copyright © 2007 prentice-hall. all rights reserved 1 long-term liabilities chapter 15

Copyright © 2007 Prentice-Hall. All rights reserved 1

Long-Term LiabilitiesLong-Term LiabilitiesLong-Term LiabilitiesLong-Term Liabilities

Chapter 15


Objective 1Objective 1Objective 1Objective 1

Account for bonds payable


Bonds: An IntroductionBonds: An IntroductionBonds: An IntroductionBonds: An Introduction

• Groups of notes payable issued to multiple lenders

• Principal (maturity value, par value)

• Maturity date

• Stated interest rate


Types of BondsTypes of BondsTypes of BondsTypes of Bonds

• Term bonds - mature at a single specified future date

• Serial bonds - mature in installments


Types of BondsTypes of BondsTypes of BondsTypes of Bonds

• Secured bonds - specific assets are pledged as collateral

• Debenture bonds - backed by the good faith of the issuer


Bond PricesBond PricesBond PricesBond Prices

• Maturity value (par)

• Discount

• Premium


Bond PricesBond PricesBond PricesBond Prices

Quoted as percent of its face value• What is the issue price of a $1,000 bond sold at

98?

$1,000 x .98 = $980

• What is the issue price of a $5,000 bond sold at 101?

$5,000 x 1.01 = $5,050


Present ValuePresent ValuePresent ValuePresent Value

• Time value of money

• Amount a person would invest today to receive a greater amount in the future

• Difference between present value and future value = Interest

Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6

Future Value$100,000

Present Value$97,000


Bond Interest RatesBond Interest RatesBond Interest RatesBond Interest Rates

• Stated interest rate– Printed on bond– Determines cash interest payments

• Market interest rate (effective rate)– Rate in effect when bonds are issued– Rate investors demand for loaning money


Bond Interest RatesBond Interest Rates

Bond Stated Rate = 9%

Market Rate = 9%

Bonds Sell AtPar (Face)

Market Rate = 8%

Bonds Sell ata Premium

Market Rate = 10%

Bonds Sell at a Discount


GENERAL JOURNAL

DATE DESCRIPTION REF DEBIT CREDIT

Issuing Bonds at ParIssuing Bonds at Par E15-17 E15-17

Issuing Bonds at ParIssuing Bonds at Par E15-17 E15-17

2006

Mar 31 Cash 400,000Bonds Payable 400,000

Sep 30 Interest Expense 14,000Cash 14,000

Dec 31 Interest Expense 7,000Interest Payable 7,000

Interest = 400,000 x .07 x ½ = 14,000

Interest = 400,000 x .07 x 3/12 = 7,000


GENERAL JOURNAL


E15-17E15-17E15-17E15-17

2007

Mar 31 Interest Expense 7,000Interest Payable 7,000

Cash 14,000


E15-18 aE15-18 aE15-18 aE15-18 aGENERAL JOURNAL


Jan 1 Cash 50,000 Bonds Payable 50,000

Jul 1 Interest Expense 1,500Cash 1,500

Cash = $50,000 x 6% x ½ = $1,500



Measure interest expense by the straight-line amortization method


GENERAL JOURNAL


Bond Discount – E15-18 bBond Discount – E15-18 bBond Discount – E15-18 bBond Discount – E15-18 b

Jan 1 Cash 47,500Discount on Bonds Payable 2,500

Bonds Payable 50,000

Contra-LiabilityAccount


Balance Sheet Presentation as of Balance Sheet Presentation as of January 1January 1


Long-term liabilities:

Bond payable $50,000

Less Discount on Bonds 2,500

$47,500

Face Value

Carrying Value


Straight-Line AmortizationStraight-Line AmortizationE15-18 bE15-18 b

Straight-Line AmortizationStraight-Line AmortizationE15-18 bE15-18 b

GENERAL JOURNAL


Jan 1 Cash 47,500Discount on Bonds Payable 2,500


Jul 1 Interest Expense 125Discount on Bonds Payable 125

1 Interest Expense 1,500Cash 1,500

Amortization of discount = $2,500 / 20 periods

Cash = $50,000 x 6% x ½ = $1,500


Balance Sheet PresentationBalance Sheet PresentationBalance Sheet PresentationBalance Sheet Presentation

July 1


Bond payable

$50,000

Less Discount on Bonds

2,375

$ 47,625

January 1


Bond payable

$50,000

Less Discount on Bonds

2,500

$ 47,500

Notice that the carrying value of the bond increases, approaching the face value


GENERAL JOURNAL


Bond Premium – E15-18 cBond Premium – E15-18 cBond Premium – E15-18 cBond Premium – E15-18 c

Jan 1 Cash 52,500Premium on Bonds Payable 2,500






Bond payable $50,000

Plus Premium on Bonds 2,500

$52,500

Face Value

Carrying Value


Straight-Line AmortizationStraight-Line AmortizationE15-18 cE15-18 c

Straight-Line AmortizationStraight-Line AmortizationE15-18 cE15-18 c

GENERAL JOURNAL


Jan 1 Cash 52,500Premium on Bonds Payable 2,500


Jul 1 Premium on Bonds Payable 125Interest Expense 125

1 Interest Expense 1,500Cash 1,500

Amortization of premium = $2,500 / 20 periods


Balance Sheet PresentationBalance Sheet PresentationBalance Sheet PresentationBalance Sheet Presentation

July 1


Bond payable

$50,000

Plus Premium on Bonds

2,375

$52,375

January 1


Bond payable

$50,000

Plus Premium on Bonds

2,500

$52,500

Notice that the carrying value of the bond decreases, approaching the face value


Adjusting EntriesAdjusting EntriesAdjusting EntriesAdjusting Entries

• When bonds are issued at a discount or premium, accrual includes amortization


Issuing Bonds Issuing Bonds Payable Payable BetweenBetween Interest Dates Interest DatesIssuing Bonds Issuing Bonds Payable Payable BetweenBetween Interest Dates Interest Dates

• Bonds can be issued between interest payment dates


Exercise 15-21Exercise 15-21Exercise 15-21Exercise 15-21

April 30Bond Date

May 31Issue Date

Oct 31Interest PaymentDate

Investor pays face value + Accrued interest$100,000 + $500($100,000 x 6% x 1/12)

Corp. pays full 6 months’of interest of $3,000


GENERAL JOURNAL



May 31 Cash 100,500Bonds Payable 100,000Interest Payable 500

Oct 31 Interest Expense 2,500Interest Payable 500

Cash 3,000

Interest payable = $100,000 x .06 x 1/12



Account for retirement and conversion of bonds payable


Bonds FeaturesBonds FeaturesBonds FeaturesBonds Features

• Convertible bonds - bondholders can convert bonds into common stock

• Callable bonds– Corporation can call and retire bonds before

maturity date– Corporation usually pays a “call price” which

is a few percentage points above par value


Retirement of Bonds PayableRetirement of Bonds PayableRetirement of Bonds PayableRetirement of Bonds Payable

• To retire a bond early, issuer can– Purchase bonds in the open market– Exercise a call option


Early Retirement of BondsEarly Retirement of BondsEarly Retirement of BondsEarly Retirement of Bonds

• Record interest expense and amortize discount or premium up to retirement date

• If carrying value of bond > cash paid = gain on early retirement of bonds

• If carrying value of bond < cash paid = loss on early retirement of bonds

• Gains or losses on early retirement of debt (if material in amount) are extraordinary items


E15-24E15-24E15-24E15-24Bonds payable

200,000

Discount on bonds

12,000

Carrying value of bondsBonds payable 100,000Less discount (6,000)

94,000

Cash paid to retire debt100,000 x 1.01 = 101,000

Loss of 7,000

200,000 x ½ 12,000 x ½


E15-24 (1)E15-24 (1)E15-24 (1)E15-24 (1)GENERAL JOURNAL


Oct 1 Bonds Payable 100,000Loss on Retirement of Bonds Payable 7,000

Discount on Bonds Payable 6,000Cash 101,000


Convertible BondsConvertible BondsConvertible BondsConvertible Bonds

• Holder has option of exchanging bond for specified number of shares of common stock

• When converted - stockholders’ equity increased by carrying amount of bonds converted


E15-24 (2)E15-24 (2)E15-24 (2)E15-24 (2)GENERAL JOURNAL


Oct 1 Bonds Payable 100,000Discount on Bonds Payable 6,000Common Stock 10,000Paid-in Capital in Excessof Par, Common 84,000

The bondholders would convert their bonds into stock when the market value of the stock to be received from conversion exceeds the market value of the bonds



Report liabilities on the balance sheet


Reporting LiabilitiesReporting LiabilitiesReporting LiabilitiesReporting Liabilities

• Current: – Interest Payable– Current portions of long-term liabilities

• Long-term:– Mortgage Payable– Capital Lease Payable– Bonds Payable



Current liabilities:Accounts payable…………………….$ 50,000Bonds payable, current……………… 20,000Salary payable……………………….. 10,000Income tax payable………………….. 8,000Interest payable……………….…..…. 7,000

Total current liabilities……………… $95,000Long-term liabilities:

Bonds payable……………….……... $180,000



Show the advantages and disadvantages of borrowing


Advantages of BondsAdvantages of BondsAdvantages of BondsAdvantages of Bonds

• Do not affect stockholder control

• Interest on bonds is tax deductible

• Can increase return on equity


Disadvantages of BondsDisadvantages of BondsDisadvantages of BondsDisadvantages of Bonds

• Require payment of both periodic interest and par value at maturity

• Can decrease return on equity when company pays more in interest than it earns on the borrowed funds


End of Chapter 15End of Chapter 15End of Chapter 15End of Chapter 15

copyright © 2007 prentice-hall. all rights reserved 1 long-term liabilities chapter 15

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