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Noncurrent Liabilities. Chapter 9. Noncurrent Liabilities . Noncurrent liabilities represent obligations of the firm that generally are due more than one year after the balance sheet date. Noncurrent Liabilities .
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Noncurrent Liabilities Chapter 9
Noncurrent Liabilities • Noncurrent liabilities represent obligations of the firm that generally are due more than one year after the balance sheet date.
Noncurrent Liabilities • The major portion of these liabilities consists of notes payable and bonds payable.
Long-Term Notes Payable • Long-term notes payable can be either interest-bearing or discounted.
Interest-Bearing Notes • With an interest-bearing note, the bank will loan the principal of the note for a specified period.
Interest-Bearing Notes • The borrower will pay interest periodically and will repay the principal at the maturity date.
Interest-Bearing Notes • Interest expense, of course, reduces Retained Earnings, as do all expenses.
Discounted Notes • Discounted notes do not require periodic payments of interest.
Discounted Notes • All long-term financing agreements involve interest, regardless of whether it is separately identified.
Discounted Notes • If a company borrows $10 million for 2 years and, because of the terms of the note, will not make periodic interest payments, then the lender will be unwilling to provide the borrower the full $10 million face amount of the note.
Discounted Notes • In this case, the note must be discounted, and the lender will lend the present value of the note, as computed by using the compound interest tables.
Discounted Notes • Assuming an interest rate of 12%, a factor of 0.797 is pulled from the Present Value of $1 table.
Discounted Notes • Multiplying $10 million by the factor, the present value (the amount which the borrower will receive in cash) is computed as $7,970,000.
Discounted Notes • The difference, $2,030,000, is the discount, which represents the interest that is associated with the transaction.
Discounted Notes • It will be recognized as Interest Expense by the borrower over the two-year period of the note.
Discounted Notes • At the maturity date, the borrower will repay $10 million to the lender.
Bonds • Bonds are individual notes, sold to individual investors as well as to financial institutions.
Bonds have several advantages: • The sale of bonds provides access to a large pool of lenders. • For some firms, selling bonds may be less expensive than other forms of borrowing. • Bond financing may offer managers greater flexibility in the future.
Bonds Payable • Bonds payable represent a major source of borrowed capital for U.S. companies.
Bonds Payable • Bonds involve the periodic payment of interest (usually every six months) and the repayment of the principal amount.
Bonds Payable • The predicted interest rate usually becomes the coupon or face or nominal rate.
Bonds Payable • It sets the cash interest payments the company will have to make.
Bonds Payable • The market rate of interest will be known only when the bonds are sold.
Bonds Payable • Because interest rates change constantly, it is rare that a bond coupon rate will equal the market rate when the bond is sold.
Bonds Payable • If the principal of a bond is $500,000 and the coupon rate is 12%, then the company will pay $60,000 ($500,000 X 12%) cash interest each year, or $30,000 every six months.
Bonds Payable • When interest is paid each six months, the interest rate is said to be compounded semiannually.
Bonds Payable • Since the bonds pay interest twice a year, the interest rate must be halved (10% per year is 5% each six months) and the number of years must be doubled.
Bonds Payable • A 6-year bond pays interest 12 times over the life of the bond.
Bonds Sold at Par • Bonds sell at par or face value when the coupon rate equals the market rate of interest on the date of sale.
Bonds Sold at Par • For a bond sold at par, on the date of sale, both Cash and Bonds Payable will increase by $100 million.
Bonds Sold at Par • On each of the two annual interest payment dates, Interest Expense will increase and Cash will decrease by $6 million.
Bonds Sold at Par • On the maturity date, both Cash and Bonds Payable will decrease by $100 million.
Bonds Sold at Discount • If, on the date of sale, the coupon rate does not equal the market rate, the bonds will sell at their present value.
Bonds Sold at Discount • If the coupon rate is below the market rate of interest on the date of sale, then the bonds will sell at a discount.
Bonds Sold at Discount • An investor will not pay face amount for a bond which has an interest rate lower than that which the investor could find elsewhere.
An example of a bond sold at a discount: • On January 3 a company sells $100,000,000 of bonds with a coupon rate of interest of 12% while the market rate of interest is 16%. • The bonds are 10-year bonds and pay interest twice a year
An example of a bond sold at a discount: • The present value of the bonds is calculated by adding the present value of the $10,000,000 to the present value of the annuity.
An example of a bond sold at a discount: • The present value of the bonds is calculated by adding the present value of the $10,000,000 to the present value of the annuity. $100,000,000 x 0.215 = $ 21,500,000 $ 6,000,000 x 9.818 = 58,908,000 $ 80,408,000
An example of a bond sold at a discount: • The coupon rate of interest is used to compute the cash interest payments ($10,000,000 X .12 X 6/12) and to compare against the market rate of interest (12% versus 16%) to let you know that the bonds are selling at a discount.
An example of a bond sold at a discount: • After that, the present value computations and interest computations are driven by the market rate of interest.
An example of a bond sold at a discount: • Because the bonds are 10-year bonds paying interest twice a year, there are 20 interest payment periods, and the market rate of interest will be halved, to 9%.
An example of a bond sold at a discount: • Upon sale of the bonds, the company will increase Cash and net Bonds Payable by $80,408,000.
