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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
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10-A1: Bond Financing
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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
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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
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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
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Bond Issuing Procedures
A16
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10-P1: Issuing Bonds at Par
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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
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$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
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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
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Bond Discount or Premium
P111
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10-P2: Issuing Bonds at a Discount
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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
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On Dec. 31, 2015, Fila should record the bond issue.
Issuing Bonds at a Discount
Par value $ 100,000 Cash proceeds 96,454 *Discount $ 3,546 *$100,000 x 96.454%
Contra-LiabilityAccount
P214
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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
Issuing Bonds at a Discount
P215
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$3,546 ÷ 4 periods = $887 (rounded)
$100,000 × 8% × ½ = $4,000
Fila will make the following entry every six months to record the cash interest payment
and the amortization of the discount.
Amortizing a Bond Discount
P216
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Straight-Line Amortization TableInterest Interest Discount Unamortized Carrying
Date Payment Expense Amortization* Discount Value12/31/2015 3,546$ 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
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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
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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
Discount on Bonds Payable Bonds Payable
P1/P219
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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.
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
Discount on Bonds Payable Bonds Payable
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
06/30/20X3 Bond Interest Expense ($280 + $62) 342Discount on Bonds Payable 62Cash ($7,000 x 8% / 2) 280
12/31/20X3 Bond Interest Expense ($280 + $62) 342Discount on Bonds Payable 62Cash ($7,000 x 8% / 2) 280
General Journal
P1/P220
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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 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
06/30/20X3 Bond Interest Expense ($280 + $62) 342Discount on Bonds Payable 62Cash ($7,000 x 8% / 2) 280
12/31/20X3 Bond Interest Expense ($280 + $62) 342Discount 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
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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.
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
Discount on Bonds Payable Bonds Payable
Debit Credit12/31/20X3 Bonds Payable 7,000
Cash 7,000
General Journal
P1/P222
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10-P3: Issuing Bonds at a Premium
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Adidas issues bonds with the following provisions:
Par Value: $100,000
Issue Price: 103.546% of par value
Stated Interest Rate: 12%
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 Premium
} Bond will sell at a premium.
P324
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Issuing Bonds at a Premium
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
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Issuing Bonds at a Premium
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
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Amortizing a Bond Premium
$3,546 ÷ 4 periods = $887 (rounded)
$100,000 × 12% × ½ = $6,000
Adidas will make the following entry every six months to record the cash interest payment
and the amortization of the discount.
P327
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Straight-Line Amortization TableInterest Interest Premium Unamortized Carrying
Date Payment Expense Amortization* Premium Value12/31/2015 3,546$ 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
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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
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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 6%, which implies a selling price of 103.71 or $7,260.
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
Premium on Bonds PayableBonds Payable
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
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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 6%, which implies a selling price of 103.71 or $7,260.
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
06/30/20X3 Bond Interest Expense ($280 - $65) 215Premium on Bonds Payable 65
Cash ($7,000 x 8% x ½) 280
12/31/20X3 Bond Interest Expense ($280 - $65) 215Premium on Bonds Payable 65
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
Premium on Bonds PayableBonds Payable
Semiannual payment = $280 ($7,000 x 8% x ½)
P331
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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 6%, which implies a selling price of 103.71 or $7,260.
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
Premium on Bonds PayableBonds Payable
Semiannual payment = $280 ($7,000 x 8% x ½)
P332
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Bond Pricing
P3
Cash Outflows related to Interest Payments
Cash Outflows for par value at end of Bond life
33
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Fila issues bonds with the following provisions:
Par Value: $100,000
Issue Price: ?
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)
P3
Present Value of a Discount Bond
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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
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10-P4: Bond Retirement
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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
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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
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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
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10-C1: Installment Notes
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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
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Note Maturity Date
Company Lender
Note Date
Single Payment of Principal plus
Interest
Long-Term Notes Payable
C1
Single Payment of Principal plus Interest
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Note Maturity Date
Company Lender
Note Date
Regular Payments of Principal plus Interest
Regular Payments of Principal plus Interest
Long-Term Notes Payable
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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.
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Installment Notes with Equal Payments
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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.
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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.
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$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
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C1/P549
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$1,000 = Present Value of an Ordinary Annuity
$1,000 = PVA (n=4, i=5%) x Payment
= 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 = 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
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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
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. $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.
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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
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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
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10-A2: Features of Bonds and Notes
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Secured and Unsecured
Term and Serial
Registered and Bearer
Convertible and Callable
Features of Bonds and Notes
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10-A3: Debt-to-Equity Ratio
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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=
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10-C2: Present Values of Bonds and Notes
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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
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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
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10-P5: Effective Interest Amortization of a Discount
Bond
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Appendix 10B: Effective Interest Amortization
P5
Effective Interest Amortization of Bond
Discount
Stated Rate: 8%
Effective Rate: 10%
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10-P6: Effective Interest Amortization of a Premium
Bond
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Appendix 10B: Effective Interest Amortization
P6
Effective Interest Amortization of Bond Premium
Stated Rate: 12%
Effective Rate: 10%
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10-C3: Issuing Bonds between Interest Dates
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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
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10-C4: Leases and Pensions
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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.
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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.
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End of Chapter 10
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