slide 10-1. slide 10-2 chapter 10 liabilities financial accounting, seventh edition
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Slide 10-1
Slide 10-2
Chapter 10
Liabilities
Financial Accounting, Seventh Edition
Slide 10-3
1. Explain a current liability, and identify the major types of current liabilities.
2. Describe the accounting for notes payable.
3. Explain the accounting for other current liabilities.
4. Explain why bonds are issued, and identify the types of bonds.
5. Prepare the entries for the issuance of bonds and interest expense.
6. Describe the entries when bonds are redeemed or converted.
7. Describe the accounting for long-term notes payable.
8. Identify the methods for the presentation and analysis of long-term liabilities.
Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives
Slide 10-4
Current LiabilitiesCurrent LiabilitiesCurrent LiabilitiesCurrent Liabilities
Notes payableNotes payable
Sales taxes payableSales taxes payable
Payroll and payroll taxesPayroll and payroll taxes
Unearned revenuesUnearned revenues
Current maturities of long-Current maturities of long-
term debtterm debt
Statement presentation and Statement presentation and
analysisanalysis
Bond basicsBond basics
Accounting for bond issuesAccounting for bond issues
Accounting for bond Accounting for bond
retirementsretirements
Accounting for long-term Accounting for long-term
notes payablenotes payable
Statement presentation and Statement presentation and
analysisanalysis
Long-Term LiabilitiesLong-Term LiabilitiesLong-Term LiabilitiesLong-Term Liabilities
LiabilitiesLiabilitiesLiabilitiesLiabilities
Slide 10-5
Current liability is debt with two key
features:
1. Company expects to pay the debt from existing
current assets or through the creation of other
current liabilities.
2. Company will pay the debt within one year or
the operating cycle, whichever is longer.
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
SO 1 Explain a current liability, and SO 1 Explain a current liability, and identify the major types of current identify the major types of current liabilities.liabilities.
Current liabilities include notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes payable, salaries payable, and interest payable.
Section 1 Section 1 Current LiabilitiesCurrent Liabilities
Slide 10-6
To be classified as a current liability, a debt must be expected to be paid:
a. out of existing current assets.
b. by creating other current liabilities.
c. within 2 years.
d. both (a) and (b).
QuestionQuestion
SO 1 Explain a current liability, and SO 1 Explain a current liability, and identify the major types of current identify the major types of current liabilities.liabilities.
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
Slide 10-7 SO 2 Describe the accounting for notes SO 2 Describe the accounting for notes
payable.payable.
Notes Payable
Written promissory note.
Require the borrower to pay interest.
Issued for varying periods.
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
Slide 10-8
Illustration: On March 1, 2011, Cole Williams borrows $100,000 from First National Bank on a 4-month, 12% note.
Instructions
a) Prepare the entry on March 1.
b) Prepare the adjusting entry on June 30, assuming monthly adjusting entries have not been made.
c) Prepare the entry at maturity (July 1).
SO 2 Describe the accounting for notes SO 2 Describe the accounting for notes payable.payable.
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
Slide 10-9
Illustration: On March 1, 2011, Cole Williams borrows $100,000 from First National Bank on a 4-month, 12% note.
a) Prepare the entry on March 1.
Notes payable
100,000
Cash 100,000
Interest payable
4,000
Interest expense 4,000
$100,000 x 12% x 4/12 = $4,000
b) Prepare the adjusting entry on June 30.
SO 2 Describe the accounting for notes SO 2 Describe the accounting for notes payable.payable.
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
Slide 10-10
Illustration: On March 1, 2011, Cole Williams borrows $100,000 from First National Bank on a 4-month, 12% note.
c) Prepare the entry at maturity (July 1).
Interest payable 4,000
Notes payable 100,000
Cash
104,000
SO 2 Describe the accounting for notes SO 2 Describe the accounting for notes payable.payable.
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
Slide 10-11 SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.
Sales Tax Payable
Sales taxes are expressed as a stated
percentage of the sales price.
Either rung up separately or included in total
receipts.
Retailer collects tax from the customer.
Retailer remits the collections to the state’s
department of revenue.
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
Slide 10-12
Illustration: The March 25 cash register reading for
Cooley Grocery shows sales of $10,000 and sales taxes
of $600 (sales tax rate of 6%), the journal entry is:
Sales
10,000
Cash 10,600
Sales tax payable
600
SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
Slide 10-13
The term “payroll” pertains to both:
Salaries - managerial, administrative, and sales
personnel (monthly or yearly rate).
Wages - store clerks, factory employees, and
manual laborers (rate per hour).
Determining the payroll involves computing three amounts: (1) gross earnings, (2) payroll deductions, and (3) net pay.
SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.
Payroll and Payroll Taxes Payable
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
Slide 10-14
Illustration: Assume a corporation records its payroll for the week of March 7 as follows:
SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.
Record the accrual of this payroll on March 7.
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
PAYCHECK: 3/7/2011 GROSS PAY (assume a LOT of employees!) $amount
avg rate $ 20 /hour
5,000 hours
$100,000
FICA (soc + medicare) $ 7,650 7.65% up to a cap
FIT (fed'l income tax withholding)
$21,864 Amount varies per employee
SIT (state income tax withholding) $ 2,922 Note: Not Wash State!
Medical
Union dues
Retirment contribution
(32,436)
NET PAY ($ AMOUNT OF PAYCHECK)
$67,564
Employee receives paycheck for the net amount.
Employer withholds the difference between Gross and Net and then remits to various authorities.
Although it is a withholding fro the employee's paycheck; it is the employer's job to withhold and remit.
See Course Pack
Slide 10-15
Illustration: Assume a corporation records its payroll for the week of March 7 as follows:
Salaries and wages expense 100,000
Federal income tax payable21,864
FICA tax payable7,650
State income tax payable 2,922Salaries and wages payable 67,564
SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.
Record the payment of this payroll on March 11.
Mar. 7
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
See Course Pack
Slide 10-16
Illustration: Assume a corporation records its payroll for the week of March 7 as follows:
Salaries and wages expense 100,000
Federal income tax payable21,864
FICA tax payable7,650
State income tax payable 2,922Salaries and wages payable 67,564
SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.
Cash
67,564
Salaries and wages payable 67,564Mar. 11
Record the payment of this payroll on March 11.
Mar. 7
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
Slide 10-17
Payroll tax expense results from three taxes that governmental agencies levy on employers. These taxes are:
FICA tax (7.65% up to a cap)
Federal unemployment tax (0.8%)
State unemployment tax (5.4%)
SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
See Course Pack
Based on the corporation’s $100,000 payroll, record the employer’s expense and liability for these payroll taxes.
Slide 10-18
Illustration: Based on the corporation’s $100,000 payroll, the company would record the employer’s expense and liability for these payroll taxes as follows.
Payroll tax expense 13,850
Federal unemployment tax payable800
FICA tax payable7,650
State unemployment tax payable 5,400
SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
Slide 10-19
Employer payroll taxes do not include:
a. Federal unemployment taxes.
b. State unemployment taxes.
c. Federal income taxes.
d. FICA taxes.
NOTE:
SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
Why not?
Slide 10-20 SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.
Unearned Revenue
Revenues that are received before the company delivers goods or provides services.
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
1. Company debits Cash, and credits a current liability account (unearned revenue).
2. When the company earns the revenue, it debits the Unearned Revenue account, and credits a revenue account.
Slide 10-21
Illustration: Assume that Superior University sells 10,000 season football tickets at $50 each for its five-game home schedule. The university makes the following entry for the sale of season tickets:
SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.
Unearned revenue
500,000
Cash 500,000Aug. 6
Ticket revenue
100,000
Unearned revenue 100,000Sept. 7
As the school completes each of the five home games, it would record the revenue earned.
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
Slide 10-22
Current Maturities of Long-Term Debt
Portion of long-term debt that comes due in the current year.
No adjusting entry required.
SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.
What is a Current Liability?What is a Current Liability?What is a Current Liability?What is a Current Liability?
Slide 10-23
Statement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and Analysis
Illustration 10-5
SO 3SO 3
Slide 10-24
Working capital is calculated as:
a. current assets minus current liabilities.
b. total assets minus total liabilities.
c. long-term liabilities minus current liabilities.
d. both (b) and (c).
QuestionQuestion
Statement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and Analysis
SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.
Slide 10-25
Liquidity refers to the ability to pay maturing obligations and meet unexpected needs for
cash.
The current ratio permits us to compare
the liquidity of different-sized
companies and of a single company at
different times.
Illustration 10-7
Illustration 10-6
Statement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and Analysis
SO 3 Explain the accounting for other current liabilities.SO 3 Explain the accounting for other current liabilities.
Analysis
Slide 10-26
Types of bonds
Bond Contracts
Journal Entries for bondsIssuing
Paying or accruing semi-annual interest
Retiring bonds (paying back principal)
Amortizing bonds
Converting bondsSO 4 Explain why bonds are issued, and identify the types of SO 4 Explain why bonds are issued, and identify the types of
bonds.bonds.
Section 2 Section 2 Long-Term LiabilitiesLong-Term Liabilities
Bond BasicsBond BasicsBond BasicsBond Basics
Slide 10-27
No, not this Bond. . . .
Slide 10-28
Long-term bondsLong-term bonds
Bonds are long-term debt agreementsThe contractual agreement specifies a fixed series of repayments
to include A series of either annual or semi-annual interest payments A lump sum payment (face value)
Slide 10-29
Advantages of Bond Advantages of Bond Financing over Common Financing over Common
StockStockStockholder controlStockholder controlTax expenseTax expenseEarnings per shareEarnings per share
Slide 10-30
The major disadvantages resulting from the use of bonds are:
a. that interest is not tax deductible and the principal must be repaid.
b. that the principal is tax deductible and interest must be paid.
c. that neither interest nor principal is tax deductible.
d. that interest must be paid and principal repaid.
Question
Bond BasicsBond BasicsBond BasicsBond Basics
SO 4 Explain why bonds are issued, and identify the types of SO 4 Explain why bonds are issued, and identify the types of bonds.bonds.
Slide 10-31
Types of Bonds
Secured and Unsecured (debenture) bonds.
Term and Serial bonds.
Registered and Bearer (or coupon) bonds.
Convertible and Callable bonds.
Bond BasicsBond BasicsBond BasicsBond Basics
SO 4 Explain why bonds are issued, and identify the types of SO 4 Explain why bonds are issued, and identify the types of bonds.bonds.
Slide 10-32
Secured Bonds...Secured Bonds...
Have specificHave specific assets assets of of the issuer pledged as the issuer pledged as collateral for bonds, collateral for bonds, e.g., real estate, or e.g., real estate, or sinking fundsinking fund
Slide 10-33
Unsecured or Unsecured or DebentureDebenture Bonds... Bonds...
Are issued against Are issued against the general credit the general credit of the borrower.of the borrower.
Slide 10-34
Term Bonds...Term Bonds...
Are due for payment (mature) at Are due for payment (mature) at
a single specified future date.a single specified future date.
Slide 10-35
Serial Bonds...Serial Bonds...
Mature in Mature in
installments.installments.
Slide 10-36
Convertible or Callable Bonds...Convertible or Callable Bonds...
ConvertibleConvertible into Stock into Stock at at Bondholders option.Bondholders option.
CallableCallable – retired early at – retired early at Issuing Company’s Issuing Company’s optionoption
Read the bond indenture!Read the bond indenture!
Slide 10-37
Issuing Procedures
Bond contract known as a bond indenture.
Represents a promise to pay:
(1) sum of money at designated maturity date, plus
(2) periodic interest at a contractual (stated) rate on the maturity amount (face value).
Paper certificate, typically a $1,000 face value.
Interest payments usually made semiannually.
Generally issued when the amount of capital needed is too large for one lender to supply.
Bond BasicsBond BasicsBond BasicsBond Basics
SO 4 Explain why bonds are issued, and identify the types of SO 4 Explain why bonds are issued, and identify the types of bonds.bonds.
Slide 10-38
Bond BasicsBond BasicsBond BasicsBond BasicsIssuer of
BondsIssuer of
Bonds
MaturityDate
MaturityDate
Illustration 10-10
Contractual Interest
Rate
Contractual Interest
Rate
Face or Par ValueFace or
Par Value
DUE 2013 DUE 2013
2013
SO 4 SO 4
Slide 10-39
How do you keep them straight?How do you keep them straight?
Indenture? – Bond ContractIndenture? – Bond Contract Debenture? – Type of bond (issued on Debenture? – Type of bond (issued on
general credit of company)general credit of company)
Slide 10-40
IndentureIndenture
Think pilgrims, think servants, think indentured servants. . ..
An indentured servant worked 7 years to pay for his trip to America. He/she signed a CONTRACT.
Slide 10-41
DEBENTURE – DIE HARDDEBENTURE – DIE HARD
Open the Safe!
Okay, maybe you didn’t see the movie, but they robbed the safe of millions of dollars worth of bonds, debenture bonds…..
Slide 10-42
Face Value...
The amount of principal due at The amount of principal due at maturity date.maturity date.
Contractual Interest Rate... (Face Interest Rate)
Is the rate used to determine the amount of cash interest the borrower pays and investor receives.
Slide 10-43
Market Interest Rate...
The rate that investors demand for loaning funds.
Not the same as contract (bond indenture) rate.
Slide 10-44
Accounting for Bond IssuesAccounting for Bond Issues
Bonds may be issued at:Bonds may be issued at:Face value Face value – – (e.g., 10% contract rate(e.g., 10% contract rate))Below face value-Below face value-discountdiscount
or or (e.g, market is 12%)(e.g, market is 12%)
Above face value-Above face value-premium premium (e.g., market is 8%)(e.g., market is 8%)
Slide 10-45
Accounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond Issues
JOURNAL ENTRIES:
Issuing Bonds
Paying semi annual interest
Accruing semi annual interest
Retiring Bonds
SO 4 Explain why bonds are issued, and identify the types of SO 4 Explain why bonds are issued, and identify the types of bonds.bonds.
See Course Pack for summary on bond and journal entries
Slide 10-46
Accounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond Issues
SO 4 Explain why bonds are issued, and identify the types of SO 4 Explain why bonds are issued, and identify the types of bonds.bonds.
See Course Pack for summary on bond and journal entries
CHAPTER 10 - LIABILITIES -- Accounting for BondsDetermining the Market Value of bonds
Contract Market Bonds Sell at: issue date: 1/1/2001 10% < 10% Premium to charge buyer for higher contract int. rate
100 five year, 10%, payable semiannually 10% = 10% Face Value
$1000 bonds at 100 (face value) 10% > 10% Discount to attract buyer
1/1/2001 face value -- issue at: 100.00 discount --issue at: 92.639 premium -- issue at: 108.111 Cash 100,000 Cash 92,639 Cash 108,111
Bond Payable 100,000 Discount on B/Pay 7,361 Premium on Bond Pay 8,111 Bond Payable 100,000 Bond Payable 100,000 To record sale of bonds
7/1/2001 Bond Interest Exp. 5,000 Bond Interest Exp. 5,736 Bond Interest Exp. 4,189
Cash 5,000 Discount on B/Pay 736 Premium on B/Pay 811 Cash 5,000 Cash 5,000
To record payment of interest To record payment of interest/amort of disc. To record payment of interest/amort of premium
12/31/2001 Bond Interest Exp. 5,000 Bond Interest Exp. 5,736 Bond Interest Exp. 4,189 Bond Int. Payable 5,000 Discount on B/Pay 736 Premium on B/Pay 811
Bond Int. Payable 5,000 Bond Int. Payable 5,000
To record accrual of interest To record accrual of interest/amort of disc. To record accrual of interest/amort of premium
1/1/2002 Bond Int. Payable 5,000 Bond Int. Payable 5,000 Bond Int. Payable 5,000 Cash 5,000 Cash 5,000 Cash 5,000
To record payment of interest To record payment of interest To record payment of interest
Cost of borrowing: 5,000 Cost of borrowing: 5,000 Cost of borrowing: 5,000 Total Payments 10 Total Payments 10 Total Payments 10 50,000 50,000 Plus discount 7,361 Less: premium (8,111)
Total cost of borrowing 50,000 Total cost of borrowing 57,361 Total cost of borrowing 41,889
At maturity Bond Payable 100,000 Bond Payable 100,000 Bond Payable 100,000 Cash 100,000 Cash 100,000 Cash 100,000
Slide 10-47
Illustration: On January 1, 2011, CandlestickCorporation issues $100,000, five-year, 10% bonds at 100 (100% of face value). Interest payable semiannually. The entry to record the sale is:
Jan. 1 Cash 100,000
Bonds payable 100,000
Accounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond Issues
Issuing Bonds at Face Value
SO 4 Explain why bonds are issued, and identify the types of SO 4 Explain why bonds are issued, and identify the types of bonds.bonds.
Slide 10-48
Illustration: On January 1, 2011, CandlestickCorporation issues $100,000, five-year, 10% bonds at 100 (100% of face value). Assume that interest ispayable semiannually on January 1 and July 1. Prepare the entry to record the payment of interest on July 1, 2011, assume no previous accrual. July 1 Bond interest expense 5,000
Cash 5,000
Issuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face Value
SO 4 Explain why bonds are issued, and identify the types of SO 4 Explain why bonds are issued, and identify the types of bonds.bonds.
Slide 10-49
Illustration: On January 1, 2011, CandlestickCorporation issues $100,000, five-year, 10% bonds at 100 (100% of face value). Assume that interest ispayable semiannually on January 1 and July 1. Prepare the entry to record the accrual of interest on December 31, 2011, assume no previous accrual. Dec. 31 Bond interest expense 5,000
Bond interest payable 5,000
Issuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face Value
SO 4 Explain why bonds are issued, and identify the types of SO 4 Explain why bonds are issued, and identify the types of bonds.bonds.
Slide 10-50
Question: What is the TOTAL cost of borrowing?
Issuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face Value
SO 4 Explain why bonds are issued, and identify the types of SO 4 Explain why bonds are issued, and identify the types of bonds.bonds.
$5,000 x 10 periods = $50,000 Bond interest expense
Slide 10-51
Determining the Market Value of Bonds
Market value is a function of the three factors that determine present value:
1. the dollar amounts to be received,
2. the length of time until the amounts are received, and
3. the market rate of interest.
The features of a bond (callable, convertible, and so on) affect the market rate of the bond.
Bond BasicsBond BasicsBond BasicsBond Basics
SO 4 Explain why bonds are issued, and identify the types of SO 4 Explain why bonds are issued, and identify the types of bonds.bonds.
Slide 10-52
Bond Prices Vary Inversely With Changes in Market Interest Rates
Slide 10-53
Bond Discount...Bond Discount...
When the investor When the investor pays pays lessless than the than the face value of the face value of the bond.bond.
WHY?WHY? To adjust the To adjust the
contractual contractual interest to the interest to the market interest market interest rate.rate.
Slide 10-54
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Illustration: On January 1, 2011, Candlestick, Inc. sells $100,000, five-year, 10% bonds for $92,639 (92.639% of face value). Interest is payable on July 1 and January 1. The entry to record the issuance is:Jan. 1 Cash 92,639
Discount on bonds payable 7,361
Bond payable 100,000
Accounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond Issues
Issuing Bonds at a Discount
Slide 10-55
Statement Presentation
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Illustration 10-13
Issuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a Discount
Slide 10-56
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Total Cost of Borrowing
Illustration 10-14
Illustration 10-15
Issuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a Discount
Slide 10-57
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Discount on Bonds Payable:
a. has a credit balance.
b. is a contra account.
c. is added to bonds payable on the balance sheet.
d. increases over the term of the bonds.
Question
Issuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a Discount
Slide 10-58
Bond Prices Vary Inversely With Changes in Market Interest Rates
Slide 10-59
Bond Premium...Bond Premium...
When the investor When the investor pays pays moremore than than the face value of the face value of the bond.the bond.
WHY?WHY? To adjust the To adjust the
contractual contractual interest to the interest to the market interest market interest rate.rate.
Slide 10-60
Karson Inc. issues 10-year bonds with a maturity value of $200,000. If the bonds are issued at a premium, this indicates that:
a. the contractual interest rate exceeds the market interest rate.
b. the market interest rate exceeds the contractual interest rate.
c. the contractual interest rate and the market interest rate are the same.
d. no relationship exists between the two rates.
Question
Accounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond Issues
SO 4 Explain why bonds are issued, and identify the types of SO 4 Explain why bonds are issued, and identify the types of bonds.bonds.
Slide 10-61
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Illustration: On January 1, 2011, Candlestick, Inc. sells $100,000, five-year, 10% bonds for $108,111 (108.111% of face value). Interest is payable on July 1 and January 1. The entry to record the issuance is:Jan. 1 Cash 108,111
Bonds payable 100,000
Premium on bond payable 8,111
Accounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond Issues
Issuing Bonds at a Premium
Slide 10-62
Statement Presentation
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing bonds at an amount different from face value is quite common. By the time a company prints the bond certificates and markets the bonds, it will be a coincidence if the market rate and the contractual rate are the same.
Illustration 10-16
Issuing Bonds at a PremiumIssuing Bonds at a PremiumIssuing Bonds at a PremiumIssuing Bonds at a Premium
Slide 10-63
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Total Cost of Borrowing
Illustration 10-17
Illustration 10-18
Issuing Bonds at a PremiumIssuing Bonds at a PremiumIssuing Bonds at a PremiumIssuing Bonds at a Premium
Slide 10-64
Bond TradingBonds traded on national securities exchanges.
Newspapers and the financial press publish bond prices and trading activity daily.
Read as: Outstanding 5.125%, $1,000 bonds that mature in 2014. Currently yield a 5.747% return. On this day, $33,965,000 of these bonds were traded. Closing price was 96.595% of face value, or $965.95 (per bond). “Bond Speak”
Bond Basics - exampleBond Basics - exampleBond Basics - exampleBond Basics - example
SO 4 Explain why bonds are issued, and identify the types of SO 4 Explain why bonds are issued, and identify the types of bonds.bonds.
Slide 10-65
Amortizing Bond Discount - Appendix Amortizing Bond Discount - Appendix 10-C10-C
Although Bond Discounts Although Bond Discounts eventuallyeventually get get written off to Bond Interest Expense, this written off to Bond Interest Expense, this must be Amortized must be Amortized over the life of the over the life of the Bond:Bond:
Slide 10-66
Amortizing Bond Discount or Amortizing Bond Discount or PremiumPremium
Candlestick would amortize the $7,361 Candlestick would amortize the $7,361 discount/premium as follows:discount/premium as follows:
$7,361 $7,361 ÷÷ 10 Interest Periods 10 Interest Periods
= $736 Semiannually= $736 Semiannually
Slide 10-67
Candlestick, Inc., sold $100,000, five-year, 10% bonds on
January 1, 2011, for $92,639 (discount of $7,361). Interest
is payable on July 1 and January 1. The bond discount
amortization for each interest period is $736 ($7,361/10).Illustration 10C-2
Amortizing Bond Discount
Straight-Line Amortization – Bond DiscountStraight-Line Amortization – Bond Discount
SO 11 Apply the straight-line method of SO 11 Apply the straight-line method of amortizing amortizing bond discount and bond bond discount and bond premium.premium.
Appendix 10C
Slide 10-68
Illustration 10C-2
Straight-Line Amortization – Bond DiscountStraight-Line Amortization – Bond Discount
SO 11 Apply the SO 11 Apply the straight-straight-line method line method of of amortizing amortizing
bond bond discount discount and bond and bond premium.premium.
Appendix 10C
Slide 10-69
Candlestick, Inc., sold $100,000, five-year, 10% bonds on
January 1, 2011, for $92,639 (discount of $7,361). Interest
is payable on July 1 and January 1. The bond discount
amortization for each interest period is $736 ($7,361/10).
Journal entry on July 1, 2011, to record the interest
payment and amortization of discount is as follows:
Interest Expense 5,736
Cash 5,000
Discount on Bonds Payable 736
July 1
Amortizing Bond Discount
Straight-Line AmortizationStraight-Line Amortization
SO 11 Apply the straight-line method of SO 11 Apply the straight-line method of amortizing amortizing bond discount and bond bond discount and bond premium.premium.
Slide 10-70
Redeeming Bonds at Maturity
SO 6 Describe the entries when bonds are redeemed or SO 6 Describe the entries when bonds are redeemed or converted.converted.
Assuming that the company pays and records separately the interest for the last interest period, Candlestick records the redemption of its bonds at maturity as follows:
Bond payable 100,000
Cash 100,000
Accounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond Retirements
Slide 10-71
Redeeming Bonds before Maturity
When a company retires bonds before maturity, it is necessary to:
1. eliminate the carrying value of the bonds at the redemption date;
2. record the cash paid; and
3. recognize the gain or loss on redemption.
The carrying value of the bonds is the face value of the bonds less unamortized bond discount or plus unamortized bond premium at the redemption date.
SO 6 Describe the entries when bonds are redeemed or SO 6 Describe the entries when bonds are redeemed or converted.converted.
Accounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond Retirements
Slide 10-72 SO 6 Describe the entries when bonds are redeemed or SO 6 Describe the entries when bonds are redeemed or
converted.converted.
When bonds are redeemed before maturity, the gain or loss on redemption is the difference between the cash paid and the:
a. carrying value of the bonds.
b. face value of the bonds.
c. original selling price of the bonds.
d. maturity value of the bonds.
Question
Accounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond Retirements
Slide 10-73
Illustration: Assume Candlestick, Inc. has sold its bonds at a premium. At the end of the eighth period, Candlestick retires these bonds at 103 after paying the semiannual interest. The carrying value of the bonds at the redemption date is $101,623. Candlestick makes the following entry to record the redemption at the end of the eighth interest period (January 1, 2015):
Bonds payable 100,000
Premium on bonds payable 1,623
Loss on redemption 1,377
Cash 103,000
SO 6 Describe the entries when bonds are redeemed or SO 6 Describe the entries when bonds are redeemed or converted.converted.
Accounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond Retirements
Slide 10-74
Converting Bonds into Common Stock
Until conversion, the bondholder receives interest on the bond.
For the issuer, the bonds sell at a higher price and pay a lower rate of interest than comparable debt securities without the conversion option.
Upon conversion, the company transfers the carrying value of the bonds to paid-in capital accounts. No gain or loss is recognized.
SO 6 Describe the entries when bonds are redeemed or SO 6 Describe the entries when bonds are redeemed or converted.converted.
Accounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond Retirements
Note: Know theory, not Journal Entry
Slide 10-75
Long-Term Notes Payable
May be secured by a mortgage that pledges title to specific assets as security for a loan
Typically, the terms require the borrower to make installment payments over the term of the loan. Each payment consists of
1. interest on the unpaid balance of the loan and
2. a reduction of loan principal.
Companies initially record mortgage notes payable at face value.
SO 7 Describe the accounting for long-term notes payable.
Accounting for Long-Term Notes Accounting for Long-Term Notes PayablePayableAccounting for Long-Term Notes Accounting for Long-Term Notes PayablePayable
Note: Know theory, not Journal Entry
Slide 10-76
Each payment on a mortgage note payable consists of:
a. interest on the original balance of the loan.
b. reduction of loan principal only.
c. interest on the original balance of the loan and reduction of loan principal.
d. interest on the unpaid balance of the loan and reduction of loan principal.
Question
SO 7 Describe the accounting for long-term notes payable.
Accounting for Long-Term Notes Accounting for Long-Term Notes PayablePayableAccounting for Long-Term Notes Accounting for Long-Term Notes PayablePayable
Slide 10-77
Presentation
SO 8 Identify the methods for the presentation and analysis of long-term liabilities.
Statement Presentation and AnalysisStatement Presentation and Analysis
Illustration 10-20
Slide 10-78
Analysis
Two ratios that provide information about debt-paying ability and long-run solvency are:
Total debt
Total assets
Debt to total
assets
=
The higher the percentage of debt to total assets, the greater the risk that the company may be unable to meet its maturing obligations.
1.1.
SO 8 Identify the methods for the presentation and analysis of long-term liabilities.
Statement Presentation and AnalysisStatement Presentation and Analysis
Slide 10-79
Two ratios that provide information about debt-paying ability and long-run solvency are:
Income before income taxes and interest expense
Interest expense
Times interest earned
=
Indicates the company’s ability to meet interest payments as they come due.
2.2.
SO 8 Identify the methods for the presentation and analysis of long-term liabilities.
Analysis
Statement Presentation and AnalysisStatement Presentation and Analysis
Slide 10-80
Illustrate: Kellogg Company had total liabilities of
$8,871 million, total assets of $11,397 million,
interest expense of $319 million, income taxes of
$444 million, and net income of $1,103 million.
SO 8 Identify the methods for the presentation and analysis of long-term liabilities.
Analysis
Illustration 10-21
Statement Presentation and AnalysisStatement Presentation and Analysis
Slide 10-81
Advantages of Bond Advantages of Bond Financing over Common Financing over Common
Stock, an illustrationStock, an illustrationStockholder controlStockholder controlTax expenseTax expenseEarnings per shareEarnings per share
Slide 10-82
Effects on earnings per share—stocks vs. bonds.
Illustration 10-9
Bond BasicsBond BasicsBond BasicsBond Basics
SO 4 Explain why bonds are issued, and identify the types of SO 4 Explain why bonds are issued, and identify the types of bonds.bonds.
Slide 10-83
The major disadvantages resulting from the use of bonds are:
a. that interest is not tax deductible and the principal must be repaid.
b. that the principal is tax deductible and interest must be paid.
c. that neither interest nor principal is tax deductible.
d. that interest must be paid and principal repaid.
Question
Bond BasicsBond BasicsBond BasicsBond Basics
SO 4 Explain why bonds are issued, and identify the types of SO 4 Explain why bonds are issued, and identify the types of bonds.bonds.
Slide 10-84
Good Bye and Good Luck!
Solutions to Bond exercise next
End of Chapter 10End of Chapter 10End of Chapter 10End of Chapter 10
Slide 10-85
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CopyrightCopyrightCopyrightCopyright
Slide 10-86
Chapter 10: Bonds! Solutions to exerciseChapter 10: Bonds! Solutions to exercise
THREE INDEPENDENT SCENARIOS
Scenario #1 Scenario #2 Scenario #3
Face Value of a single Bond $1,000 $1,000 $1,000
Coupon Rate 10% 10% 10%
Term of the Bond (life)/ Date Issued, frequency of interest
5 year/ 1/1/2001, every 6 months
5 year/ 1/1/2001, every 6 months
5 year/ 1/1/2001, every 6 months
How many bonds did you issue? 1,000 1,000 1,000
What is the face value of the bond issuance?
$1,000,000 $1,000,000 $1,000,000
Market interest rate for bonds of similar risk?
10% 10.52% 9.49%
Which bond is more attractive to buyer and why?
Neither Market Ours!
How often is interest paid? Yearly or semiannually? When do you pay interest?
Every 6 months Jan 1 and July 1
Every 6 months Jan 1 and July 1
Every 6 months Jan 1 and July 1
How much interest do you pay? $50,000 $50,000 $50,000
Selling price per bond, In “bondspeak” 100 98 102
What was your Selling price (average) in $ per bond?
$1,000 $980 $1,020
How much did you receive for all of the bonds?
$1,000,000 $980,000 $1,020,000
At the end of the life of the bond, what is the principal that you OWE the bondholders?
$1,000,000 $1,000,000 $1,000,000
How much did this bond COST you? $500,000 $520,000 $480,000
Slide 10-87
Chapter 10: Bonds! Solutions to exerciseChapter 10: Bonds! Solutions to exercise
Accounting 202 – BOND REVIEWOn January 1st, 2001, Yao Corporation issued 6 year, $200,000 face value bonds (5% coupon) at 93.69. Interest is payable semiannually on January 1 and July 1.•Prepare the journal entry to record the issuance of the bonds on January 1, 2001 (2 pts)•Prepare the journal entry to record the first interest payment on July 1, 2001 (3 pts)•Prepare the journal entry to record the accrual of interest on December 31, 2001 (3 pts)•Prepare the journal entry to record the retirement of the bond on Jan 1, 2007, after the last interest payment has been made (2 pts).•Calculate the total interest expense recorded on the books of Yao Clothes and the total cash paid for interest during the life of the bond. If the amounts differ, calculate the difference and explain what caused it. (2 pts)•Show an Amortization Schedule for this bond
Slide 10-88
Chapter 10: Bonds! Solutions to exerciseChapter 10: Bonds! Solutions to exercise
# DATE Account Titles AND Description Debit Credit
a 1/1/01 Cash 187,380 Discount on Bonds Payable 12,620 Bonds Payable 200,000To record bonds issued at discount
b 07/01/01 Bond Interest Expense 6,052 Discount on Bonds Payable 1,052 Cash 5,000To record semiannual interest payment
c 12/31/01 Bond Interest Expense 6,052 Discount on Bonds Payable 1,052 Interest Payable 5,000To record semiannual accrual of interest
d 01/01/07 Bonds Payable 200,000 Cash 200,000To record retirement of bonds
e INTEREST EXP = $5,000 * 12 = $60,000 + $12,620 = $72,620
CASH INTEREST PAID = $5,000 * 12 = $60,000
The difference is the discount amount which cost the company an additional interest amount of $12,620.
Slide 10-89
Chapter 10: Bonds! Solutions to exerciseChapter 10: Bonds! Solutions to exercise
2) Prepare a BOND AMORTIZATION Schedule
A B C D E
Semi-annual int.
period Interest to be Paid
(reduction to cash) Interest Expense to
be Recorded Amount of Prem/Disc
Amortization Unamortiz'd
Prem/Disc Bond Carrying Value
Issue dt1/1/01 12,620
187,380
7/1/2001 5,000 6,052 1,052 11,568188,432
1/1/2002 5,000 6,052 1,052 10,516 189,484
7/1/2002 5,000 6,052 1,052 9,464 190,536
1/1/2003 5,000 6,052 1,052 8,412 191,588
7/1/2003 5,000 6,052 1,052 7,360 192,640
1/1/2004 5,000 6,052 1,052 6,308 193,692
7/1/2004 5,000 6,052 1,052 5,256 194,744
1/1/2005 5,000 6,052 1,052 4,204 195,796
7/1/2005 5,000 6,052 1,052 3,152 196,848
1/1/2006 5,000 6,052 1,052 2,100 197,900
7/1/2006 5,000 6,052 1,052 1,048 198,952
1/1/2007 5,000 6,048 1,048* 0 200,000
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