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Chapter 10

Chapter 10. Reporting and Analyzing Long-Term Liabilities. Conceptual Learning Objectives. C1: Explain the types and payment patterns of notes C2: Appendix 14A: Explain and compute the present value of an amount to be paid at a future date

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Chapter 10

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  1. Chapter 10 Reporting and Analyzing Long-Term Liabilities

  2. Conceptual Learning Objectives C1: Explain the types and payment patterns of notes C2:Appendix 14A: Explain and compute the present value of an amount to be paid at a future date C3:Appendix 14C: Describe the accrual of bond interest when bond payments do not align with accounting periods C4:Appendix 14D: Describe the accounting for leases and pensions

  3. Analytical Learning Objectives A1: Compare bond financing with stock financing A2: Assess debt features and their implications A3: Compute the debt-to-equity ratio and explain its use

  4. Procedural Learning Objectives P1: Prepare entries to record bond issuance and bond interest expense P2: Compute and record amortization of bond discount P3: Compute and record amortization of bond premium P4: Record the retirement of bonds P5: Prepare entries to account for notes

  5. Advantages of Bonds A1 Bonds do not affect stockholder control. Interest on bonds is tax deductible. Bonds can increase return on equity.

  6. Disadvantages of Bonds A1 Bonds require payment of both periodic interest and par value at maturity. Bonds can decrease return on equity when the company pays more in interest than it earns on the borrowed funds.

  7. Bond Trading A2 Bond market values are expressed as a percent of their par value.

  8. Bond Issuing Procedures A1 . . .an investment firm called an underwriter. The underwriter sells the bonds to. . . A company sells the bonds to. . . A trustee monitors the bond issue. . . . investors

  9. Bond Selling Price Bond Certificate at Par Value Basics of Bonds A1 Investors Corporation

  10. Bond Interest Payments Basics of Bonds A1 Corporation Investors Bond Interest Payments Interest Payment = Bond Par Value ´ Stated Interest Rate Bond Issue Date

  11. Bond Par Value at Maturity Date Basics of Bonds A2 Corporation Investors Bond Issue Date Bond Maturity Date

  12. Issuing Bonds at Par P1 King Co. issues the following bonds on January 1, 2008 Par Value = $1,000,000 Stated Interest Rate = 10% Interest Dates = 6/30 and 12/31 Bond Date = Jan. 1, 2008 Maturity Date = Dec. 31, 2027 (20 years)

  13. Issuing Bonds at Par P1 The entry on June 30, 2008, to record the first semiannual interest payment is . . . $1,000,000 × 10% × ½ year = $50,000This entry is made every six months until the bonds mature.

  14. Issuing Bonds at Par P1 On Dec. 31, 2027, the bonds mature, King Co. makes the following entry . . . The debt has now been extinguished.

  15. Bond Discount or Premium P1

  16. Issuing Bonds at a Discount P2 Prepare the entry for Jan. 1, 2008, to record the following bond issue by Rose Co. Par Value = $1,000,000Issue Price = 92.6405% of par valueStated Interest Rate = 10%Market Interest Rate = 12%Interest Dates = 6/30 and 12/31Bond Date = Jan. 1, 2008 Maturity Date = Dec. 31, 2012 (5 years) } Bond will sell at a discount.

  17. Issuing Bonds at a Discount P2 $1,000,000´ 92.6405% Amortizing the discount increases Interest Expense over the outstanding life of the bond.

  18. Issuing Bonds at a Discount P2 On Jan. 1, 2008, Rose Co. would record the bond issue as follows. Contra-Liability Account

  19. Issuing Bonds at a Discount P2 Maturity Value Carrying Value Using the straight-line method, the discount amortization will be $7,360 every six months. $73,595 ÷ 10 periods = $7,360* *(rounded)

  20. Issuing Bonds at a Discount P2 Make the following entry every six months to record the cash interest payment and the amortization of the discount. $73,595 ÷ 10 periods = $7,360 (rounded) $1,000,000 × 10% × ½ = $50,000

  21. P2

  22. Straight-Line and Effective Interest Methods P2 Both methods report the same amount ofinterest expense over the life of the bond.

  23. Issuing Bonds at a Premium P3 Prepare the entry for Jan. 1, 2008, to record the following bond issue by Rose Co. Par Value = $1,000,000Issue Price = 108.1145% of par valueStated Interest Rate = 10%Market Interest Rate = 8%Interest Dates = 6/30 and 12/31Bond Date = Jan. 1, 2008 Maturity Date = Dec. 31, 2012 (5 years) } Bond will sell at a premium.

  24. Issuing Bonds at a Premium P3 $1,000,000´ 108.1145% Amortizing the premium decreasesInterest Expense over the life of the bond.

  25. Issuing Bonds at a Premium P3 On Jan. 1, 2008, Rose Co. would record the bond issue as follows. Adjunct-Liability Account

  26. Issuing Bonds at a Premium P3 Using the straight-line method, the premium amortization will be $8,115 every six months. $81,145 ÷ 10 periods = $8,115 (rounded)

  27. Issuing Bonds at a Premium P3 This entry is made every six months to record the cash interest payment and the amortization of the premium. $81,145 ÷ 10 periods = $8,115 (rounded) $1,000,000 × 10% × ½ = $50,000

  28. P3

  29. Accruing Bond Interest Expense C3 End of accounting period Interest Payment Dates Jan. 1 Apr. 1 Oct. 1 Dec. 31 3 months’ accrued interest At year-end, an adjusting entry is necessary to recognize bond interest expense accrued since the most recent interest payment.

  30. Present Value of a Discount Bond C2 Calculate the issue price of Rose Inc.’s bonds. Par Value = $1,000,000 Issue Price = ? Stated Interest Rate = 10% Market Interest Rate = 12% Interest Dates = 6/30 and 12/31 Bond Date = Jan. 1, 2008 Maturity Date = Dec. 31, 2012 (5 years)

  31. Present Value of a Discount Bond C2 1. Semiannual rate = 6% (Market rate 12% ÷ 2) 2. Semiannual periods = 10 (Bond life 5 years × 2) $1,000,000 × 10% × ½ = $50,000

  32. Bond Retirement P4 • At Maturity • Before Maturity • Carrying Value > Retirement Price = Gain • Carrying Value < Retirement Price = Loss

  33. Types of Bonds A2 Secured and Unsecured Convertible and Callable Term and Serial Registered and Bearer

  34. Bond Retirement • The carrying value of the bond at maturity should equal its par value. • Sometimes bonds are retired prior to their maturity. • Two common ways to retire bonds are through the exercise of a callable option or through purchasing them on the open market. • Callable bonds present several accounting issues including calculating gains and losses.

  35. Long-Term Notes Payable C1 Are you ready to discuss long-term notes payable?

  36. Long-Term Notes Payable C1 Cash Note Payable Company Lender When is the repayment of the principal and interest going to be made? Note Date Note Maturity Date

  37. Long-Term Notes Payable C1 Single Payment of Principal plus Interest Company Lender Single Payment of Principal plus Interest Note Date Note Maturity Date

  38. Long-Term Notes Payable C1 Regular Payments of Principal plus Interest Company Lender Regular Payments of Principal plus Interest Payments can either be equal principal payments plus interest or equal payments. Note Date Note Maturity Date

  39. Installment Notes with Equal Principal Payments C1 Annual payments decrease. The principal payments are $10,000 each year. Interest expense decreases each year.

  40. Installment Notes with Equal Payments C1 Annual payments are constant. The principal payments increase each year. Interest expense decreases each year.

  41. Mortgage Notes and Bonds C1 • 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.

  42. Debt-to- Equity Ratio Total Liabilities Total Equity = Debt-to-Equity Ratio A3 This ratio helps investors determine the risk of investing in a company by dividing its total liabilities by total equity.

  43. Issuing Bonds Between Interest Dates C3 Apr. 1, 2008Bond Issue Date June 30, 2008First Interest Payment Jan. 1, 2008 Bond Date Accrued interest Investor pays bond purchase price + accrued interest.

  44. Issuing Bonds Between Interest Dates C3 Apr. 1, 2008 Bond Issue Date June 30, 2008First Interest Payment Jan. 1, 2008 Bond Date Earned interest Accrued interest Investor receives 6 months’ interest.

  45. Issuing Bonds Between Interest Dates C 3 Prepare the entry to record the following bond issue by King Co. on Apr. 1, 2008. Par Value = $1,000,000Stated Interest Rate = 10%Market Interest Rate = 10%Interest Dates = 6/30 and 12/31Bond Date = Jan. 1, 2008Maturity Date = Dec. 31, 2012 (5 years)

  46. Issuing Bonds Between Interest Dates C3 At the date of issue the following entry is made: The first interest payment on June 30, 2005 is:

  47. End of Chapter 10

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