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Long-Term Liabilities

Long-Term Liabilities. Chapter 13. Objective 1. Account for bonds payable. Bonds: An Introduction. Groups of notes payable issued to multiple lenders Principal (maturity value, par value) Maturity date Stated interest rate. Types of Bonds.

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Long-Term Liabilities

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  1. Long-Term Liabilities Chapter 13

  2. Objective 1 Account for bonds payable

  3. Bonds: An Introduction • Groups of notes payable issued to multiple lenders • Principal (maturity value, par value) • Maturity date • Stated interest rate

  4. Types of Bonds • Term bonds - mature at a single specified future date • Serial bonds - mature in installments

  5. Types of Bonds • Secured bonds - specific assets are pledged as collateral • Debenture bonds - backed by the good faith of the issuer

  6. Bond Prices • Maturity value (par) • Discount • Premium

  7. Bond Prices Quoted as percent of its face value • What is the issue price of a $1,000 bond sold at 98? $1,000 x .98 = $980 • What is the issue price of a $5,000 bond sold at 101? $5,000 x 1.01 = $5,050

  8. Present Value • Time value of money • Amount a person would invest today to receive a greater amount in the future • Difference between present value and future value = Interest Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Future Value $100,000 Present Value $97,000

  9. Bond Interest Rates • Stated interest rate • Printed on bond • Determines cash interest payments • Market interest rate (effective rate) • Rate in effect when bonds are issued • Rate investors demand for loaning money

  10. Bond Interest Rates Bond Stated Rate = 9% Market Rate = 8% Market Rate = 9% Market Rate = 10% Bonds Sell ata Premium Bonds Sell At Par (Face) Bonds Sell at a Discount

  11. Issuing Bonds at Par E13-17 2006 Mar 31 Cash 400,000 Bonds Payable 400,000 Sep 30 Interest Expense 14,000 Cash 14,000 Dec 31 Interest Expense 7,000 Interest Payable 7,000 Interest = 400,000 x .07 x ½ = 14,000 Interest = 400,000 x .07 x 3/12 = 7,000

  12. E13-17 2007 Mar 31 Interest Expense 7,000 Interest Payable 7,000 Cash 14,000

  13. E13-18 a Jan 1 Cash 50,000 Bonds Payable 50,000 Jul 1 Interest Expense 1,500 Cash 1,500 Cash = $50,000 x 6% x ½ = $1,500

  14. Objective 2 Measure interest expense by the straight-line amortization method

  15. Contra-Liability Account Bond Discount – E13-18 b Jan 1 Cash 47,500 Discount on Bonds Payable 2,500 Bonds Payable 50,000

  16. Face Value Carrying Value Balance Sheet Presentation as of January 1 Long-term liabilities: Bond payable $50,000 Less Discount on Bonds 2,500 $47,500

  17. Straight-Line AmortizationE13-18 b Jan 1 Cash 47,500 Discount on Bonds Payable 2,500 Bonds Payable 50,000 Jul 1 Interest Expense 125 Discount on Bonds Payable 125 1 Interest Expense 1,500 Cash 1,500 Amortization of discount = $2,500 / 20 periods Cash = $50,000 x 6% x ½ = $1,500

  18. Balance Sheet Presentation July 1 Long-term liabilities: Bond payable $50,000 Less Discount on Bonds 2,375 $ 47,625 January 1 Long-term liabilities: Bond payable $50,000 Less Discount on Bonds 2,500 $ 47,500 Notice that the carrying value of the bond increases, approaching the face value

  19. Bond Premium – E13-18 c Jan 1 Cash 52,500 Premium on Bonds Payable 2,500 Bonds Payable 50,000

  20. Face Value Carrying Value Balance Sheet Presentation as of January 1 Long-term liabilities: Bond payable $50,000 Plus Premium on Bonds 2,500 $52,500

  21. Straight-Line AmortizationE13-18 c Jan 1 Cash 52,500 Premium on Bonds Payable 2,500 Bonds Payable 50,000 Jul 1 Premium on Bonds Payable 125 Interest Expense 125 1 Interest Expense 1,500 Cash 1,500 Amortization of premium = $2,500 / 20 periods

  22. Balance Sheet Presentation July 1 Long-term liabilities: Bond payable $50,000 Plus Premium on Bonds 2,375 $52,375 January 1 Long-term liabilities: Bond payable $50,000 Plus Premium on Bonds 2,500 $52,500 Notice that the carrying value of the bond decreases, approaching the face value

  23. Adjusting Entries • When bonds are issued at a discount or premium, accrual includes amortization

  24. Issuing Bonds Payable Between Interest Dates • Bonds can be issued between interest payment dates

  25. Corp. pays full 6 months’ of interest of $3,000 Investor pays face value + Accrued interest $100,000 + $500 ($100,000 x 6% x 1/12) Exercise 13-21 April 30 Bond Date May 31 Issue Date Oct 31 Interest Payment Date

  26. Exercise 13-21 May 31 Cash 100,500 Bonds Payable 100,000 Interest Payable 500 Oct 31 Interest Expense 2,500 Interest Payable 500 Cash 3,000 Interest payable = $100,000 x .06 x 1/12

  27. Objective 3 Account for retirement and conversion of bonds payable

  28. Bonds Features • Convertible bonds - bondholders can convert bonds into common stock • Callable bonds • Corporation can call and retire bonds before maturity date • Corporation usually pays a “call price” which is a few percentage points above par value

  29. Retirement of Bonds Payable • To retire a bond early, issuer can • Purchase bonds in the open market • Exercise a call option

  30. Early Retirement of Bonds • Record interest expense and amortize discount or premium up to retirement date • If carrying value of bond > cash paid = gain on early retirement of bonds • If carrying value of bond < cash paid = loss on early retirement of bonds • Gains or losses on early retirement of debt (if material in amount) are extraordinary items

  31. Discount on bonds Bonds payable 200,000 12,000 E13-24 200,000 x ½ 12,000 x ½ Carrying value of bonds Bonds payable 100,000 Less discount (6,000) 94,000 Cash paid to retire debt 100,000 x 1.01 = 101,000 Loss of 7,000

  32. E13-24 (1) Oct 1 Bonds Payable 100,000 Loss on Retirement of Bonds Payable 7,000 Discount on Bonds Payable 6,000 Cash 101,000

  33. Convertible Bonds • Holder has option of exchanging bond for specified number of shares of common stock • When converted - stockholders’ equity increased by carrying amount of bonds converted

  34. E13-24 (2) The bondholders would convert their bonds into stock when the market value of the stock to be received from conversion exceeds the market value of the bonds Oct 1 Bonds Payable 100,000 Discount on Bonds Payable 6,000 Common Stock 10,000 Paid-in Capital in Excess of Par, Common 84,000

  35. Objective 4 Report liabilities on the balance sheet

  36. Reporting Liabilities • Current: • Interest Payable • Current portions of long-term liabilities • Long-term: • Mortgage Payable • Capital Lease Payable • Bonds Payable

  37. Exercise 13-25 Current liabilities: Accounts payable…………………….$ 50,000 Bonds payable, current……………… 20,000 Salary payable……………………….. 10,000 Income tax payable………………….. 8,000 Interest payable……………….…..…. 7,000 Total current liabilities……………… $95,000 Long-term liabilities: Bonds payable……………….……... $180,000

  38. Objective 5 Show the advantages and disadvantages of borrowing

  39. Advantages of Bonds • Do not affect stockholder control • Interest on bonds is tax deductible • Can increase return on equity

  40. Disadvantages of Bonds • Require payment of both periodic interest and par value at maturity • Can decrease return on equity when company pays more in interest than it earns on the borrowed funds

  41. End of Chapter 13

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