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Issue and Redemption of Long-
term Liabilities
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ISSUE OF LONG-TERM LIABILITIES(E.G. BONDS)
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Long-term Liabilities
• A liability is an obligation of the business to
pay cash for goods or services taken on credit
or for money borrowed.
• Liabilities can be classified as either current or
long-term.
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Current liabilities
• Obligations that fall within the coming year
e.g. accounts payable, owing on rent etc, bank
overdraft
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Long-term liabilities
• Obligations due beyond one year.
• E.g. bonds, notes payable and mortgage
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Bonds
• Projects that demand large amounts of money
often are funded from bond issuances.
• Which are essentially loans from the general
public.
• Both private and public sector organisations
may use issue of bonds.
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What is a bond?
• A bond is its issuer’s written promise to pay
back an amount borrowed upon maturity plus
interest at specified times.
• A bond is a debt owed by the enterprise to the
bondholder.
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Example of a Bond
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Advantages of bonds
• Bonds do not affect owner control (equity
financing affects ownership of a company but
bonds financing do not).
• Interest on bonds is tax deductible
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Disadvantages of bonds
• The business is obligated to pay back the bond
on maturity and pay interest throughout the
life of the bond
• Creditors such as bond holders have a claim
on the business.
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Issuance of Bonds
• Bonds may be sold to the public at par or no
par (discount or premium).
• (but we will focus on “at par”.
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Bond issue price and rate of return
• The issue price of bonds is dependent on thedominant rate.
• There is the contractual rate of interest which
is stated on the bond certificate and there isthe market rate of interest which representsthe rate of return demanded by investors.
•
When the MARKET RATE equals the statedrate the bond will be issued at face or parvalue.
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• The bond will sell at Par value when the
market rate = contractual rate.
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Case 1 - Issuing bonds at par
• Grace Co. Ltd is issued $800 000 of 9%, 10
year bonds dated January 1, 2011, that
matures on December 31, 2021 and pay
interest semi-annually on each June 30 andDec. 31.
• Task: show the relevant journal entries
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Case 2
• On Jan 1, 2013, the Dash Corporation issued
$1000 000 par value, of 10 year, 10% bonds.
The bonds annual interest payments becomes
payable on every December 31.
• Required: the relevant journal entries
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REDEMPTION OF LONG-TERMLIABILITIES E.G. BONDS
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Bonds and Sinking Funds
• When debentures or bonds are issued
consideration should be given to having the cash
pay off the debt instruments upon maturity!
• Therefore, when a bond is issued, the issuercreates a sinking fund (reserve) to provide the
necessary funds at redemption.
•The sinking funds assures investors that enoughmoney will be available to repay the bonds and
other debt instruments upon maturity
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template
The JournalDate Details Debit$ Credit $
Bonds sinking fund
cash
X xxxx xxx
X xxxx xxx
To record annual installments to sinking
fund
Cash
Sinking fund investment income
X xxx
X xxx
Being sinking funds earnings
Bonds payable
Bonds sinking fund
X xxxx xxx
X xxxx xxx
The payment of bonds upon maturity
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Case1 – Redemption of bonds
• On December 31, 2013, Jesu Inc issued $2
000 000 par value 8% 5-year bonds. The bonds
contract calls for a sinking fund to be maintained
thoughout the life of the bond. The company isto make five annual payments of $327 595 to the
fund beginning December 31, 2014. The fund
will earn a net return of 10%.
• Task: the relevant journal entries for the
redemption of bonds
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Case 2
• Margo Inc
• See handout
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