slide 10-1. slide 10-2 chapter 10 liabilities financial accounting, seventh edition

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Chapter 10

Liabilities

Financial Accounting, Seventh Edition

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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

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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

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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

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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.


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.


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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.


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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.



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c) Prepare the entry at maturity (July 1).

Interest payable 4,000

Notes payable 100,000

Cash

104,000



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.


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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.


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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.


Payroll and Payroll Taxes Payable


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Illustration: Assume a corporation records its payroll for the week of March 7 as follows:


Record the accrual of this payroll on March 7.


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

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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


Record the payment of this payroll on March 11.

Mar. 7


See Course Pack

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Salaries and wages expense 100,000

Federal income tax payable21,864


State income tax payable 2,922Salaries and wages payable 67,564


Cash

67,564

Salaries and wages payable 67,564Mar. 11

Record the payment of this payroll on March 11.

Mar. 7


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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%)



See Course Pack

Based on the corporation’s $100,000 payroll, record the employer’s expense and liability for these payroll taxes.

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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


State unemployment tax payable 5,400



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Employer payroll taxes do not include:

a. Federal unemployment taxes.

b. State unemployment taxes.

c. Federal income taxes.

d. FICA taxes.

NOTE:



Why not?

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.


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.

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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:


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.


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Current Maturities of Long-Term Debt

Portion of long-term debt that comes due in the current year.

No adjusting entry required.



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Statement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and Analysis

Illustration 10-5

SO 3SO 3

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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



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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



Analysis

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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

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No, not this Bond. . . .

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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)

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Advantages of Bond Advantages of Bond Financing over Common Financing over Common

StockStockStockholder controlStockholder controlTax expenseTax expenseEarnings per shareEarnings per share

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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


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.

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Types of Bonds

Secured and Unsecured (debenture) bonds.

Term and Serial bonds.

Registered and Bearer (or coupon) bonds.

Convertible and Callable bonds.



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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

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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.

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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.

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Serial Bonds...Serial Bonds...

Mature in Mature in

installments.installments.

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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!

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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.



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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

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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)

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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.

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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…..

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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.

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Market Interest Rate...

The rate that investors demand for loaning funds.

Not the same as contract (bond indenture) rate.

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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%)

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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


See Course Pack for summary on bond and journal entries

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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

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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


Issuing Bonds at Face Value


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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


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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



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Question: What is the TOTAL cost of borrowing?



$5,000 x 10 periods = $50,000 Bond interest expense

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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.



52

Bond Prices Vary Inversely With Changes in Market Interest Rates

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.

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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


Issuing Bonds at a Discount

55

Statement Presentation


Illustration 10-13

Issuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a Discount

56


Total Cost of Borrowing

Illustration 10-14

Illustration 10-15


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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


58

Bond Prices Vary Inversely With Changes in Market Interest Rates

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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.

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



61


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


Premium on bond payable 8,111


Issuing Bonds at a Premium

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Statement Presentation


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

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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

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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


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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:

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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

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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

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

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.

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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

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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.



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


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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):


Premium on bonds payable 1,623

Loss on redemption 1,377

Cash 103,000



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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.



Note: Know theory, not Journal Entry

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

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

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

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.



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.


Analysis


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.


Analysis

Illustration 10-21


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

82

Effects on earnings per share—stocks vs. bonds.

Illustration 10-9



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



84

Good Bye and Good Luck!

Solutions to Bond exercise next

End of Chapter 10End of Chapter 10End of Chapter 10End of Chapter 10

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CopyrightCopyrightCopyrightCopyright

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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



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



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

87


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

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# 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.

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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

slide 10-1. slide 10-2 chapter 10 liabilities financial accounting, seventh edition

Documents

current liability

edition slide

existing current assets

accounts payable

salaries payable

accrued liabilities

notes payable100

bond issues accounting