long-term liabilities chapter 12 ©2014 pearson education, inc. publishing as prentice hall12-1

Long-Term Liabilities

Chapter 12

©2014 Pearson Education, Inc. Publishing as Prentice Hall 12-1

Learning Objectives

1. Journalize transactions for long-term notes payable and mortgages payable

2. Describe bonds payable

3. Journalize transactions for bonds payable and interest expense using the straight-line amortization method


Learning Objectives

4. Journalize transactions to retire bonds payable

5. Report liabilities on the balance sheet

6. Use the debt to equity ratio to evaluate business performance


Learning Objectives

7. Use time value of money to compute the present value of future amounts (Appendix 12A)

8. Journalize transactions for bonds payable and interest expense using the effective-interest amortization method (Appendix 12B)


Learning Objective 1

Journalize Journalize transactions for transactions for long-term notes long-term notes

payable and payable and mortgages mortgages

payablepayable


Long-Term Notes Payable

• Notes that do not Notes that do not need to be paid need to be paid within one year or within one year or one operating one operating cycle, whichever cycle, whichever is longer.is longer.– The portion due in The portion due in

the current year is the current year is reclassified as a reclassified as a current liability.current liability.

• Notes are recorded Notes are recorded at the amount at the amount borrowed.borrowed.

• Interest is not Interest is not recorded until the recorded until the end of the period.end of the period.• Interest accruals Interest accruals

are part of the are part of the adjusting adjusting process.process.



On December 31, 2014, Smart Touch On December 31, 2014, Smart Touch Learning signed a $20,000 note payable. It is Learning signed a $20,000 note payable. It is due in 4 annual payments of $5,000 plus 6% due in 4 annual payments of $5,000 plus 6%

interest each December 31. interest each December 31.

Prepare the journal entry to record Prepare the journal entry to record Smart Touch Learning’s note payable.Smart Touch Learning’s note payable.



On December 31, 2014, Smart Touch On December 31, 2014, Smart Touch Learning signed a $20,000 note payable. It is Learning signed a $20,000 note payable. It is due in 4 annual payments of $5,000 plus 6% due in 4 annual payments of $5,000 plus 6%

interest each December 31. interest each December 31.


Notes Payable Interest

Interest on Notes Payable is computed as:

Beginning Balance

x Interest Rate x Time

The beginning balance will decline each period by the

amount of the principal payment.

Interest rates are always

expressed as the rate for a whole year.

This is the portion of a year that the

interest period covers.



On December 31, 2014, Smart Touch Learning On December 31, 2014, Smart Touch Learning signed a $20,000 note payable. It is due in 4 signed a $20,000 note payable. It is due in 4 annual payments of $5,000 plus 6% interest annual payments of $5,000 plus 6% interest

each December 31. Compute interest for 2015. each December 31. Compute interest for 2015.

Beginning Balance

x Interest Rate x Time =



On December 31, 2014, Smart Touch Learning On December 31, 2014, Smart Touch Learning signed a $20,000 note payable. It is due in 4 signed a $20,000 note payable. It is due in 4 annual payments of $5,000 plus 6% interest annual payments of $5,000 plus 6% interest

each December 31. Compute interest for 2015. each December 31. Compute interest for 2015.

Beginning Balance

x Interest Rate x Time =

20,000$ x 6.00% x 1 =

1,200$


Interest Amortization

When a loan is taken out, an amortization When a loan is taken out, an amortization schedule is prepared showing payments and schedule is prepared showing payments and

interest over the term of the loan.interest over the term of the loan.

Beginning Balance

Principal Payment

Interest Expense

Total Payment

Ending Balance

12/31/2014 20,000$ 12/31/2015 20,000$ 5,000$ 1,200$ 6,200$ 15,000 12/31/2016 15,000 5,000 900 5,900 10,000 12/31/2017 10,000 5,000 600 5,600 5,000 12/31/2018 5,000 5,000 300 5,300 -

Total 20,000$ 3,000$ 23,000$


Recording Interest

Record the payment at December 31, 2015.

Beginning Balance

Principal Payment

Interest Expense

Total Payment

Ending Balance

12/31/2014 20,000$ 12/31/2015 20,000$ 5,000$ 1,200$ 6,200$ 15,000


On January 1, 2014, Fox Corporation signed an On January 1, 2014, Fox Corporation signed an $80,000, four-year, 4% note. The loan required $80,000, four-year, 4% note. The loan required Fox to make payments annually on December Fox to make payments annually on December

31 of $20,000 principal plus interest.31 of $20,000 principal plus interest.

Journalize the issuance of the note on Journalize the issuance of the note on January 1, 2014.January 1, 2014.




Journalize the first payment on Journalize the first payment on December 31, 2014.December 31, 2014.



Describe bonds Describe bonds payablepayable


Bonds

• Long-term debt Long-term debt issued to multiple issued to multiple lenders.lenders.– Usually in $1,000 Usually in $1,000

increments.increments.

• Each bondholder Each bondholder gets a bond gets a bond certificate.certificate.

TERMINOLOGY:TERMINOLOGY:•Face valueFace value•Interest rateInterest rate•Issue dateIssue date•Maturity dateMaturity date•Payment termsPayment terms


Types of Bonds

Secured BondsSecured Bonds

Backed by specific assets that Backed by specific assets that have been pledged as have been pledged as

collateral.collateral.

Debentures (Unsecured Debentures (Unsecured Bonds)Bonds)

No collateral.No collateral.

Term BondTerm Bond

The bond principal is The bond principal is due in full at a single due in full at a single

maturity date.maturity date.

Serial BondSerial Bond

The bond principal is The bond principal is repaid in installments repaid in installments

over the maturity over the maturity period.period.


Bond Prices

• The face value of the The face value of the bond defines how much bond defines how much principal will be paid at principal will be paid at maturity.maturity.

• The bond selling price The bond selling price on the issue date will on the issue date will depend on:depend on:– The stated interest rate on The stated interest rate on

the bond, andthe bond, and

– The market rate of The market rate of interest of similar bonds interest of similar bonds on the date of issue.on the date of issue.

Bond Issued at:Bond Issued at:•Face value: Face value: stated stated rate = market raterate = market rate•Discount: Discount: stated stated rate < market raterate < market rate•Premium: Premium: stated stated rate > market raterate > market rate


Bond Prices


Determine whether the following bonds Determine whether the following bonds payable will be issued at face value, at a payable will be issued at face value, at a

premium, or at a discount.premium, or at a discount.•A 10% bonds payable is issued when the A 10% bonds payable is issued when the

market interest rate = 8%.market interest rate = 8%.•A 10% bonds payable is issued when the A 10% bonds payable is issued when the

market interest rate = 10%.market interest rate = 10%.•A 10% bonds payable is issued when the A 10% bonds payable is issued when the

market interest rate = 12%.market interest rate = 12%.



premium, or at a discount.premium, or at a discount.•PREMIUMPREMIUM

•A 10% bonds payable is issued when the A 10% bonds payable is issued when the market interest rate = 10%.market interest rate = 10%.

•A 10% bonds payable is issued when the A 10% bonds payable is issued when the market interest rate = 12%.market interest rate = 12%.




•FACE VALUEFACE VALUE•A 10% bonds payable is issued when the A 10% bonds payable is issued when the

market interest rate = 12%.market interest rate = 12%.




•FACE VALUEFACE VALUE•DISCOUNTDISCOUNT



Journalize Journalize transactions for transactions for

bonds payable and bonds payable and interest expense interest expense

using the straight-using the straight-line amortization line amortization

methodmethod


Recording Bonds Payable at Face Value

Smart Touch Learning has $100,000 of 9% Smart Touch Learning has $100,000 of 9% bonds payable that mature in five years. The bonds payable that mature in five years. The

company issues the bonds on January 1, 2014 company issues the bonds on January 1, 2014 when the market rate is 9%.when the market rate is 9%.

Journalize the issuance of the bonds Journalize the issuance of the bonds on January 1, 2014.on January 1, 2014.


Recording Bonds Payable at Face Value

Smart Touch Learning has $100,000 of 9% Smart Touch Learning has $100,000 of 9% bonds payable that mature in five years. The bonds payable that mature in five years. The

company issues the bonds on January 1, 2014 company issues the bonds on January 1, 2014 when the market rate is 9%.when the market rate is 9%.


Recording Bonds Issued at a Discount

• When the bond interest rate < the market rate, the bonds are issued at a discount.

• The difference between the bonds payable and the cash received is recorded as a Bond Discount (a contra-liability)– The discount is amortized

over the life of the bond.

Interest Expense Interest Expense each period will each period will

be the sum of the be the sum of the computed interest computed interest

payment + the payment + the amortized portion amortized portion of the discount.of the discount.



Smart Touch Learning issues $100,000 of 9%, Smart Touch Learning issues $100,000 of 9%, 5-year bonds that pay interest semiannually. 5-year bonds that pay interest semiannually.

The market rate of interest is 10%.The market rate of interest is 10%.

Smart Touch Learning actually receives Smart Touch Learning actually receives $96,149, and records a discount of $3,851.$96,149, and records a discount of $3,851.

Journalize the issuance of the bonds Journalize the issuance of the bonds on January 1, 2014.on January 1, 2014.



Smart Touch Learning issues $100,000 of 9%, Smart Touch Learning issues $100,000 of 9%, 5-year bonds that pay interest semiannually. 5-year bonds that pay interest semiannually.

The market rate of interest is 10%.The market rate of interest is 10%.

Smart Touch Learning actually receives Smart Touch Learning actually receives $96,149, and records a discount of $3,851.$96,149, and records a discount of $3,851.


Straight-Line Amortization of the Discount

Payment Date

Interest Payment

Discount Amortized

Interest Expense Bond BV

1/1/2014 96,149$ 6/30/2014 4,500$ 385$ 4,885$ 96,534

12/31/2014 4,500 385 4,885 96,919 6/30/2015 4,500 385 4,885 97,304

12/31/2015 4,500 385 4,885 97,689 6/30/2016 4,500 385 4,885 98,074

12/31/2016 4,500 385 4,885 98,459 6/30/2017 4,500 385 4,885 98,844

12/31/2017 4,500 385 4,885 99,229 6/30/2018 4,500 385 4,885 99,614

12/31/2018 4,500 386 4,886 100,000 Total 45,000$ 3,851$ 48,851$



Using the discount amortization table, Using the discount amortization table, record Smart Touch Learning’s first record Smart Touch Learning’s first interest payment on June 30, 2014.interest payment on June 30, 2014.



Journalize Journalize transactions to transactions to

retire bonds retire bonds payablepayable


Retirement at Maturity

Smart Touch Learning has $100,000 of 9% Smart Touch Learning has $100,000 of 9% bonds that mature on December 31, 2018. (bonds that mature on December 31, 2018. (Note Note that all interest has already been paid and the that all interest has already been paid and the

discount is fully amortized.discount is fully amortized.))

Record the retirement of the bonds at Record the retirement of the bonds at December 31, 2018.December 31, 2018.


Retirement at Maturity

Smart Touch Learning has $100,000 of 9% Smart Touch Learning has $100,000 of 9% bonds that mature on December 31, 2018. (bonds that mature on December 31, 2018. (Note Note that all interest has already been paid and the that all interest has already been paid and the

discount is fully amortized.discount is fully amortized.))


Retirement Before Maturity

• The full Bonds Payable will be retired.The full Bonds Payable will be retired.• The cash paid will not equal the face The cash paid will not equal the face

value.value.• The remaining discount or premium will The remaining discount or premium will

be removed.be removed.• The difference will be recorded as The difference will be recorded as

either aeither a– Gain on Retirement of BondsGain on Retirement of Bonds– Loss on Retirement of BondsLoss on Retirement of Bonds



On December 31, 2014, Smart Touch Learning On December 31, 2014, Smart Touch Learning decides to retire its bonds by paying $95,000, decides to retire its bonds by paying $95,000,

after only two interest payments. The table after only two interest payments. The table indicates that the discount balance is now indicates that the discount balance is now

$3,081.$3,081.

Record the early retirement of the Record the early retirement of the bonds at December 31, 2014.bonds at December 31, 2014.



On December 31, 2014, Smart Touch Learning On December 31, 2014, Smart Touch Learning decides to retire its bonds by paying $95,000, decides to retire its bonds by paying $95,000,

after only two interest payments. The table after only two interest payments. The table indicates that the discount balance is now indicates that the discount balance is now

$3,081.$3,081.


Herrera Corporation issued a $400,000, 4.5%, Herrera Corporation issued a $400,000, 4.5%, 10-year bond payable on January 1, 2014. 10-year bond payable on January 1, 2014.

Journalize the retirement of the bond payable Journalize the retirement of the bond payable at maturity.at maturity.

Record the bond retirement and Record the bond retirement and include the correct date.include the correct date.


Smart Touch Learning issued a $400,000, 4.5%, Smart Touch Learning issued a $400,000, 4.5%, 10-year bond payable on January 1, 2014. 10-year bond payable on January 1, 2014.

Journalize the retirement of the bond payable Journalize the retirement of the bond payable at maturity.at maturity.



Report liabilities Report liabilities on the balance on the balance

sheetsheet


Reporting Liabilities

• Liabilities Liabilities are grouped are grouped on the on the Balance Balance Sheet as Sheet as either either Current or Current or Long-Term.Long-Term.

Current Liabilities Accounts Payable 17,000$ Employee Income Taxes Payable 2,000 FICA - OASDI Taxes Payable 1,158 FICA - Medicare Taxes Payable 855 Other Current Liabilities 3,175 Current Portion of Mortgage Payable 1,305 Current Portion of Long-Term Notes 5,000 Total Current Liabilities 30,493$ Long-Term Liabilities Notes Payable 15,000 Mortgage Payable 97,541 Bonds Payable 100,000 Less: Discount on Bonds Payable (3,081) Total Long-Term Liabilities 209,460 Total Liabilities 239,953$

SMART TOUCH LEARNINGBalance Sheet (Partial)

December 31, 2014Liabilities

Current Liabilities Accounts Payable 17,000$ Employee Income Taxes Payable 2,000 FICA - OASDI Taxes Payable 1,158 FICA - Medicare Taxes Payable 855 Other Current Liabilities 3,175 Current Portion of Mortgage Payable 1,305 Current Portion of Long-Term Notes 5,000 Total Current Liabilities 30,493$ Long-Term Liabilities Notes Payable 15,000 Mortgage Payable 97,541 Bonds Payable 100,000 Less: Discount on Bonds Payable (3,081) Total Long-Term Liabilities 209,460 Total Liabilities 239,953$

SMART TOUCH LEARNINGBalance Sheet (Partial)

December 31, 2014Liabilities



Use the debt to Use the debt to equity ratio to equity ratio to

evaluate business evaluate business performanceperformance


Debt to Equity Ratio

• Shows the proportion of total liabilities to Shows the proportion of total liabilities to total equity.total equity.

• A measure of “financial leverage.”A measure of “financial leverage.”• A ratio > 1, the company is financing more A ratio > 1, the company is financing more

assets with debt than with equity.assets with debt than with equity.– The higher the ratio, the more financial risk the The higher the ratio, the more financial risk the

company has.company has.


=

Total Liabilities ÷ Total Equity



The information below is from the 2011 Annual The information below is from the 2011 Annual Report for Green Mountain Coffee Report for Green Mountain Coffee

Roasters, Inc.Roasters, Inc.

Calculate the Debt to Equity Ratio for 2011.Calculate the Debt to Equity Ratio for 2011.




= Total Liabilities ÷ Total Equity

= $1,285,672 ÷ $1,912,215

= 0.67


Compute the Debt to Equity Ratio for Payne Compute the Debt to Equity Ratio for Payne Corporation for 2014.Corporation for 2014.


Compute the Debt to Equity Ratio for Payne Compute the Debt to Equity Ratio for Payne Corporation for 2014.Corporation for 2014.

Debt to Equity Ratio = Total Liabilities ÷ Total Equity = $20,000 ÷ $40,000

= 0.50



Use time value of Use time value of money to compute money to compute the present value the present value of future amounts of future amounts

(Appendix 12A)(Appendix 12A)


Time Value of Money

• Sometimes, we need to know how Sometimes, we need to know how much an amount of money will grow if much an amount of money will grow if interest is applied for several years.interest is applied for several years.

• A mathematical formula will allow us to A mathematical formula will allow us to make the calculation:make the calculation:

Future Value

= Present Value

x ( 1 + interest

rate )number of periods


Time Value of Money

If we invest $10,000 today at 6% interest and If we invest $10,000 today at 6% interest and leave it for 5 years, how much will we have at leave it for 5 years, how much will we have at

the end of the period?the end of the period?

Future Value

= Present Value

x ( 1 + interest



Time Value of Money

If we invest $10,000 today at 6% interest and If we invest $10,000 today at 6% interest and leave it for 5 years, how much will we have at leave it for 5 years, how much will we have at

the end of the period?the end of the period?

Future Value

= Present Value

x ( 1 + interest


= $10,000 x ( 1 + 0.06 )5

= $10,000 x ( )5

= $10,000 x ( ) = $13,382

1.061.3382


Present Value of a Lump Sum

• The formula can also be worked The formula can also be worked backward to determine today’s value of backward to determine today’s value of a future amount.a future amount.

• Simply use the inverse of the future Simply use the inverse of the future value multiplier.value multiplier.

Present Value

= Future Value

× 1 / ( 1 + interest




At 6% interest, how much would we need At 6% interest, how much would we need to invest today in order to have $13,382 to invest today in order to have $13,382

in 5 years?in 5 years?


Present Value

= Future Value




At 6% interest, how much would we need At 6% interest, how much would we need to invest today in order to have $13,382 to invest today in order to have $13,382

in 5 years?in 5 years?


Present Value

= Future Value



= $13,382 × 1 / ( 1 + 0.06 )5

= $13,382 × 1 / ( )5

= $13,382 × 1 / ( ) = $13,382 × = $10,000

1.061.3382

0.74727

Present Value of an Annuity

• The total grows faster, if we also add a fixed The total grows faster, if we also add a fixed amount each period to the original amount each period to the original investment.investment.

• The present value of an annuity factor can be The present value of an annuity factor can be found in a table (see Appendix B in the text).found in a table (see Appendix B in the text).


= Periodic Payment

x Annuity PV factor for i, n



What is the present day equivalent of an What is the present day equivalent of an annuity of $2,000 per year for 5 years at 6%?annuity of $2,000 per year for 5 years at 6%?


= Periodic Payment




What is the present day equivalent of an What is the present day equivalent of an annuity of $2,000 per year for 5 years at 6%?annuity of $2,000 per year for 5 years at 6%?


= Periodic Payment


= $2,000 x Annuity PV factor for 6%, 5 years

= $2,000 x 4.212 = $8,424


Pricing Bonds Payable

• We can use the Present Value of a We can use the Present Value of a Lump Sum (PV) and the Present Value Lump Sum (PV) and the Present Value of an Annuity (PVA) concepts to of an Annuity (PVA) concepts to determine the selling price of a bond.determine the selling price of a bond.

• Bonds sell at the present value of all of Bonds sell at the present value of all of the related cash flows:the related cash flows:– The periodic interest payments.The periodic interest payments.– The payout of principal at the end of the The payout of principal at the end of the

bond term.bond term.


Pricing Bonds Payable

Smart Touch Learning issues $100,000 of Smart Touch Learning issues $100,000 of 5-year, 9% bonds that pay interest semi-5-year, 9% bonds that pay interest semi-annually. The market interest rate is 10%.annually. The market interest rate is 10%.

– Maturity Payment = $100,000Maturity Payment = $100,000– Periodic Interest = $4,500Periodic Interest = $4,500– Interest rate = 5% Interest rate = 5% (10% semiannually)(10% semiannually)– Number of periods = 10 Number of periods = 10 (payments twice a (payments twice a

year for 5 years)year for 5 years)


Step 1: Present Value of the Principal

• This will be added to the present value This will be added to the present value of the interest payments.of the interest payments.

Present Value

= Future Value

÷ ( 1 + interest


= $100,000 ÷ ( 1 + 0.05 )10

= $100,000 ÷ ( )10

= $100,000 ÷ ( ) = $61,400 (rounded)

1.051.6289


Step 2: Present Value of the Interest Payments

• This will be added to the present value This will be added to the present value of the principal.of the principal.


= Periodic Payment


= $4,500 x Annuity PV factor for i=5%, n=10

= $4,500 x 7.722 = $34,749


Step 3: Present Value of the Bond Payable

This bond payable will sell at a discount This bond payable will sell at a discount of $3,851.of $3,851.

Present Value of the Bond Payable

= PV of the Principal

+PVA of the Interest

Payments = $61,400 + $34,749 = $96,149



Journalize Journalize transactions for bonds transactions for bonds

payable and interest payable and interest expense using the expense using the effective-interest effective-interest

amortization method amortization method

(Appendix 12B)(Appendix 12B)


Effective Interest Method for Interest Amortization

• Earlier we used a straight-line approach Earlier we used a straight-line approach for amortizing the discount and for amortizing the discount and determining interest expense.determining interest expense.

• The “effective interest method” The “effective interest method” computes interest expense based on computes interest expense based on the carrying amount of the bond, and the carrying amount of the bond, and “backs into” the discount amortization “backs into” the discount amortization each period.each period.



Payment Date

Interest Payment

Interest Expense

Discount Amortized Bond BV

1/1/2014 96,149$ 6/30/2014 4,500$ 4,807$ 307$ 96,456

12/31/2014 4,500 4,823 323 96,779 6/30/2015 4,500 4,839 339 97,118

12/31/2015 4,500 4,856 356 97,474 6/30/2016 4,500 4,874 374 97,848

12/31/2016 4,500 4,892 392 98,240 6/30/2017 4,500 4,912 412 98,652

12/31/2017 4,500 4,933 433 99,085 6/30/2018 4,500 4,954 454 99,539

12/31/2018 4,500 4,961 461 100,000 Total 45,000$ 48,851$ 3,851$


End of Chapter 12


long-term liabilities chapter 12 ©2014 pearson education, inc. publishing as prentice hall12-1

Documents

longterm notes payable

bonds payable

pearson education

mortgages payable

prentice hall12

learning objectives

annual payments

smart touch learnings