accounting for long-term liabilities chapter 10 copyright © 2016 mcgraw-hill education. all rights...

Accounting for Long-Term Liabilities

Chapter 10

Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of

McGraw-Hill Education.

Wild, Shaw, and ChiappettaFinancial & Managerial Accounting6th Edition

Wild, Shaw, and ChiappettaFinancial & Managerial Accounting6th Edition

10-A1: Bond Financing

2

14 - 3

Bond Interest Payments

CorporationInvestors

Bond Issue Date

Bond Interest Payments

Interest Payment = Bond Par Value × Stated Interest Rate x Time

Interest Payment = Bond Par Value × Stated Interest Rate x Time

Bond FinancingTransactions during the bond life

A13

14 - 4

Bond Financing

Bonds do not affect owner control.

Interest on bonds is tax deductible.

Bonds can increase return on equity.

Advantages

Bonds require payment of both

periodic interest and par value at maturity.

Bonds can decrease return on equity.

Disadvantages

A14

14 - 5

Bond Trading

A1

Bonds are securities that can be purchased or sold in the securities markets. They have a

market value which is expressed as a percent of their par value. The closing price indicates that the IBM stock is being sold at 121.18% of

face value.

5

14 - 6

Bond Issuing Procedures

A16

10-P1: Issuing Bonds at Par

7

14 - 8

Issuing Bonds at ParOn Jan. 1, 2015, a company issued the following bonds:

Par Value: $800,000Stated Interest Rate: 9%

Interest Dates: 6/30 and 12/31Maturity Date = Dec. 31, 2034 (20 years)

P18

14 - 9

$800,000 × 9% × ½ year = $36,000

Issuing Bonds at ParOn June 30, 2015, the issuer of the bond pays the first

semiannual interest payment of $36,000.

P1

This entry is made every six months until the bonds mature.

9

14 - 10

Issuing Bonds at ParOn December 31, 2034, the bonds mature and the

issuer of the bond pays face value of $800,000 to the bondholders.

P110

14 - 11

Bond Discount or Premium

P111

10-P2: Issuing Bonds at a Discount

12

14 - 13

Fila issues bonds with the following provisions:

Par Value: $100,000

Issue Price: 96.454% of par value

Stated Interest Rate: 8%

Market Interest Rate: 10%

Interest Dates: 6/30 and 12/31

Bond Date: Dec. 31, 2015

Maturity Date: Dec. 31, 2017 (2 years)

Issuing Bonds at a Discount

} Bond will sell at a discount.

P213

14 - 14

On Dec. 31, 2015, Fila should record the bond issue.


Par value $ 100,000 Cash proceeds 96,454 *Discount $ 3,546 *$100,000 x 96.454%

Contra-LiabilityAccount

P214

14 - 15

Long-term Liabilities: Bonds Payable 100,000 Less: Discount on Bonds Payable 3,546 96,454

Partial Balance Sheet as of Dec. 31, 2015

Maturity Value Carrying Value


P215

14 - 16

$3,546 ÷ 4 periods = $887 (rounded)

$100,000 × 8% × ½ = $4,000

Fila will make the following entry every six months to record the cash interest payment

and the amortization of the discount.

Amortizing a Bond Discount

P216

14 - 17

Straight-Line Amortization TableInterest Interest Discount Unamortized Carrying

Date Payment Expense Amortization* Discount Value12/31/2015 3,546$ 96,454$ 6/30/2016 4,000$ 4,887$ 887$ 2,659 97,341

12/31/2016 4,000 4,887 887 1,772 98,228 6/30/2017 4,000 4,887 887 885 99,115

12/31/2017 4,000 4,885 885 - 100,000 16,000$ 19,546$ 3,546$

* Rounded.

Amortizing a Bond Discount

P2

These two columns always sum to par value for a

discount bond.17

NEED-TO-KNOW

Semiannual Period-End Carrying Value(0) 12/31/20X1 $248 $6,752(1) 06/30/20X2 186 6,814(2) 12/31/20X2 124 6,876(3) 06/30/20X3 62 6,938(4) 12/31/20X3 0 $7,000

Change in Carrying Value$248 / 4 semiannual periods = $62 per period

12/31/20X1 248 12/31/20X1 7,00006/30/20X2 6212/31/20X2 6206/30/20X3 6212/31/20X3 62

12/31/20X3 0 12/31/20X3 7,000

A company issues 8%, two-year bonds on December 31, 20X1, with a par value of $7,000 and semiannual interest payments. On the issue date, the annual market rate for these bonds is 10%, which implies a selling price of 96.46 or $6,752.

(a) Prepare an amortization table for these bonds; use the straight-line method to amortize the discount. Then, prepare journal entries to record (b) the issuance of bonds on December

31, 20X1; (c ) the first through fourth interest payments on each June 30 and December 31; and (d) the maturity of the bond on December 31, 20X3.

Discount on Bonds Payable Bonds Payable

Unamortized Discount<< $7,000 x .9646 = $6,752

P1/P218

NEED-TO-KNOWA company issues 8%, two-year bonds on December 31, 20X1, with a par value of $7,000 and semiannual interest payments. On the issue date, the annual market rate for these bonds is 10%, which implies a selling price of 96.46 or $6,752.

Debit Credit12/31/20X1 Cash ($7,000 x .9646) 6,752

Discount on Bonds Payable 248Bonds Payable 7,000

General Journal

12/31/20X1 248 12/31/20X1 7,00006/30/20X2 6212/31/20X2 6206/30/20X3 6212/31/20X3 62

12/31/20X3 0 12/31/20X3 7,000


P1/P219


12/31/20X1 248 12/31/20X1 7,00006/30/20X2 6212/31/20X2 6206/30/20X3 6212/31/20X3 62

12/31/20X3 0 12/31/20X3 7,000


Debit Credit06/30/20X2 Bond Interest Expense ($280 + $62) 342

Discount on Bonds Payable 62Cash ($7,000 x 8% / 2) 280

12/31/20X2 Bond Interest Expense ($280 + $62) 342Discount on Bonds Payable 62Cash ($7,000 x 8% / 2) 280



General Journal

P1/P220


Debit Credit06/30/20X2 Bond Interest Expense ($280 + $62) 342

Discount on Bonds Payable 62Cash ($7,000 x 8% / 2) 280




General Journal

Interest expense = Amount repaid minus amount borrowed4 payments of $280 $1,1201 payment of $7,000 7,000Total repaid 8,120Borrowed 6,752Total bond interest expense $1,368 ÷ 4 = $342

P1/P221


12/31/20X1 248 12/31/20X1 7,00006/30/20X2 6212/31/20X2 6206/30/20X3 6212/31/20X3 62

12/31/20X3 0 12/31/20X3 7,000


Debit Credit12/31/20X3 Bonds Payable 7,000

Cash 7,000

General Journal

P1/P222

10-P3: Issuing Bonds at a Premium

23

14 - 24

Adidas issues bonds with the following provisions:

Par Value: $100,000

Issue Price: 103.546% of par value






Issuing Bonds at a Premium

} Bond will sell at a premium.

P324

14 - 25


Par value $ 100,000 Cash proceeds 103,546 *Premium $ 3,546 *$100,000 x 103.546%

Adjunct-LiabilityAccount

On Dec. 31, 2013, Adidas will record the bond issue as:On Dec. 31, 2013, Adidas will record the bond issue as:

P325

14 - 26


Long-term Liabilities: Bonds Payable 100,000 Plus: Premum on Bonds Payable 3,546 103,546

Partial Balance Sheet as of Dec. 31, 2015

Maturity Value

Carrying Value

P326

14 - 27

Amortizing a Bond Premium

$3,546 ÷ 4 periods = $887 (rounded)

$100,000 × 12% × ½ = $6,000

Adidas will make the following entry every six months to record the cash interest payment

and the amortization of the discount.

P327

14 - 28

Straight-Line Amortization TableInterest Interest Premium Unamortized Carrying

Date Payment Expense Amortization* Premium Value12/31/2015 3,546$ 103,546$ 6/30/2016 6,000$ 5,113$ 887$ 2,659 102,659

12/31/2016 6,000 5,113 887 1,772 101,772 6/30/2017 6,000 5,113 887 885 100,885

12/31/2017 6,000 5,115 885 - 100,000 24,000$ 20,454$ 3,546$

* Rounded.

Amortizing a Bond Premium

P328

NEED-TO-KNOW

Semiannual Period-End Carrying Value(0) 12/31/20X1 $260 $7,260(1) 06/30/20X2 195 7,195(2) 12/31/20X2 130 7,130(3) 06/30/20X3 65 7,065(4) 12/31/20X3 0 $7,000

Change in Carrying Value$260 / 4 semiannual periods = $65 per period

12/31/20X1 26012/31/20X1 7,00006/30/20X2 6512/31/20X2 6506/30/20X3 6512/31/20X3 65

12/31/20X3 012/31/20X3 7,000

A company issues 8%, two-year bonds on December 31, 20X1, with a par value of $7,000 and semiannual interest payments. On the issue date, the annual market rate for these bonds is 6%, which implies a selling price of 103.71 or $7,260.

(a) Prepare an amortization table for these bonds; use the straight-line method to amortize the premium. Then, prepare journal entries to record (b) the issuance of bonds on December 31, 20X1; (c ) the first through fourth interest payments on each June 30 and December 31; and (d) the maturity of the bond on December 31, 20X3.

Premium on Bonds PayableBonds Payable

Unamortized Premium<< $7,000 x 1.0371 = $7,260

P329


Debit Credit12/31/20X1 Cash ($7,000 x 1.0371) 7,260

Premium on Bonds Payable 260Bonds Payable 7,000

General Journal

12/31/20X1 26012/31/20X1 7,00006/30/20X2 6512/31/20X2 6506/30/20X3 6512/31/20X3 65

12/31/20X3 012/31/20X3 7,000


Interest expense = Amount repaid minus amount borrowed

4 payments of $280 $1,1201 payment of $7,000 7,000Total repaid 8,120Borrowed 7,260Total bond interest expense $ 860 ÷ 4 = $215 per period

Semiannual payment = $280 ($7,000 x 8% x ½)

P330


Debit Credit06/30/20X2 Bond Interest Expense ($280 - $65) 215

Premium on Bonds Payable 65Cash ($7,000 x 8% x ½) 280

12/31/20X2 Bond Interest Expense ($280 - $65) 215Premium on Bonds Payable 65

Cash ($7,000 x 8% x ½) 280


Cash ($7,000 x 8% x ½) 280


Cash ($7,000 x 8% x ½) 280

General Journal

12/31/20X1 26012/31/20X1 7,00006/30/20X2 6512/31/20X2 6506/30/20X3 6512/31/20X3 65

12/31/20X3 012/31/20X3 7,000



P331


Debit Credit12/31/20X3 Bonds Payable 7,000

Cash 7,000

General Journal

12/31/20X1 26012/31/20X1 7,00006/30/20X2 6512/31/20X2 6506/30/20X3 6512/31/20X3 65

12/31/20X3 012/31/20X3 7,000



P332

14 - 33

Bond Pricing

P3

Cash Outflows related to Interest Payments

Cash Outflows for par value at end of Bond life

33

14 - 34

Fila issues bonds with the following provisions:

Par Value: $100,000

Issue Price: ?






P3

Present Value of a Discount Bond

34

14 - 35

Present Value of a Discount BondTo calculate Present Value, we need relevant interest rate

and number of periods.Semiannual rate = 5% (Market rate 10% ÷ 2)

Semiannual periods = 4 (Bond life 2 years × 2)

$100,000 × 8% × ½ = $4,000

P335

10-P4: Bond Retirement

36

14 - 37

Bond Retirement

Retirement of the Fila bonds at maturity for $100,000 cash.

Because any discount or premium will be fully amortized at maturity, the carrying value of the bonds will be equal to par value.

P437

14 - 38

Bond RetirementRetirement of Bonds before Maturity

Carrying Value > Retirement Price = GainCarrying Value < Retirement Price = Loss

Assume that $100,000 of callable bonds will be retired on July 1, 2015, after the first interest payment. The

bond carrying value is $104,500.The bonds have a call premium of $3,000.

P438

14 - 39

Bond Retirement

Conversion of Bonds to Stock

On January 1, $100,000 par value bonds of Converse, with a carrying value of $100,000, are converted to

15,000 shares of $2 par value common stock.

15,000 shares × $2 par value per shareP439

10-C1: Installment Notes

40

14 - 41

Note Maturity Date

Note PayableNote Payable

Cash

Company Lender

Note Date

When is the repayment of the principal and interest going to be made?

Long-Term Notes Payable

C141

14 - 42

Note Maturity Date

Company Lender

Note Date

Single Payment of Principal plus

Interest


C1

Single Payment of Principal plus Interest

42

14 - 43

Note Maturity Date

Company Lender

Note Date

Regular Payments of Principal plus Interest

Regular Payments of Principal plus Interest


C143

14 - 44

Installment NotesOn January 1, 2015, Foghog borrows $60,000 from a

bank to purchase equipment. It signs an 8% installment note requiring 6 annual payments of

principal plus interest.

Computation Table Table Value

Present Value Payment

Principal divided by PV factor

PV of Annuity of $1 (B.3) 4.6229 60,000 12,979

Compute the periodic payment by dividing the face amount of the note by the present value factor.

C144

14 - 45

Installment Notes with Equal Payments

C145

14 - 46

Installment Notes with Equal PaymentsLet’s record the first payment made on

December 31, 2015 by Foghog to the bank.

Refer back to the amortization schedule to make the December 31, 2016 payment on the note.

C146

14 - 47

Mortgage Notes and Bonds

A mortgage is a legal agreement that helps protect the lender if the borrower fails to make the

required payments.

It gives the lender the right to be paid out of the cash proceeds from the sale of the borrower’s assets specifically identified in the mortgage

contract.

C147

$1,000 = Present Value of an Ordinary Annuity

$1,000 = PVA (n=4, i=5%) x Payment

On January 1, 20X1, a company borrows $1,000 cash by signing a four-year, 5% installment note. The note requires four equal total payments of accrued interest and principal on December 31 of each year from 20X1 through 20X4.

1. Compute the amount of each of the four equal total payments.

$1,000 = PaymentPVA (n=4, i=5%)

NEED-TO-KNOW

PV of $1

FV of $1

PV Ord Ann

FV Ord Ann

C1/P548

C1/P549

$1,000 = Present Value of an Ordinary Annuity

$1,000 = PVA (n=4, i=5%) x Payment

= Payment


1. Compute the amount of each of the four equal total payments.

$1,000 = Payment

$1,000 = Payment3.5460

$282

PVA (n=4, i=5%)

NEED-TO-KNOW

PV of $1

FV of $1

PV Ord Ann

FV Ord Ann

C1/P550

2. Prepare an amortization table for this installment note.

Period End

(A)Beginning

Balance

(B)Debit

Interest Expense[5% x (A)]

(C)Debit Notes

Payable[(D) - (B)]

(D)CreditCash

(E)Ending Balance[(A) - (C)]

12/31/20X1 $1,000 $50 $232 $282 $76812/31/20X2 768 38 244 282 52412/31/20X3 524 26 256 282 26812/31/20X4 268 14 268 282 0

$128 $1,000 $1,128


1. Compute the amount of each of the four equal total payments. $282

NEED-TO-KNOW

3. Prepare journal entries to record the loan on January 1, 20X1, and the four payments from December 31, 20X1, through December 31, 20X4.

C1/P551

Period End

(A)Beginning

Balance

(B)Debit

Interest Expense[5% x (A)]

(C)Debit Notes

Payable[(D) - (B)]

(D)CreditCash

(E)Ending Balance[(A) - (C)]

12/31/20X1 $1,000 $50 $232 $282 $76812/31/20X2 768 38 244 282 52412/31/20X3 524 26 256 282 26812/31/20X4 268 14* 268 282 0

Debit Credit01/01/20X1 Cash 1,000

Notes payable 1,000

12/31/20X1 Interest expense ($1,000 x .05) 50Notes payable 232

Cash 282

12/31/20X2 Interest expense ($768 x .05) 38Notes payable 244

Cash 282

12/31/20X3 Interest expense ($524 x .05) 26Notes payable 256

Cash 282

12/31/20X4 Interest expense (* Rounded) 14Notes payable 268

Cash 282

General Journal

NEED-TO-KNOW

C1/P552

14 - 53

Global ViewAccounting for Bonds and Notes

The definitions and characteristics of bonds and notes are broadly similar for both U.S. GAAP and IFRS. The accounting for issuances of

bonds, market pricing, and retirement of both bonds and notes is similar. Both U.S. GAAP and IFRS also allow companies to account for bonds

and notes using fair value.

Accounting for Leases and PensionsBoth U.S. GAAP and IFRS require companies to distinguish between

operating leases and capital leases; with IFRS calling the latter finance leases. The accounting and reporting for leases are broadly similar, with the main difference that the criteria for identifying a lease as a

capital or finance lease is more general under IFRS. For pensions, the methods of accounting and reporting are similar for both U.S. GAAP and

IFRS. 53

10-A2: Features of Bonds and Notes

54

14 - 55

Secured and Unsecured

Term and Serial

Registered and Bearer

Convertible and Callable

Features of Bonds and Notes

A255

10-A3: Debt-to-Equity Ratio

56

14 - 57

This ratio helps investors determine the risk of investing in a company by dividing its total liabilities

by total equity.

Debt-to-Equity RatioDebt-to-

equity ratioTotal liabilities

Total equity=

A357

10-C2: Present Values of Bonds and Notes

58

14 - 59

Present Value of $1 Rate

Periods 3% 4% 5%1 0.9709 0.9615 0.9524 2 0.9426 0.9246 0.9070 3 0.9151 0.8890 0.8638 4 0.8885 0.8548 0.8227 5 0.8626 0.8219 0.7835 6 0.8375 0.7903 0.7462 7 0.8131 0.7599 0.7107 8 0.7894 0.7307 0.6768 9 0.7664 0.7026 0.6446

10 0.7441 0.6756 0.6139

Appendix 10A: Present Values of Bonds and Notes

Face amount = $100,000Contract rate = 8%Market rate = 10%Interest paid semiannually

First, we calculate the present value of the principal repayment in 4 periods (2 years × 2 payments per year, using 5% market rate (10% annual rate ÷ 2 payments per year).

$100,000 × 0.8227 = $82,270C259

14 - 60

Present Value of Annuity of $1 Rate

Periods 3% 4% 5%1 0.9709 0.9615 0.9524 2 1.9135 1.8861 1.8594 3 2.8286 2.7751 2.7232 4 3.7171 3.6299 3.5460 5 4.5797 4.4518 4.3295 6 5.4172 5.2421 5.0757 7 6.2303 6.0021 5.7864 8 7.0197 6.7327 6.4632 9 7.7861 7.4353 7.1078

10 8.5302 8.1109 7.7217

Appendix 10A: Present Values of Bonds and Notes

$100,000 × 8% × ½ = $4,000

Semiannual Interest Annuity

Present Amount PV Factor ValuePrincipal $ 100,000 0.8227 $ 82,270 Interest 4,000 3.5460 14,184 Issue price of debt $ 96,454

$4,000 × 3.5460 = $14,184

C260

10-P5: Effective Interest Amortization of a Discount

Bond

61

14 - 62

Appendix 10B: Effective Interest Amortization

P5

Effective Interest Amortization of Bond

Discount

Stated Rate: 8%

Effective Rate: 10%

62

10-P6: Effective Interest Amortization of a Premium

Bond

63

14 - 64

Appendix 10B: Effective Interest Amortization

P6

Effective Interest Amortization of Bond Premium

Stated Rate: 12%

Effective Rate: 10%

64

10-C3: Issuing Bonds between Interest Dates

65

14 - 66

Appendix 10C: Issuing Bonds Between Interest Dates

Avia sells $100,000 of its 9% bonds at par on March 1, 2015, 60 days after the stated issue date. The interest on Avia bonds is payable

semiannual on each June 30 and December 31.

Stated Issuedate 1/1 Date of sale 3/1

First Interestdate 6/30

$1,500 accrued $3,000 earnedBondholder pays$1,500 to issuer

Issuer pays $4,500 to bondholder

C366

10-C4: Leases and Pensions

67

14 - 68

Appendix 10D: Leases and Pensions

A lease is a contractual agreement between the lessor (asset owner) and the lessee (asset renter or tenant) that grants the lessee the right to

use the asset for a period of time in return for cash (rent) payments.

Operating LeasesOperating leases are short-term (or cancelable) leases in which the lessor retains the risks and rewards of ownership. Examples include

most car and apartment rental agreements.

Capital LeasesCapital leases are long-term (or non-cancelable) leases by which the lessor transfers substantially all risks and rewards of ownership to the lessee. Examples include leases of airplanes and department store

buildings.

C468

14 - 69

Appendix 10D: Leases and Pensions

A pension is a contractual agreement between an employer and its employees for the employer to provide

benefits (payments) to employees after they retire.

Defined Benefit PlansThe employer’s contributions vary, depending on

assumptions about future pension assets and liabilities. A pension liability is reported when the accumulated

benefit obligation is more than the plan assets, a so-called underfunded plan.

C469

14 - 70

End of Chapter 10

70

accounting for long-term liabilities chapter 10 copyright © 2016 mcgraw-hill education. all rights...

Documents

bond issuer

year bond

bond lifea1314

bond financingbonds

resulting bond

bond issuances

bond holder

equity financing