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Chapter 15

Chapter 15. Long-Term Liabilities. Accounting Principles, Ninth Edition. Explain why bonds are issued. Prepare the entries for the issuance of bonds and interest expense. Describe the entries when bonds are redeemed or converted. Describe the accounting for long-term notes payable.

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Chapter 15

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  1. Chapter15 Long-Term Liabilities Accounting Principles, Ninth Edition

  2. Explain why bonds are issued. Prepare the entries for the issuance of bonds and interest expense. Describe the entries when bonds are redeemed or converted. Describe the accounting for long-term notes payable. Contrast the accounting for operating and capital leases. Identify the methods for the presentation and analysis of long-term liabilities. Study Objectives

  3. Long-Term Liabilities Bonds Basics Bond Issues Bond Retirements Other Long-Term Liabilities Statement Presentation and Analysis Types of bonds Issuing procedures Trading Market value Issuing bonds at face value Discount or premium Issuing bonds at a discount Issuing bonds at a premium Redeeming bonds at maturity Redeeming bonds before maturity Converting bonds into common stock Long-term notes payable Lease liabilities Presentation Analysis

  4. Bond Basics Bondsare a form of interest-bearing notes payable. Three advantages over common stock: • Stockholder control is not affected. • Tax savings result. • Earnings per share may be higher. SO 1 Explain why bonds are issued.

  5. Bond Basics Effects on earnings per share—stocks vs. bonds. Illustration 15-2 SO 1 Explain why bonds are issued.

  6. Bond Basics Question The major disadvantages resulting from the use of bonds are: • that interest is not tax deductible and the principal must be repaid. • that the principal is tax deductible and interest must be paid. • that neither interest nor principal is tax deductible. • that interest must be paid and principal repaid. SO 1 Explain why bonds are issued.

  7. Bond Basics • Types of Bonds • Secured and Unsecured (debenture) bonds. • Term and Serial bonds. • Registered and Bearer (or coupon) bonds. • Convertible and Callable bonds. SO 1 Explain why bonds are issued.

  8. Bond Basics • Issuing Procedures • Bond contract known as a bond indenture. • Represents a promise to pay: • sum of money at designated maturity date, plus • 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. SO 1 Explain why bonds are issued.

  9. Bond Basics Issuer of Bonds Illustration 15-3 Maturity Date Contractual Interest Rate Face or Par Value SO 1 Explain why bonds are issued.

  10. Bond Basics • Bond Trading • Bonds 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 2011. 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. SO 1 Explain why bonds are issued.

  11. Bond Basics • Determining the Market Value of Bonds • Market value is a function of the three factors that determine present value: • the dollar amounts to be received, • the length of time until the amounts are received, and • the market rate of interest. The features of a bond (callable, convertible, and so on) affect the market rate of the bond. SO 1 Explain why bonds are issued.

  12. Accounting for Bond Issues Assume Contractual Rate of 8% Market Interest Bonds Sold At 6% Premium 8% Face Value Discount 10% SO 2 Prepare the entries for the issuance of bonds and interest expense.

  13. Accounting for Bond Issues Question The rate of interest investors demand for loaning funds to a corporation is the: • contractual interest rate. • face value rate. • market interest rate. • stated interest rate. SO 2 Prepare the entries for the issuance of bonds and interest expense.

  14. Accounting for Bond Issues Question Karson Inc. issues 10-year bonds with a maturity value of $200,000. If the bonds are issued at a premium, this indicates that: • the contractual interest rate exceeds the market interest rate. • the market interest rate exceeds the contractual interest rate. • the contractual interest rate and the market interest rate are the same. • no relationship exists between the two rates. SO 2 Prepare the entries for the issuance of bonds and interest expense.

  15. Issuing Bonds at Face Value Illustration: On January 1, 2010, Candlestick Corporation issues $100,000, five-year, 10% bonds at 100 (100% of face value). The entry to record the sale is: Jan. 1 Cash 100,000 Bonds payable 100,000 SO 2 Prepare the entries for the issuance of bonds and interest expense.

  16. Issuing Bonds at Face Value Illustration: On January 1, 2010, Candlestick Corporation issues $100,000, five-year, 10% bonds at 100 (100% of face value). Assume that interest is payable semiannually on January 1 and July 1. Prepare the entry to record the payment of interest on July 1, 2010, assume no previous accrual. July 1 Bond interest expense 5,000 Cash 5,000 SO 2 Prepare the entries for the issuance of bonds and interest expense.

  17. Issuing Bonds at Face Value Illustration: On January 1, 2010, Candlestick Corporation issues $100,000, five-year, 10% bonds at 100 (100% of face value). Assume that interest is payable semiannually on January 1 and July 1. Prepare the entry to record the accrual of interest on December 31, 2010, assume no previous accrual. Dec. 31 Bond interest expense 5,000 Bond interest payable 5,000 SO 2 Prepare the entries for the issuance of bonds and interest expense.

  18. Issuing Bonds at a Discount Illustration: On January 1, 2010, 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 SO 2 Prepare the entries for the issuance of bonds and interest expense.

  19. Issuing Bonds at a Discount Statement Presentation Illustration 15-6 SO 2 Prepare the entries for the issuance of bonds and interest expense.

  20. Issuing Bonds at a Discount Total Cost of Borrowing Illustration 15-7 Illustration 15-8 SO 2 Prepare the entries for the issuance of bonds and interest expense.

  21. Issuing Bonds at a Discount Question Discount on Bonds Payable: • has a credit balance. • is a contra account. • is added to bonds payable on the balance sheet. • increases over the term of the bonds. SO 2 Prepare the entries for the issuance of bonds and interest expense.

  22. Issuing Bonds at a Premium Illustration: On January 1, 2010, 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 Bonds payable 100,000 Premium on bond payable 8,111 SO 2 Prepare the entries for the issuance of bonds and interest expense.

  23. Issuing Bonds at a Premium Statement Presentation Illustration 15-9 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. SO 2 Prepare the entries for the issuance of bonds and interest expense.

  24. Issuing Bonds at a Premium Total Cost of Borrowing Illustration 15-10 Illustration 15-11 SO 2 Prepare the entries for the issuance of bonds and interest expense.

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