holding
senior loans to convert them into equity stakes in a recapitalization initiative that saw the firm
reverse imminent debt covenant violation. It is, therefore, evident in the article that debt
covenant hypothesis is prominent in the article.
Roberts and Sufi (2009) observe that debt covenant violation cases are costly to the firm
because they lead to an increase of the firm’s cost of debt capital, thus, reducing the ability of a
firm to borrow and invest in potentially viable investments. The management of Nine
Entertainment, thus, sought to engage in a dialogue with senior lenders, such as the two major
creditors, Apollo and Oaktree hedge funds, to mitigate insolvency of the firm due to violation of
the debt covenant. Chava and Roberts (2008) state that firms that are close to violating debt
covenants engage in re-negotiations with borrowers to minimize chances of total debt covenant
violation. Chava and Roberts (2008) continue to state that the options available on renegotiation
of debt covenants include conversion of debt into equity, reduction in loan capital and increasing
of loan spreads. In the case of Nine Entertainment, lenders converted a total of $200million owed
to equity a move that saved the firm agony of debt violation.
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Conclusion
Debt covenants are financial arrangements that companies enter with creditors requiring a
company to ensure that the company operates within certain debt limits. The debt covenant, for
example, stipulates the level of gearing a company is to maintain, interest cover, working capital
and debt service cover. If these borrowing conditions are breached, creditors demand immediate
repayment or renegotiate the debt on unfavorable terms. It is for these reasons that the
management of Nine Entertainment entered into renegotiation of debts it owed creditors to
ameliorate its debt structure and avoid debt covenant violation. 
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References
Chava, R. & Roberts, M. (2008). How does financing impact investment? The role of debt
covenants. Journal of Finance, 63, pp. 2085-2121.
Deegan, C. M. (2009). In Financial Accounting Theory. North Ryde: McGraw-Hill.
Roberts, M. & Sufi, A. (2009). Control rights and capital structure: An empirical investigation.
Journal of Finance, 64, 1657-1695. 
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