Financial Accounting: Copyright 2004 The McGraw-Hill Companies, Inc. Permission required for reproduction or display. PowerPoint Presentation Materials For Financial Accounting: A New Perspective by Paul Solomon

How Financing Activities Affect Financial Statements CHAPTER 13 How Financing Activities Affect Financial Statements

PERFORMANCE OBJECTIVES 1 PO49: Calculate simple interest; record transactions related to note payable PO50: calculate company payroll liabilities PO51: Apply present value concept; calculate, record, present balance sheet, income statement, cash flow effects

PERFORMANCE OBJECTIVES 2 PO53: Distinguish financial statement effects of effective interest, straight-line bond amortization PO55: Calculate, record, present financial statement effects of stockholder equity transactions

USER FOCUS Intuitive explanation of bond discount, premium Numerical explanation of bond discount, premium Discount, premium unrelated to bond’s profitability How to determine estimated pension liability

INSIGHTS Using a shortcut to calculate subsequent present value calculations Why do bond transactions involve 2 interest rates?

FINANCING ACTIVITY TRANSACTIONS K1 L W A2 Obtained money to start business Borrowed money from bank Repaid credit line Exchange noncurrent liability for asset Cash withdrawal by owner Inventory contribution by new owner

CMU Balance Sheet 12/31 Noncurrent Liability Notes payable 4,000 Owner’s Equity Contributed capital Retained earnings $40,000 21,900 61,900

CMU Income Statement for Year Ended 12/31 Revenues Sales Service Interest Expenses Cost of goods sold Other Loss on sale equipment Net income $86,600 600 300 $30,000 27,150 350 $87,500 57,500

CMU Statement of Cash Flows for Year Ended 12/31 Cash flows from financing Contributions by owner Proceeds from credit line Repayment of credit line Withdrawals by owner Net cash from financing $30,000 5.000 <5,000> <8,100> $21,900 Supplemental: noncash investing, financing Exchanged 2-year promissory note for computer equipment

CMU Balance Sheet 12/31 Current liabilities Accounts payable Salaries payable Deferred revenue Notes payable Total current liabilities $350 750 2,000 6,000 $9,100

MEASURING PAYABLES Transaction C1 G C2 J1 J2 Equipment purchase Inventory purchase Repayment Conversion account to note

PROMISSORY NOTE Written contract 1 person (maker) promises to pay another (payee) Payment on certain date (maturity date) Principal Interest Interest bearing or non-interest bearing

MEASURING, RECORDING NOTE: Transactional Analysis Account Assets = Liabilities + Equity Accounts payable Notes payable - current <6,000> 6,000

MEASURING, RECORDING NOTE: Journal Entry Account Debit Credit Accounts payable Notes payable- current 6,000

INTEREST EXPENSE: Transactional Analysis Account Assets = Liabilities + Equity Interest expense Cash 30 <30>

INTEREST EXPENSE: Journal Entry Account Debit Credit Interest expense Cash 30

REPAYMENT OF NOTE: Transactional Analysis Account Assets = Liabilities + Equity Notes payable – current Cash <6,000>

REPAYMENT OF NOTE: Journal Entry Account Debit Credit Notes payable – current Cash 6,000

MEASURING, REPORTING OTHER CURRENT LIABILITIES Salaries, payroll tax liabilities Social Security tax matching State unemployment compensation tax Federal unemployment compensation tax Income tax liabilities

INCOME TAX LIABILITIES: Transaction Analysis Account Assets = Liabilities + Equity Income tax expense Income tax payable 4,500 <4,500>

INCOME TAX LIABILITIES: Journal Entry Account Debit Credit Income tax expense Income tax payable 4,500

OTHER ACCRUED LIABILITIES: Transaction Analysis Account Assets = Liabilities + Equity Miscellaneous expense Accounts payable 350 <350>

OTHER ACCRUED LIABILITIES: Journal Entry Account Debit Credit Miscellaneous expense Accounts payable 350

ACCOUNTING FOR NONCURRENT LIABILITIES Noncurrent notes payable Bonds

MEASURE NONCURRENT LIABILITIES: Present Value Noncurrent liabilities include multiple cash flows Financial statements include current & past amounts More precise income measure

NON-INTEREST-BEARING NOTE CMU can Buy land for $10,000 cash today or Exchange an 8% non-interest-bearing note for land Pay principal ($10,000) + interest ($1,664) in 2 years

AMORTIZATION TABLE: Non-interest-bearing Note Year end Interest expense (8%) Cash payment Balance 1 2 800 864 11,664 10,000 10,800

INSTALLMENT LOANS Examples Each payment is Automobile Home, building Consumer, equipment Each payment is Part principal Part interest

AMORTIZATION TABLE: Land Installment Loan Time (Debit) Interest Expense Note Payable (Credit) Cash Unpaid Principal 1 2 3 $8,000 5,536 2,874 $30,803 33,268 35,929 $38,803 $100,000 69,197

INSIGHT: 13-1: Present Value Shortcut What is the present value of the final payment for land at the end of year 2? Payment * PVAIF $38,803 * .92593 = $35,930 $35,930 -$38,803 1 2 3

MONTHLY CAR PAYMENT Susan bought car (Transaction R) with $4,000 cash and note payable for $20,000 Principle amount = $20,000 60 monthly payments 12% annual (1% monthly) interest Note = PVAIF * Payment $20,000 = 44.95504 * Payment Payment = $444.89

BUSINESS AUTOMOBILE: Transaction Analysis Account Assets = Liabilities + Equity Automobile Note payable Cash 24,000 <4,000> 20,000

BUSINESS AUTOMOBILE: Journal Entry Account Debit Credit Automobile Notes payable Cash 24,000 20,000 4,000

AMORTIZATION TABLE: Automobile Note Payable Month (Debit) Interest Expense Note Payable (Credit) Cash Unpaid Balance 1 2 $200.00 197.55 $244.89 247.34 $444.89 444.89 $20,000.00 19,755.11 19,507.77

PAYMENTS ON NOTE: Transaction Analysis Account Assets = Liabilities + Equity 1/30 Interest expense Note payable Cash <444.89> <244.89> <200.00> 2/29 Interest expense Note payable Cash <444.89> <247.34> <197.55>

PAYMENTS ON NOTE: Journal Entry Account Debit Credit 1/30 Interest expense Note payable Cash 200.00 244.89 444.89 2/29 Interest expense Note payable Cash 197.55 247.34 444.89

BALANCE SHEET PRESENTATION OF LIABILITY Note Payable Amortization 244.89 20,000.00 1/01 PV 247.34 19,755.11 1/30 PV 19,507.77 2/29 PV

AMORTIZATION TABLE: Transaction L Note Payable Bought computer for business Month (Debit) Interest Expense Note Payable (Credit) Cash Unpaid Balance 1 2 3 $40.00 38.52 37.02 $148.29 149.77 151.27 $188.29 188.29 $4,000.00 3,851.71 3,701.94 3,550.67

PAYMENTS ON NOTE: Transaction L Analysis Payment on computer for business Account Assets = Liabilities + Equity Interest expense Note payable Cash <188.29> <148.29> <40.00>

PAYMENTS ON NOTE: Journal Entry Payment on computer bought for business Account Debit Credit Interest expense Note payable Cash 40.00 148.29 188.29

NATURE OF BOND Formal certificate of long-term indebtedness Used to raise large amounts of cash Borrowed from large group unrelated investors

BOND TERMINOLOGY Face value Stated interest rate Amount issuer promises to repay Stated interest rate Used to calculate cash interest payments Effective interest rate Market rate, yield Used to price bond

INSIGHT 13-2: Why Do Bonds Have 2 Interest Rates? Management sets stated interest rate as close to prevailing market rate as possible Market rate subject to change before bonds sold Insight: matter of timing

MEASURING BOND PRICE Case 1: Bonds issued at face value Stated interest rate = Market interest (yield) Case 2: Bonds issued at discount Stated interest rate < Market interest (yield) Case 3: Bonds issued at premium Stated interest rate > Market interest (yield)

USER FOCUS 13-1: Intuitive Explanation Discount, Premium Bond offers 10% interest Market offers 12% interest Solution: motivate buyer by offering discount Premium Bond offers 10% Market offers 8% Solution: buyers bid price up

10 YEAR BONDS ISSUED AT FACE VALUE Stated interest = Market interest = 10% PV $100,000 (i=5%; n=20) = 100,000*.37689 = $37,689 PVA $5,000 (i=5%; n=20) = 5,000*12.46221 = 62,311 $100,000

USER FOCUS 13-2: 10 YEAR BONDS ISSUED AT DISCOUNT Face value = $100,000 Stated interest = 10% Market interest (yield) = 12% PV $100,000 (i=6%; n=20) = 100,000*.311804 = $31,804 PVA $5,000 (i=5%; n=20) = 5,000* 11.46992 = 57,350 $88,530

INTEREST PAYMENT WITH DISCOUNT: Transaction Analysis 6/30 End first bond interest period Account Assets = Liabilities + Equity Interest expense Bond discount Cash <5,000> 311.80 <5,311.80>

INTEREST PAYMENT WITH DISCOUNT: Journal Entry 6/30 End first interest period Account Debit Credit Interest expense Bond discount Cash 5,311.80 311.80 5,000.00

FINANCIAL STATEMENT EFFECTS WITH DISCOUNT Long-term Debt 1/01/1 06/30/1 12/31/1 Bond payable Less: Discount Net book value $100,000 11,470 $88,530 11,158 $88,842 10,828 $89,172

USER FOCUS 13-3: 10 YEAR BONDS ISSUED AT PREMIUM Face value = $100,000 Stated interest = 10% Market interest (yield) = 8% PV $100,000 (i=5%; n=20) = 100,000*..45639 = $45,639 PVA $5,000 (i=5%; n=20) = 5,000*13.59033 = 67,952 $113,590

INTEREST PAYMENT WITH PREMIUM: Transaction Analysis 6/30 End first interest period Account Assets = Liabilities + Equity Interest expense Bond premium Cash <5,000> 311.80 <5,311.80>

INTEREST PAYMENT WITH DISCOUNT: Journal Entry 6/30 End first interest period Account Debit Credit Interest expense Bond discount Cash 5,311.80 311.80 5,000.00

FINANCIAL STATEMENT EFFECTS WITH PREMIUM Long-term Debt 1/01/1 06/30/1 12/31/1 Bond payable Less: Discount Net book value $100,000 13,590 $113,590 13,134 $113,134 12,659 $112,659

USER FOCUS 13-4: Discount/Premium & Bond Profitability Market rate governs bond’s profitability If stated interest rate < market rate Bond sells at discount If stated interest rate > market rate (yield) Bond sells at premium

MEASURING CAPITAL CONTRIBUTIONS Capital stock Par, stated value represents legal capital Does not represent market value Additional Paid-in-Capital Excess above par value paid on original sale

SALE COMMON STOCK: Transaction Analysis Issued 2,000 shares of $1 par value stock at $10 per share Account Assets = Liabilities + Equity Cash Common stock Additional PIC 20,000 2,000 18,000

SALE COMMON STOCK: Journal Entry Issued 2,000 shares of $1 par value stock at $10 per share Account Debit Credit Cash Common Stock Additional PIC 20,000 2,000 18,000

STOCK DIVIDENDS Stock dividend Distribution of stock Given to conserve cash Shifts portion of retained earnings into contributed capital No change total stockholders’ equity Recorded at Market value if < 20% Par value if > 20%

STOCK SPLITS Stock split Issues shares to present owners Proportional reduction in par value Generally followed by reduction in market price No change in contributed capital, retained earnings, total stockholders’ equity

TREASURY STOCK Corporations own shares repurchased to Provide shares for stock option plans Reduce outstanding shares; increase EPS Contract business operations Provide shares for acquisition of other companies Buy out ownership interest; protect from hostile takeover

ACQUIRING TREASURY STOCK: Transaction Analysis Repurchase 1,000 shares of own stock for $125 per share Account Assets = Liabilities + Equity Treasury stock Cash <125,000>

ACQUIRING TREASURY STOCK: Journal Entry Repurchase 1,000 shares own stock for $125 Account Debit Credit Treasury stock Cash 125,000