long-term liabilities

PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 14

LONG-TERM LIABILITIES

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BOND FINANCING

Bonds do not affect owner control.

Bonds do not affect owner control.

Interest on bonds is tax deductible.

Interest on bonds is tax deductible.

Bonds can increase return on equity.

Bonds can increase return on equity.

AdvantagesAdvantages

Bonds require Bonds require payment of both payment of both

periodic interest and periodic interest and par value at maturity.par value at maturity.

Bonds require Bonds require payment of both payment of both

periodic interest and periodic interest and par value at maturity.par value at maturity.

Bonds can decrease Bonds can decrease return on equity.return on equity.

Bonds can decrease Bonds can decrease return on equity.return on equity.

DisadvantagesDisadvantages

A1

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ISSUING BONDS AT PAR

On Jan. 1, 2011, a company issued the following bonds:Par Value: $800,000

Stated Interest Rate: 9%Interest Dates: 6/30 and 12/31

Maturity Date = Dec. 31, 2030 (20 years)

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$800,000 × 9% × ½ year = $36,000$800,000 × 9% × ½ year = $36,000


On June 30, 2011, the issuer of the bond pays the first semiannual interest payment of $36,000.

On June 30, 2011, 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.This entry is made every six months until the bonds mature.

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On December 31, 2030, the bonds mature and the issuer of the bond pays face value of $800,000 to the

bondholders.

On December 31, 2030, the bonds mature and the issuer of the bond pays face value of $800,000 to the

bondholders.

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BOND DISCOUNT OR PREMIUMP1

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Fila issues bonds with the following provisions: Fila issues bonds with the following provisions:

Par Value: $100,000Par Value: $100,000

Issue Price: 96.454% of par valueIssue Price: 96.454% of par value

Stated Interest Rate: 8%Stated Interest Rate: 8%

Market Interest Rate: 10%Market Interest Rate: 10%

Interest Dates: 6/30 and 12/31Interest Dates: 6/30 and 12/31

Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011

Maturity Date: Dec. 31, 2013 (2 years)Maturity Date: Dec. 31, 2013 (2 years)









ISSUING BONDS AT A DISCOUNT

}} Bond will sell at a discount.

P2

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On Dec. 31, 2011, Fila should record the bond issue.On Dec. 31, 2011, Fila should record the bond issue.On Dec. 31, 2011, Fila should record the bond issue.On Dec. 31, 2011, Fila should record the bond issue.


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

Contra-LiabilityContra-LiabilityAccountAccount

Contra-LiabilityContra-LiabilityAccountAccount

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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, 2011

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


Maturity ValueMaturity ValueMaturity ValueMaturity Value

Carrying ValueCarrying ValueCarrying ValueCarrying Value


Amortizing a Bond DiscountAmortizing a Bond DiscountUsing the Using the straight-line methodstraight-line method, the discount amortization will , the discount amortization will

be $887 be $887 (rounded) (rounded) every six months. every six months.

$3,546 ÷ 4 periods = $887 $3,546 ÷ 4 periods = $887 (rounded)(rounded)

Amortizing a Bond DiscountAmortizing a Bond DiscountUsing the Using the straight-line methodstraight-line method, the discount amortization will , the discount amortization will



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$3,546 ÷ 4 periods = $887 (rounded)

$100,000 × 8% × ½ = $4,000


$100,000 × 8% × ½ = $4,000

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

the amortization of the discount.the amortization of the discount.

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


AMORTIZING A BOND DISCOUNT

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Adidas issues bonds with the following provisions: Adidas issues bonds with the following provisions:








Adidas issues bonds with the following provisions: Adidas issues bonds with the following provisions:








ISSUING BONDS AT A PREMIUM

}} Bond will sell at a premium.

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

Adjunct-LiabilityAdjunct-LiabilityAccountAccount

Adjunct-LiabilityAdjunct-LiabilityAccountAccount

On Dec. 31, 2011, Adidas will record the bond issue as:On Dec. 31, 2011, Adidas will record the bond issue as:On Dec. 31, 2011, Adidas will record the bond issue as:On Dec. 31, 2011, Adidas will record the bond issue as:

P3

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


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


Maturity ValueMaturity ValueMaturity ValueMaturity Value

Carrying ValueCarrying ValueCarrying ValueCarrying Value

Amortizing a Bond PremiumAmortizing a Bond PremiumUsing the Using the straight-line methodstraight-line method, the premium amortization will , the premium amortization will



Amortizing a Bond PremiumAmortizing a Bond PremiumUsing the Using the straight-line methodstraight-line method, the premium amortization will , the premium amortization will



P3

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AMORTIZING A BOND PREMIUM


$100,000 × 12% × ½ = $6,000


$100,000 × 12% × ½ = $6,000

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


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


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Issue Price: ?Issue Price: ?

Stated Interest Rate: 8% Stated Interest Rate: 8%







Issue Price: ?Issue Price: ?

Stated Interest Rate: 8% Stated Interest Rate: 8%





ISSUING BONDS AT A DISCOUNTP2

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PRESENT VALUE OF A DISCOUNT BOND

To calculate Present Value, we need relevant interest rate To calculate Present Value, we need relevant interest rate and number of periods.and number of periods.

Semiannual rate = 5% (Market rate 10% ÷ 2)Semiannual rate = 5% (Market rate 10% ÷ 2)Semiannual periods = 4 (Bond life 2 years × 2)Semiannual periods = 4 (Bond life 2 years × 2)

To calculate Present Value, we need relevant interest rate To calculate Present Value, we need relevant interest rate and number of periods.and number of periods.

Semiannual rate = 5% (Market rate 10% ÷ 2)Semiannual rate = 5% (Market rate 10% ÷ 2)Semiannual periods = 4 (Bond life 2 years × 2)Semiannual periods = 4 (Bond life 2 years × 2)

$100,000 × 8% × ½ = $4,000$100,000 × 8% × ½ = $4,000$100,000 × 8% × ½ = $4,000$100,000 × 8% × ½ = $4,000

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

DEBT-TO-EQUITY RATIO

Debt-to-

Equity Ratio

Total Liabilities

Total Equity=

A3

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END OF CHAPTER 14

long-term liabilities

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