Chapter

10 LIABILITIES COMMON TO CORPORATE BUSINESSES

Relatively small debt needs can be filled from

single sources.

Relatively small debt needs can be filled from

single sources.

BanksInsurance

CompaniesPension

Plans

or or

Long-Term DebtLong-Term Debt

Large debt needs are often filled by issuing bonds.

Large debt needs are often filled by issuing bonds.

Long-Term DebtLong-Term Debt

• Example: A short term Loan being routinely extended or Long term Liability to be rescheduled before its maturity.

• The long term liabilities of this nature are classified as Long Term Liabilities in Balance Sheet.

Maturing Obligations Intended to be RefinancedMaturing Obligations Intended to be Refinanced

Long-term notes that call for a series of installment payments.

Long-term notes that call for a series of installment payments.

Each payment covers interest for the period AND a portion of the

principal.

Each payment covers interest for the period AND a portion of the

principal.

With each payment, the interest portion gets

smaller and the principal portion gets larger.

With each payment, the interest portion gets

smaller and the principal portion gets larger.

Installment Notes PayableInstallment Notes Payable

• Identify the unpaid principal balance.

• Unpaid Principal × Interest rate = Interest expense.

• Installment payment - Interest expense = Reduction in unpaid principal balance.

• Compute new unpaid principal balance.

• Identify the unpaid principal balance.

• Unpaid Principal × Interest rate = Interest expense.

• Installment payment - Interest expense = Reduction in unpaid principal balance.

• Compute new unpaid principal balance.

Allocating Installment Payments Between Interest and Principal

Allocating Installment Payments Between Interest and Principal

On January 1, 2003, Rocket Corp. borrowed $7,581.57 from First Bank of River City. The loan was a five-year loan and

had an interest rate of 10%. The annual payment is $2,000.

Prepare an amortization table for Rocket Corp.’s loan.

On January 1, 2003, Rocket Corp. borrowed $7,581.57 from First Bank of River City. The loan was a five-year loan and

had an interest rate of 10%. The annual payment is $2,000.

Prepare an amortization table for Rocket Corp.’s loan.

Allocating Installment Payments Between Interest and Principal

Allocating Installment Payments Between Interest and Principal

Date Payment

Interest Expense

(10%)

Reduction in Unpaid

BalanceUnpaid

Balance

Jan. 1, 2003 7,581.57$ Dec. 31, 2003 2,000.00$ 758.16$ 1,241.84$ 6,339.73 Dec. 31, 2004 2,000.00 633.97 1,366.03 4,973.70 Dec. 31, 2005 2,000.00 497.37 1,502.63 3,471.07 Dec. 31, 2006 2,000.00 347.11 1,652.89 1,818.18 Dec. 31, 2007 2,000.00 181.82 1,818.18 (0.00)

Allocating Installment Payments Between Interest and Principal

Allocating Installment Payments Between Interest and Principal

The information needed for the journal entry can be found on the amortization table. The payment

amount, the interest expense, and the amount to credit to principal are all on the table.

The information needed for the journal entry can be found on the amortization table. The payment

amount, the interest expense, and the amount to credit to principal are all on the table.

Date Description Debit Credit

Dec. 31 Interest Expense 758.16 Note Payable 1,241.84 Cash 2,000.00

Allocating Installment Payments Between Interest and Principal

Allocating Installment Payments Between Interest and Principal

Bonds usually involve the borrowing of a large sum of money, called principal.

The principal is usually paid back as a lump sum at the end of the bond period.

Individual bonds are often denominated with a par value, or face value, of $1,000.

Bonds usually involve the borrowing of a large sum of money, called principal.

The principal is usually paid back as a lump sum at the end of the bond period.

Individual bonds are often denominated with a par value, or face value, of $1,000.

Bonds PayableBonds Payable

• Bonds usually carry a stated rate of interest, also called a contract rate/coupon rate.

• Interest is normally paid semiannually.

• Interest is computed as:

Interest = Principal × Stated Rate × Time Interest = Principal × Stated Rate × Time

Bonds PayableBonds Payable

• Bonds are issued through an intermediary called an underwriter.

• Bonds can be sold on organized securities exchanges.

• Bonds are issued through an intermediary called an underwriter.

• Bonds can be sold on organized securities exchanges.

Bonds PayableBonds Payable

Mortgage Bonds

Mortgage Bonds

Convertible Bonds

Convertible Bonds Junk BondsJunk Bonds

Debenture Bonds

Debenture Bonds

Types of BondsTypes of Bonds

On January 1, 2003, Rocket Corp. issues $1,500,000 of 12%, 10-year bonds payable. Interest is payable

semiannually, each July 1 and January 1.

Assume the bonds are issued at face value.Record the issuance of the bonds.

On January 1, 2003, Rocket Corp. issues $1,500,000 of 12%, 10-year bonds payable. Interest is payable

semiannually, each July 1 and January 1.

Assume the bonds are issued at face value.Record the issuance of the bonds.

Accounting for Bonds PayableAccounting for Bonds Payable

Date Description Debit Credit

Jan. 1Date Description Debit Credit

Jan. 1 Cash 1,500,000 Bonds Payable 1,500,000

Record the interest paymenton July 1, 2003.

Record the interest paymenton July 1, 2003.

Accounting for Bonds PayableAccounting for Bonds Payable

Date Description Debit Credit

July 1Date Description Debit Credit

July 1 Interest Expense 90,000 Cash 90,000

On January 1, 2005, wells Corporation issues $1,000,000 of 12%, 20-year bonds payable at 97 to

underwriter. Interest is payable semiannually, each July 1 and January 1.

Record the issuance of the bonds.

On January 1, 2005, wells Corporation issues $1,000,000 of 12%, 20-year bonds payable at 97 to

underwriter. Interest is payable semiannually, each July 1 and January 1.

Record the issuance of the bonds.

Accounting for Bonds Payable: Issuance at Discount

Accounting for Bonds Payable: Issuance at Discount

Date Description Debit Credit

Jan. 1Date Description Debit Credit

Jan. 1 Cash 970,000 Discount on Bonds Payble 30,000 Bonds Payable 1,000,000

To Record the Interest Expense of the bonds.Semiannual Interest Payment ($1,000,000 x 12% x ½) $60,000Add: Semiannual Amortization of Bond Discount ($30,000 discount / 20 years) x 1/2 750Semiannual Interest Expense $60,750

To Record the Interest Expense of the bonds.Semiannual Interest Payment ($1,000,000 x 12% x ½) $60,000Add: Semiannual Amortization of Bond Discount ($30,000 discount / 20 years) x 1/2 750Semiannual Interest Expense $60,750

Accounting for Bonds Payable: Issuance at Discount

Accounting for Bonds Payable: Issuance at Discount

Date Description Debit Credit

Jan. 1Date Description Debit Credit

Jan. 1 Bond Interest Expense 60,750 Cash 60,000 Discount on Bonds Payable 750

On March 1, 2005, wells Corporation issues $1,000,000 of 12%, 20-year bonds payable at 103 to underwriter.

Interest is payable semiannually, each September 1 and March 1.

Record the issuance of the bonds.

On March 1, 2005, wells Corporation issues $1,000,000 of 12%, 20-year bonds payable at 103 to underwriter.

Interest is payable semiannually, each September 1 and March 1.

Record the issuance of the bonds.

Accounting for Bonds Payable: Issuance at Premium

Accounting for Bonds Payable: Issuance at Premium

Date Description Debit Credit

Jan. 1Date Description Debit Credit

Jan. 1 Cash 1,030,000 Premium on Bonds Payable 30,000 Bonds Payable 1,000,000

To Record the Interest Expense of the bonds.Semiannual Interest Payment ($1,000,000 x 12% x ½) $60,000Less: Semiannual Amortization of Bond Discount ($30,000 discount / 20 years) x 1/2 750Semiannual Interest Expense $59,250

To Record the Interest Expense of the bonds.Semiannual Interest Payment ($1,000,000 x 12% x ½) $60,000Less: Semiannual Amortization of Bond Discount ($30,000 discount / 20 years) x 1/2 750Semiannual Interest Expense $59,250

Accounting for Bonds Payable: Issuance at Premiums

Accounting for Bonds Payable: Issuance at Premiums

Date Description Debit Credit

Jan. 1Date Description Debit Credit

Jan. 1 Bond Interest Expense 59,250 Premium on BondsPayable 750 Cash 60,000

Present value of the bond + Accrued interest since the

last interest payment = Selling price of the bond

Bonds Sold Between Interest DatesBonds Sold Between Interest Dates

•Bonds are often sold between interest dates.

•The selling price of the bond is computed as:

•Bonds are often sold between interest dates.

•The selling price of the bond is computed as:

Bonds Sold Between Interest DatesBonds Sold Between Interest Dates

Example: Wells Corporation issues $1 Million of 12%

bonds at par value. On May 1 – two months after the

March issuance date printed on bond. Interest is paid

bi-annuallyDate Description Debit Credit

May 1 Cash 1,020,000 Bonds Payable 1,000,000 Bond Interest Payable 20,000

Bonds Sold Between Interest DatesBonds Sold Between Interest Dates

Four Months later on the regular semi annual interest payment date, following entry is passed:

Date Description Debit Credit

September 1 Bond Interest Payable 20,000 Bond Interest Expense 40,000

Cash 60,000

Gains or losses incurred as a result of retiring bonds should be reported as extraordinary items on the income

statement.

Gains or losses incurred as a result of retiring bonds should be reported as extraordinary items on the income

statement.

Exercising a callprovision.

Purchasing thebonds on theopen m arket.

Bonds can be re tired by . . .

Early Retirement of DebtEarly Retirement of Debt

Redeeming Bonds at Maturity

Accounting for Bond RetirementsAccounting for Bond Retirements

San Marcos HS records the redemption of its bonds at maturity as follows assuming bonds were issued at par and are redeemed at par:

Bonds payable 100,000

Cash 100,000

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.

Accounting for Bond RetirementsAccounting for Bond Retirements

Illustration: The San Marcos HS, 8% bonds of $100,000 issued on Jan. 1, 2007, are recalled at 105 on Dec. 31, 2008. Assume that the carrying value of the bonds at the redemption date is $98,183. Journal entry at Dec. 31, 2008:

Bonds payable 100,000

Loss on bond redemption 6,817

Cash ($100,000 x 105%) 105,000

Discount on bonds payable 1,817

Accounting for Bond RetirementsAccounting for Bond Retirements

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.

Accounting for Bond RetirementsAccounting for Bond Retirements

E15-6 Nocioni Company issued $1,000,000 of bonds on January 1, 2008.

Instructions: Prepare the journal entry to record the conversion of the bonds into 30,000 shares of $10 par value common stock. Assume the bonds were issued at par.

Bonds payable 1,000,000

Common stock (30,000 x $10) 300,000

Paid-in capital in excess of par 700,000

Accounting for Bond RetirementsAccounting for Bond Retirements