CHAPTER 15

1. LONG-TERM LIABILITIES CHAPTER 15 Accounting Principles, Eighth Edition

2. Long-Term Liabilities Bonds Basics Accounting for Bond Issues Accounting for Bond Retirements Accounting for 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

3. Bond Basics • Bondsare: • interest-bearing notes payable • issued by corporations, universities, and governmental agencies • like common stock, can be sold in small denominations (usually a thousand dollars) • attract many investors LO 1 Explain why bonds are issued.

4. Bond Basics To obtain large amounts of long-term capital, management usually must decide whether to issue bonds or to use equity financing (common stock). Three advantages over common stock: • Stockholder control is not affected. • Tax savings result. • Earnings per share may be higher. • Two disadvantages over common stock: • 1)Interest must be paid on a periodic basis • 2)Principal (face value) must be repaid at maturity LO 1 Explain why bonds are issued.

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

6. Secured Bonds: also called debenture bonds are issued against the general credit of the barrower. Unsecured Bonds: have specific assets of the issuer pledged as collateral for the bonds Ex. Mortgage Types of Bonds: Secured and Unsecured

7. Types of Bonds: Term and Serial Bonds 3) Term bonds - bonds that mature at a single specified future date 4) Serial bonds - bonds that mature in installments

8. Types of BondsConvertible and Callable • Convertible • convert the bonds into common stock at holder’s option • Callable • subject to call and retirement at a stated dollar amount prior to maturity at the option of the issuer

9. Bond Basics • Issuing Procedures • Bond contract is 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 has a $1,000 face value. • Interest payments are • usually made semiannually. • Generally issued when the amount of capital needed is too large for one lender to supply. LO 1 Explain why bonds are issued.

10. Bond Basics Issuer of Bonds Illustration 15-3 Maturity Date Contractual Interest Rate Face or Par Value LO 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, • the market rate of interest. The features of a bond (callable, convertible, etc) affect the market rate of the bond. • A corporation only makes journal entries when it issues or buys back bonds, and when bondholders convert bonds into common stock. • Transactions between a bondholder and other investors are not journalized by the issuing corporation. LO 1 Explain why bonds are issued.

12. Issuing Bonds at Face Value Illustration: On January 1, 2010, San Marcos HS issues $100,000, three-year, 8% bonds at 100 (100% of face value). Interest is paid annually each Dec. 31. Jan. 1 Cash 100,000 Bonds payable 100,000 Dec. 31 Interest expense 8,000 Cash 8,000 Companies classify bond interest payable as a current liability. LO 2 Prepare the entries for the issuance of bonds and interest expense.

13. Issuing bonds at a $ amount different from face value is quite common. (Meaning… a $1,000 bond does not always sell for $1,000.) http://www.old-stocks-bonds.com/gm-214384a.jpg Why? 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 (face) rate are the same. The Real World

14. Accounting for Bond Issues Assume Contractual (Face) Rate of 8% $1,000 Face Value Bonds Sold At… Market Interest 6% Premium 8% Face Value Discount 10% LO 2 Prepare the entries for the issuance of bonds and interest expense.

15. Issuing Bonds at a Discount Illustration: On January 1, 2010, San Marcos HS issues $100,000, three-year, 8% bonds for $95,027 (95.027% of face value). Jan. 1 Cash 95,027 Discount on bonds payable 4,973 Bonds payable 100,000 Although discount on bonds payable has a debt balance, it is not an asset. LO 2 Prepare the entries for the issuance of bonds and interest expense.

16. Issuing Bonds at a Premium Illustration: On January 1, 2010, San Marcos HS issues $100,000, three-year, 8% bonds for $105,346 (105.346% of face value). Jan. 1 Cash 105,346 Premium on bonds payable 5,346 Bonds payable 100,000 LO 2 Prepare the entries for the issuance of bonds and interest expense.

17. Accounting for Other Long-Term Liabilities • 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 • interest on the unpaid balance of the loan and • a reduction of loan principal. • Companies initially record mortgage notes payable at face value. LO 4 Describe the accounting for long-term notes payable.

18. Accounting for Other Long-Term Liabilities Lease Liabilities - A lease is a contract between a lessor (owner of the property) and a lessee (renter of the property). Illustration 15-13