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PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA
Chapter 14
LONG-TERM LIABILITIES
McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
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BOND FINANCING
Bonds do not affect owner control.
Interest on bonds is tax deductible.
Bonds can increase return on equity.
Advantages
Bonds require payment of both
periodic interest and par value at maturity.
Bonds can decrease return on equity.
Disadvantages
A1
FINANCIAL LEVERAGE IF IT EANRS MORE THAN IT PAYS ON B. INTEREST
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BOND TRADING A1
Bonds are securities that can be purchased or sold in the securities markets. They have a
market value which is expressed as a percent of their par value. The closing price indicates that the IBM stock is being sold at 119.25% of
face value.
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BOND ISSUING PROCEDURES A1
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Bond Certificate
Bond Selling Price
Corporation Investors
BOND ISSUANCES P1
Transaction on the Bond Issue Date
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Bond Interest Payments
Corporation Investors
Bond Issue Date
Bond Interest Payments
Interest Payment = Bond Par Value × Stated Interest Rate x Time
BOND ISSUANCES
Transactions during the bond life
P1
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Bond Face Value
Corporation Investors
BOND ISSUANCES
Transaction on the Maturity Date
P1
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ISSUING BONDS AT PAR
On Jan. 1, 2011, a company issued the following bonds: Par Value: $800,000
Stated Interest Rate: 9% Interest Dates: 6/30 and 12/31
Maturity Date = Dec. 31, 2030 (20 years)
P1
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$800,000 × 9% × ½ year = $36,000
ISSUING BONDS AT PAR
On June 30, 2011, the issuer of the bond pays the first semiannual interest payment of $36,000.
P1
This entry is made every six months until the bonds mature.
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ISSUING BONDS AT PAR
On December 31, 2030, the bonds mature and the issuer of the bond pays face value of $800,000 to the
bondholders.
P1
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BOND DISCOUNT OR PREMIUM P1
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Fila issues bonds with the following provisions: Par Value: $100,000 Issue Price: 96.454% of par value Stated Interest Rate: 8% Market Interest Rate: 10% Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years)
ISSUING BONDS AT A DISCOUNT
} Bond will sell at a discount.
P2
ISSUE AT DISCOUNT IF MARKET RATE HIGHER THAN CONTRACT RATE ISSUE PRICE LESS THAN CONTRACT VALUE
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On Dec. 31, 2011, Fila should record the bond issue.
ISSUING BONDS AT A DISCOUNT
Par value $ 100,000 Cash proceeds 96,454 Discount $ 3,546 *$100,000 x 96.454%
Contra-Liability Account
P2
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Long-term Liabilities: Bonds Payable 100,000 Less: Discount on Bonds Payable 3,546 96,454
Partial Balance Sheet as of Dec. 31, 2011
Maturity Value
Carrying Value
ISSUING BONDS AT A DISCOUNT
Amortizing a Bond Discount Using the straight-line method, the discount amortization will
be $887 (rounded) every six months.
$3,546 ÷ 4 periods = $887 (rounded)
P2
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$3,546 ÷ 4 periods = $887 (rounded)
$100,000 × 8% × ½ = $4,000
Fila will make the following entry every six months to record the cash interest payment and
the amortization of the discount.
AMORTIZING A BOND DISCOUNT P2
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Straight-Line Amortization TableInterest Interest Discount Unamortized Carrying
Date Payment Expense Amortization* Discount Value12/31/2011 3,546$ 96,454$ 6/30/2012 4,000$ 4,887$ 887$ 2,659 97,341
12/31/2012 4,000 4,887 887 1,772 98,228 6/30/2013 4,000 4,887 887 885 99,115
12/31/2013 4,000 4,885 885 - 100,000 16,000$ 19,546$ 3,546$
* Rounded.
AMORTIZING A BOND DISCOUNT P2
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Adidas issues bonds with the following provisions: Par Value: $100,000 Issue Price: 103.546% of par value Stated Interest Rate: 12% Market Interest Rate: 10% Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years)
ISSUING BONDS AT A PREMIUM
} Bond will sell at a premium.
P3
ISSUE AT PTEMIOUM IF MARKET RATE LOWER THAN CONTRACT RATE ISSUE PRICE MORE THAN CONTRACT VALUE
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ISSUING BONDS AT A PREMIUM
Par value $ 100,000 Cash proceeds 103,546 * Premium $ 3,546 *$100,000 x 103.546%
Adjunct-Liability Account
On Dec. 31, 2011, Adidas will record the bond issue as:
P3
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ISSUING BONDS AT A PREMIUM
Long-term Liabilities: Bonds Payable 100,000 Plus: Premum on Bonds Payable 3,546 103,546
Partial Balance Sheet as of Dec. 31, 2011
Maturity Value
Carrying Value
Amortizing a Bond Premium Using the straight-line method, the premium amortization will
be $887 (rounded) every six months.
$3,546 ÷ 4 periods = $887 (rounded)
P3
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AMORTIZING A BOND PREMIUM
$3,546 ÷ 4 periods = $887 (rounded)
$100,000 × 12% × ½ = $6,000
Adidas will make the following entry every six months to record the cash interest payment and
the amortization of the discount.
P3
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Straight-Line Amortization TableInterest Interest Premium Unamortized Carrying
Date Payment Expense Amortization* Premium Value12/31/2011 3,546$ 103,546$ 6/30/2012 6,000$ 5,113$ 887$ 2,659 102,659
12/31/2012 6,000 5,113 887 1,772 101,772 6/30/2013 6,000 5,113 887 885 100,885
12/31/2013 6,000 5,115 885 - 100,000 24,000$ 20,454$ 3,546$
* Rounded.
AMORTIZING A BOND PREMIUM P3
CARRYING VALUE =PAR VALUE +UNAMORTIZED PREMIUM
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BOND PRICING P2
Cash Outflows related to Interest Payments
Cash Outflows for par value at end of Bond life
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Fila issues bonds with the following provisions: Par Value: $100,000 Issue Price: ? Stated Interest Rate: 8% Market Interest Rate: 10% Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years)
ISSUING BONDS AT A DISCOUNT P2
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PRESENT VALUE OF A DISCOUNT BOND To calculate Present Value, we need relevant interest rate
and number of periods. Semiannual rate = 5% (Market rate 10% ÷ 2)
Semiannual periods = 4 (Bond life 2 years × 2)
$100,000 × 8% × ½ = $4,000
P2
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BOND RETIREMENT
Retirement of the Fila bonds at maturity for $100,000 cash.
Because any discount or premium will be fully amortized at maturity, the carrying value of the bonds will be equal to par value.
P4
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BOND RETIREMENT Retirement of Bonds before Maturity
Carrying Value > Retirement Price = Gain Carrying Value < Retirement Price = Loss
Assume that $100,000 of callable bonds will be retired on July 1, 2011, after the first interest payment. The
bond carrying value is $104,500.The bonds have a call premium of $3,000.
P4
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BOND RETIREMENT By Conversion
On January 1, $100,000 par value bonds of Converse, with a carrying value of $100,000, are converted to 15,000 shares
of $2 par value common stock.
15,000 shares × $2 par value per share
P4
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Note Maturity Date
Note Payable
Cash
Company Lender
Note Date
When is the repayment of the principal and interest going to be made?
LONG-TERM NOTES PAYABLE C1
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Note Maturity Date
Company Lender
Note Date
Single Payment of Principal plus
Interest
Single Payment of Principal plus Interest
LONG-TERM NOTES PAYABLE C1
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Note Maturity Date
Company Lender
Note Date
Regular Payments of Principal plus Interest
Payments either can be equal principal payments plus interest
or equal payments.
Regular Payments of Principal plus Interest
LONG-TERM NOTES PAYABLE C1
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INSTALLMENT NOTES On January 1, 2011, Foghog borrows $60,000 from a bank to
purchase equipment. It signs an 8% installment note requiring 6 annual payments of principal plus interest.
Computation Table Table Value
Present Value Payment
Principal divided by PV factor
PV of Annuity of $1 (B.3) 4.6229 60,000 12,979
Compute the periodic payment by dividing the face amount of the note by the present value factor.
C1
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INSTALLMENT NOTES WITH EQUAL PAYMENTS
C1
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INSTALLMENT NOTES WITH EQUAL PAYMENTS Let’s record the first payment made on December 31,
2011 by Foghog to the bank.
Refer back to the amortization schedule to make the December 31, 2012 payment on the note.
P5
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MORTGAGE NOTES AND BONDS A legal agreement that helps protect the
lender if the borrower fails to make the required payments.
Gives the lender the right to be paid out of the cash proceeds from the sale of the borrower’s assets specifically identified in the mortgage contract.
C1
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GLOBAL VIEW Accounting for Bonds and Notes
The definitions and characteristics of bonds and notes are broadly similar for both U.S. GAAP and IFRS. The accounting for issuances of
bonds, market pricing, and retirement of both bonds and notes is similar. Both U.S. GAAP and IFRS also allow companies to account for bonds
and notes using fair value.
Accounting for Leases and Pensions Both U.S. GAAP and IFRS require companies to distinguish between
operating leases and capital leases; with IFRS calling the latter finance leases. The accounting and reporting for leases are broadly similar with the main difference that the criteria for identifying a lease as a capital or finance lease is more general under IFRS. For pensions, the methods of accounting and reporting are similar for both U.S. GAAP and IFRS.
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Secured and Unsecured
Term and Serial
Registered and Bearer
Convertible and Callable
FEATURES OF BONDS AND NOTES A2
Term bonds are scheduled for maturity on one specified date. Serial bonds mature at more than one date.
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This ratio helps investors determine the risk of investing in a company by dividing its total liabilities by total equity.
DEBT-TO-EQUITY RATIO
Debt-to-
Equity Ratio
Total Liabilities
Total Equity =
A3
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Present Value of $1 Rate
Periods 3% 4% 5% 1 0.9709 0.9615 0.9524 2 0.9426 0.9246 0.9070 3 0.9151 0.8890 0.8638 4 0.8885 0.8548 0.8227 5 0.8626 0.8219 0.7835 6 0.8375 0.7903 0.7462 7 0.8131 0.7599 0.7107 8 0.7894 0.7307 0.6768 9 0.7664 0.7026 0.6446
10 0.7441 0.6756 0.6139
APPENDIX 14A: PRESENT VALUES OF BONDS AND NOTES
Face amount = $100,000 Contract rate = 8% Market rate = 10% Interest paid semiannually First, we calculate the present value of the principal repayment in 4 periods (2 years × 2 payments per year, using 5% market rate (10% annual rate ÷ 2 payments per year).
$100,000 × 0.8227 = $82,270
C2
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Present Value of Annuity of $1 Rate
Periods 3% 4% 5% 1 0.9709 0.9615 0.9524 2 1.9135 1.8861 1.8594 3 2.8286 2.7751 2.7232 4 3.7171 3.6299 3.5460 5 4.5797 4.4518 4.3295 6 5.4172 5.2421 5.0757 7 6.2303 6.0021 5.7864 8 7.0197 6.7327 6.4632 9 7.7861 7.4353 7.1078
10 8.5302 8.1109 7.7217
APPENDIX 14A: PRESENT VALUES OF BONDS AND NOTES
$100,000 × 8% × ½ = $4,000
Semiannual Interest Annuity
Present Amount PV Factor Value Principal $ 100,000 0.8227 $ 82,270 Interest 8,000 3.5460 14,184 Issue price of debt $ 96,454
$4,000 × 3.5460 = $14,184
C2
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APPENDIX 14B: EFFECTIVE INTEREST AMORTIZATION
Effective Interest Amortization ScheduleInterest Interest Discount Unamortized Carrying
Date Payment Expense Amortization* Discount Value12/31/2011 3,546$ 96,454$ 6/30/2012 4,000$ 4,823$ 823$ 2,723 97,277
12/31/2012 4,000 4,864 864 1,859 98,141 6/30/2013 4,000 4,907 907 952 99,048
12/31/2013 4,000 4,952 952 0 100,000 16,000$ 19,546$ 3,546$
* Rounded.
$96,454 × 5% = $4,823 $100,000 - $2,723 = $97,277
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APPENDIX14C: ISSUING BONDS BETWEEN INTEREST DATES
Avia sells $100,000 of its 9% bonds at par on March 1, 2011, 60 days after the stated issue date. The interest on Avia bonds is payable
semiannual on each June 30 and December 31. Stated Issue
date 1/1 Date of sale 3/1 First Interest
date 6/30 $1,500 accrued $3,000 earned
Bondholder pays $1,500 to issuer
Issuer pays $4,500 to bondholder
C3
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APPENDIX 14D: LEASES AND PENSIONS A lease is a contractual agreement between the lessor (asset owner) and the lessee (asset renter or tenant) that grants the lessee the right to use
the asset for a period of time in return for cash (rent) payments.
Operating Leases Operating leases are short-term (or cancelable) leases in which the lessor retains
the risks and rewards of ownership. Examples include most car and apartment rental agreements.
Capital Leases Capital leases are long-term (or non-cancelable) leases by which the lessor
transfers substantially all risks and rewards of ownership to the lessee. Examples include leases of airplanes and department store buildings.
C4
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APPENDIX 14D: LEASES AND PENSIONS A pension is a contractual agreement between an
employer and its employees for the employer to provide benefits (payments) to employees after they retire.
Defined Benefit Plans The employer’s contributions vary, depending on
assumptions about future pension assets and liabilities. A pension liability is reported when the accumulated
benefit obligation is more than the plan assets, a so-called underfunded plan.
C4
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END OF CHAPTER 14