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CHAPTER 15

LONG-TERM LIABILITIES. CHAPTER 15. Accounting Principles, Eighth Edition. Long-Term Liabilities. Long-Term Liabilities. Obligations that are expected to be paid after one year Include bonds, long-term notes, and lease obligations. Bond Basics. Bonds are:.

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CHAPTER 15

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

  2. Long-Term Liabilities Long-Term Liabilities Obligations that are expected to be paid after one year Include bonds, long-term notes, and lease obligations

  3. Bond Basics Bondsare: 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: LO 1 Explain why bonds are issued.

  5. Bond Basics Two disadvantages over common stock: LO 1 Explain why bonds are issued.

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

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

  8. Types of Bonds: Term and Serial Bonds 3) Term bonds – 4) Serial bonds -

  9. Types of BondsConvertible and Callable • Convertible • Callable

  10. 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. LO 1 Explain why bonds are issued.

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

  12. Bond Basics - Bond Trading • $800,000,000,000 average daily trading volume in the U.S. • Bonds traded on national securities exchanges and OTC. • Newspapers & 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. LO 1 Explain why bonds are issued.

  13. Bond Basics - Determining the Market Value of Bonds Market value is a function of the three factors that determine present value: The features of a bond (callable, convertible, etc) affect the market rate of the bond. LO 1 Explain why bonds are issued.

  14. The Accounting… • 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. • After the bond is sold – the issuing company does not journalize any further sales between investors…. why? LO 2 Prepare the entries for the issuance of bonds and interest expense.

  15. 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 Dec. 31 LO 2 Prepare the entries for the issuance of bonds and interest expense.

  16. 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? The Real World

  17. 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.

  18. If the market rate is 10%, will this bond sell at a premium or discount? What will it sell for in $?

  19. 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 LO 2 Prepare the entries for the issuance of bonds and interest expense.

  20. Issuing Bonds at a Discount Statement Presentation LO 2 Prepare the entries for the issuance of bonds and interest expense.

  21. 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 LO 2 Prepare the entries for the issuance of bonds and interest expense.

  22. Issuing Bonds at a Discount 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. LO 2 Prepare the entries for the issuance of bonds and interest expense.

  23. Accounting for Bond Retirements Redeeming Bonds at Maturity How does San Marcos HS records the redemption of its bonds at maturity. What is the entry. LO 3 Describe the entries when bonds are redeemed or converted.

  24. Accounting for Bond Retirements E15-6Nocioni Company issued $1,000,000 of bonds on January 1, 2010. Instructions: Prepare the journal entry to record the conversion of the bonds into 30,000 shares of $10 par value common stock. Assume the bonds were issued at par. LO 3 Describe the entries when bonds are redeemed or converted.

  25. 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.

  26. Accounting for Other Long-Term Liabilities Exercise: On December 31, 2008Tucki Co. receives $240,000 when it issues a $240,000, 10%, mortgage note payable to the Bank to construct a building. The terms provide for semiannual installment payments of $16,000 on June 30 and December 31. Prepare the journal entries to record the mortgage loan and the first installment payment. Dec. 31 Jun. 30 *($240,000 x 10% x 6/12 = $12,000) * LO 4 Describe the accounting for long-term notes payable.

  27. 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

  28. Accounting for Other Long-Term Liabilities The issue of how to report leases is the case of substance versus form. Operating Lease Capital Lease Journal Entry: Rent expense xxx Cash xxx Journal Entry: Leased equipment xxx Lease liability xxx A lease that transfers substantially all of the benefits and risks of property ownership should be capitalized. (i.e. leasing for years vs. leasing for a month) LO 5 Contrast the accounting for operating and capital leases.

  29. Accounting for Other Long-Term Liabilities • To capitalize a lease, one or more of four criteria must be met: • Transfers ownership to the lessee. • Contains a bargain purchase option. • Lease term is >= 75% of the estimated economic life of the leased property. • The present value of the minimum lease payments >= 90% of the fair value of the leased property. LO 5 Contrast the accounting for operating and capital leases.

  30. Accounting for Other Long-Term Liabilities Exercise: On January 1, 2010, Burke Corporation signed a 5-year noncancelable lease for a machine. The machine has an estimated useful life of 6 years and the present value of the lease payments is $36,144, which is equal to the fair market value of the equipment. There is no transfer of ownership during the lease term, nor is there any bargain purchase option. Instructions (a)What type of lease is this? Explain. (b) Prepare the journal entry to record the lease on January 1, 2010. LO 5 Contrast the accounting for operating and capital leases.

  31. Capitalization Criteria: Transfer of ownership Bargain purchase option Lease term => 75% of economic life of leased property Present value of minimum lease payments => 90% of FMV of property Accounting for Other Long-Term Liabilities Exercise: (a)What type of lease is this? Explain. Capital Lease? Lease term 5 yrs. Economic life 6 yrs. 83.3% PV and FMV are the same. LO 5 Contrast the accounting for operating and capital leases.

  32. Accounting for Other Long-Term Liabilities Exercise: (b) Prepare the journal entry to record the lease on January 1, 2010. Jan. 1 The portion of the lease liability expected to be paid in the next year is a current liability. The remainder is classified as a long-term liability. LO 5 Contrast the accounting for operating and capital leases.

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