1

Long-term Liabilities

ACCTG 5120David Plumlee

page2

Overview – L-t liabilities Terminology Conceptual issues Bond Valuation Examples

Par, below par and above par Journal entries

Interest methods Between interest dates

page3

How are L-t Liabilities Measured?

How are l-t liabilities valued on the balance sheet?

What interest rate is used to find the bond’s value?

page4

Bond Terminology Serial vs. term Deep discount Debenture Bearer or coupon Callable Convertible

page5

Bond Interest Interest Payments equal….

Interest Expense equals….

page6

Data for Example

face value = $1,000,000 term = 5 years issued January 1, year 1 interest paid semi-annually, June

30 and December 31 annual coupon rate = 10% annual market (or effective) rate:

Case: A = 10% B = 8% C = 12%

page7

Bond Issue-Time line

page8

Case A: Market = 10%

Price = PV of Maturity Value + PV of Interest Price = PV of Maturity Value + PV of Interest AnnuityAnnuity

page9

Entry to Record Bond Issue

page10

Discount or premium?

Discounts or Premia arise if the stated interest rate differs from the market rate when the debt is issued

page11

Case B: Market = 8%

Price = PV of Maturity Value + PV of Interest Price = PV of Maturity Value + PV of Interest AnnuityAnnuity

page12

Entry To Record Bond Issue

page13

Case C: Market = 12%

Price = PV of Maturity Value + PV of Interest Price = PV of Maturity Value + PV of Interest AnnuityAnnuity

page14

Entry To Record Bond Issue

page15

What do you do with the discount or premium? Discounts and premia are

amortized over the remaining life of the debt

Two amortization methods are possible straight-line effective interest

page16

Straight-line Amortization

Total discount or premium divided by the number of remaining interest periods is expensed each period

Interest expense is a constant amount each period

Easy to use

page17

Effective Interest Amortization

Discount or premium is amortized over remaining life of bond

Interest Expense is a constant % of carrying value

More representationally faithful Required under GAAP, if

materially different

page18

A Bond Example

Alpha Corp. issued $100,000 of 8% (payable semi-annually on June 30 and December 31), 5 year bonds. The bonds were dated and sold on January 1, 1998, at an effective rate of 10 percent.

page19

Compute the price of the bond

Maturity value of bonds payable PV of $100,000 5 years at 10%

100,000 *.61391 (PVIF 10,5%) PV of $4,000 at 10% annually

4000*7.72173 (PVOA 10,5%)

Proceeds from sale of bonds

Discount on bonds payable

page20

Bond Discount Amortization-SL

Cash Interest Discount CarryingDate Paid Expense Amortized Amt of Bonds1-1-

007-1-001-1-01

7-1-011-1-02

1-1-05

-0- -0- -0-

page21

Bond Discount Amortization-EI

Cash Interest Discount CarryingDate Paid Expense Amortized Amt of Bonds1-1-

007-1-001-1-01

7-1-011-1-02

1-1-05

-0- -0- -0-

page22

Bond Discount Amortization-EI

Cash Interest Discount CarryingDate Paid Expense Amortized Amt of Bonds1-1-

007-1-001-1-01

7-1-011-1-02

1-1-05

-0- -0- -0-4,0004,000

4,000

4,000

4,000

page23

Journal entries - for sale and first interest payment

page24

Other issues--

Interest period and accounting period do not coincide

Apportion interest/discount or premium amounts to proper accounting periods

page25

Year end 10/31 instead of 12/31

page26

Extinguishment of debt Retirement of debt before maturity In-substance defeasance

Irrevocably transfers assets sufficient to retire debt

Defeasance Debtor is legally released from payments

GAAP requires gain or loss to be reported as EXTRAORDINARY item if material reported separately on the income statement reported net of related taxes

page27

Long-term notes payable Issued for cash and other rights

Need to record the discount and ‘rights’

Issued for property, goods…. Use present value of note or goods,

whichever is more ‘determinable’

Mortgage notes payable pledges title to property as security

page28

Off-balance-sheet financing

Obligations that do not meet the strict definition of debt

Leases prior to FABS 13

page29

Balance sheet presentation Long term debt-often single line item Disclose next five years of debt payments Off-balance sheet items... Debt Extinguishment--income statement

Describe transaction Tax effect per share gain/loss

Analysis of debt Times interest earned Debt to total assets

page30

Appendix 14 A -- FAS 114 - Loan Impairments Creditors perspective Inability to collect loan and interest amounts Creditor determines WHEN and in WHAT amount

loan is impaired based on present value of expected future payments and recorded carrying value

Journal entriesUncollectible accounts expense DR

Allowance account CR