Long-Term Liabilities Chapter 14 ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Learning Objectives Journalize transactions for long-term notes payable and mortgages payable Describe bonds payable Journalize transactions for bonds payable and interest expense using the straight-line amortization method ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Learning Objectives Journalize transactions to retire bonds payable Report liabilities on the balance sheet Use the debt to equity ratio to evaluate business performance ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Learning Objectives Use time value of money to compute the present value of future amounts (Appendix 14A) Journalize transactions for bonds payable and interest expense using the effective-interest amortization method (Appendix 14B) ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Learning Objective 1 Journalize transactions for long-term notes payable and mortgages payable ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Long-Term Notes Payable Notes are recorded at the amount borrowed. Interest is not recorded until the end of the period. Interest accruals are part of the adjusting process. Notes that do not need to be paid within one year or one operating cycle, whichever is longer. The portion due in the current year is reclassified as a current liability. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Long-Term Notes Payable On December 31, 2014, Smart Touch Learning signed a $20,000 note payable. It is due in 4 annual payments of $5,000 plus 6% interest each December 31. Prepare the journal entry to record Smart Touch Learning’s note payable. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Long-Term Notes Payable On December 31, 2014, Smart Touch Learning signed a $20,000 note payable. It is due in 4 annual payments of $5,000 plus 6% interest each December 31. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Notes Payable Interest Interest on Notes Payable is computed as: The beginning balance will decline each period by the amount of the principal payment. Interest rates are always expressed as the rate for a whole year. This is the portion of a year that the interest period covers. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Notes Payable Interest On December 31, 2014, Smart Touch Learning signed a $20,000 note payable. It is due in 4 annual payments of $5,000 plus 6% interest each December 31. Compute interest for 2015. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Notes Payable Interest On December 31, 2014, Smart Touch Learning signed a $20,000 note payable. It is due in 4 annual payments of $5,000 plus 6% interest each December 31. Compute interest for 2015. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Interest Amortization When a loan is taken out, an amortization schedule is prepared showing payments and interest over the term of the loan. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Record the payment at December 31, 2015. Recording Interest Record the payment at December 31, 2015. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Record the payment at December 31, 2015. Recording Interest Record the payment at December 31, 2015. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Journalize the issuance of the note on January 1, 2014. >TRY IT! On January 1, 2014, Fox Corporation signed an $80,000, four-year, 4% note. The loan required Fox to make payments annually on December 31 of $20,000 principal plus interest. Journalize the issuance of the note on January 1, 2014. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall >TRY IT! On January 1, 2014, Fox Corporation signed an $80,000, four-year, 4% note. The loan required Fox to make payments annually on December 31 of $20,000 principal plus interest. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Journalize the first payment on December 31, 2014. >TRY IT! On January 1, 2014, Fox Corporation signed an $80,000, four-year, 4% note. The loan required Fox to make payments annually on December 31 of $20,000 principal plus interest. Journalize the first payment on December 31, 2014. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall >TRY IT! On January 1, 2014, Fox Corporation signed an $80,000, four-year, 4% note. The loan required Fox to make payments annually on December 31 of $20,000 principal plus interest. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Describe bonds payable Learning Objective 2 Describe bonds payable ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Bonds TERMINOLOGY: Face value Interest rate Issue date Maturity date Payment terms Long-term debt issued to multiple lenders. Usually in $1,000 increments. Each bondholder gets a bond certificate. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall

Debentures (Unsecured Bonds) Types of Bonds Term Bond The bond principal is due in full at a single maturity date. Secured Bonds Backed by specific assets that have been pledged as collateral. Debentures (Unsecured Bonds) No collateral. Serial Bond The bond principal is repaid in installments over the maturity period. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Bond Prices Bond Issued at: Face value: stated rate = market rate Discount: stated rate < market rate Premium: stated rate > market rate The face value of the bond defines how much principal will be paid at maturity. The bond selling price on the issue date will depend on: The stated interest rate on the bond, and The market rate of interest of similar bonds on the date of issue. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Bond Prices ©2014 Pearson Education, Inc. Publishing as Prentice Hall

>TRY IT! Determine whether the following bonds payable will be issued at face value, at a premium, or at a discount. A 10% bonds payable is issued when the market interest rate = 8%. A 10% bonds payable is issued when the market interest rate = 10%. A 10% bonds payable is issued when the market interest rate = 12%. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

>TRY IT! Determine whether the following bonds payable will be issued at face value, at a premium, or at a discount. PREMIUM A 10% bonds payable is issued when the market interest rate = 10%. A 10% bonds payable is issued when the market interest rate = 12%. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

A 10% bonds payable is issued when the market interest rate = 12%. >TRY IT! Determine whether the following bonds payable will be issued at face value, at a premium, or at a discount. PREMIUM FACE VALUE A 10% bonds payable is issued when the market interest rate = 12%. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall >TRY IT! Determine whether the following bonds payable will be issued at face value, at a premium, or at a discount. PREMIUM FACE VALUE DISCOUNT ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Learning Objective 3 Journalize transactions for bonds payable and interest expense using the straight-line amortization method ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Recording Bonds Payable at Face Value Smart Touch Learning has $100,000 of 9% bonds payable that mature in five years. The company issues the bonds on January 1, 2014 when the market rate is 9%. Journalize the issuance of the bonds on January 1, 2014. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Recording Bonds Payable at Face Value Smart Touch Learning has $100,000 of 9% bonds payable that mature in five years. The company issues the bonds on January 1, 2014 when the market rate is 9%. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Recording Bonds Issued at a Discount Interest Expense each period will be the sum of the computed interest payment + the amortized portion of the discount. When the bond interest rate < the market rate, the bonds are issued at a discount. The difference between the bonds payable and the cash received is recorded as a Bond Discount (a contra-liability) The discount is amortized over the life of the bond. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Recording Bonds Issued at a Discount Smart Touch Learning issues $100,000 of 9%, 5-year bonds that pay interest semiannually. The market rate of interest is 10%. Smart Touch Learning actually receives $96,149, and records a discount of $3,851. Journalize the issuance of the bonds on January 1, 2014. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Recording Bonds Issued at a Discount Smart Touch Learning issues $100,000 of 9%, 5-year bonds that pay interest semiannually. The market rate of interest is 10%. Smart Touch Learning actually receives $96,149, and records a discount of $3,851. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Straight-Line Amortization of the Discount ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Straight-Line Amortization of the Discount Using the discount amortization table, record Smart Touch Learning’s first interest payment on June 30, 2014. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Straight-Line Amortization of the Discount Using the discount amortization table, record Smart Touch Learning’s first interest payment on June 30, 2014. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Journalize transactions to retire bonds payable Learning Objective 4 Journalize transactions to retire bonds payable ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Retirement at Maturity Smart Touch Learning has $100,000 of 9% bonds that mature on December 31, 2018. (Note that all interest has already been paid and the discount is fully amortized.) Record the retirement of the bonds at December 31, 2018. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Retirement at Maturity Smart Touch Learning has $100,000 of 9% bonds that mature on December 31, 2018. (Note that all interest has already been paid and the discount is fully amortized.) ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Retirement Before Maturity The full Bonds Payable will be retired. The cash paid will not equal the face value. The remaining discount or premium will be removed. The difference will be recorded as either a Gain on Retirement of Bonds Loss on Retirement of Bonds ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Retirement Before Maturity On December 31, 2014, Smart Touch Learning decides to retire its bonds by paying $95,000, after only two interest payments. The table indicates that the discount balance is now $3,081. Record the early retirement of the bonds at December 31, 2014. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Retirement Before Maturity On December 31, 2014, Smart Touch Learning decides to retire its bonds by paying $95,000, after only two interest payments. The table indicates that the discount balance is now $3,081. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Record the bond retirement and include the correct date. >TRY IT! Herrera Corporation issued a $400,000, 4.5%, 10-year bond payable on January 1, 2014. Journalize the retirement of the bond payable at maturity. Record the bond retirement and include the correct date. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall >TRY IT! Smart Touch Learning issued a $400,000, 4.5%, 10-year bond payable on January 1, 2014. Journalize the retirement of the bond payable at maturity. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Report liabilities on the balance sheet Learning Objective 5 Report liabilities on the balance sheet ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Reporting Liabilities Liabilities are grouped on the Balance Sheet as either Current or Long-Term. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Use the debt to equity ratio to evaluate business performance Learning Objective 6 Use the debt to equity ratio to evaluate business performance ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Debt to Equity Ratio Shows the proportion of total liabilities to total equity. A measure of “financial leverage.” A ratio > 1, the company is financing more assets with debt than with equity. The higher the ratio, the more financial risk the company has. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Debt to Equity Ratio The information below is from the 2011 Annual Report for Green Mountain Coffee Roasters, Inc. Calculate the Debt to Equity Ratio for 2011. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Debt to Equity Ratio ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Compute the Debt to Equity Ratio for Payne Corporation for 2014. >TRY IT! Compute the Debt to Equity Ratio for Payne Corporation for 2014. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Compute the Debt to Equity Ratio for Payne Corporation for 2014. >TRY IT! Compute the Debt to Equity Ratio for Payne Corporation for 2014. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Learning Objective 7 Use time value of money to compute the present value of future amounts (Appendix 14A) ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Time Value of Money Sometimes, we need to know how much an amount of money will grow if interest is applied for several years. A mathematical formula will allow us to make the calculation: ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Time Value of Money If we invest $10,000 today at 6% interest and leave it for 5 years, how much will we have at the end of the period? ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Time Value of Money If we invest $10,000 today at 6% interest and leave it for 5 years, how much will we have at the end of the period? ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Present Value of a Lump Sum The formula can also be worked backward to determine today’s value of a future amount. Simply use the inverse of the future value multiplier. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Present Value of a Lump Sum At 6% interest, how much would we need to invest today in order to have $13,382 in 5 years? ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Present Value of a Lump Sum At 6% interest, how much would we need to invest today in order to have $13,382 in 5 years? ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Present Value of an Annuity The total grows faster, if we also add a fixed amount each period to the original investment. The present value of an annuity factor can be found in a table (see Appendix B in the text). ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Present Value of an Annuity What is the present day equivalent of an annuity of $2,000 per year for 5 years at 6%? ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Present Value of an Annuity What is the present day equivalent of an annuity of $2,000 per year for 5 years at 6%? ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Pricing Bonds Payable We can use the Present Value of a Lump Sum (PV) and the Present Value of an Annuity (PVA) concepts to determine the selling price of a bond. Bonds sell at the present value of all of the related cash flows: The periodic interest payments. The payout of principal at the end of the bond term. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Pricing Bonds Payable Smart Touch Learning issues $100,000 of 5-year, 9% bonds that pay interest semi-annually. The market interest rate is 10%. Maturity Payment = $100,000 Periodic Interest = $4,500 Interest rate = 5% (10% semiannually) Number of periods = 10 (payments twice a year for 5 years) ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Step 1: Present Value of the Principal This will be added to the present value of the interest payments. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Step 2: Present Value of the Interest Payments This will be added to the present value of the principal. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Step 3: Present Value of the Bond Payable This bond payable will sell at a discount of $3,851. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Learning Objective 8 Journalize transactions for bonds payable and interest expense using the effective-interest amortization method (Appendix 14B) ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Effective Interest Method for Interest Amortization Earlier we used a straight-line approach for amortizing the discount and determining interest expense. The “effective interest method” computes interest expense based on the carrying amount of the bond, and “backs into” the discount amortization each period. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Effective Interest Method for Interest Amortization ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Effective Interest Method for Interest Amortization Using the discount amortization table, record Smart Touch Learning’s first interest payment on June 30, 2014. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Effective Interest Method for Interest Amortization Using the discount amortization table, record Smart Touch Learning’s first interest payment on June 30, 2014. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall End of Chapter 14 ©2014 Pearson Education, Inc. Publishing as Prentice Hall