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

Long-Term Liabilities Bonds Basics Accounting for Bond Issues Accounting for Bond Retirements Accounting for Other Long-Term Liabilities Statement Presentation and Analysis Types of bonds Issuing procedures Trading Market value Issuing bonds at face value Discount or premium Issuing bonds at a discount Issuing bonds at a premium Redeeming bonds at maturity Redeeming bonds before maturity Converting bonds into common stock Long-term notes payable Lease liabilities Presentation Analysis Service Cost - Actuaries compute service cost as the present value of the new benefits earned by employees during the year. Future salary levels considered in calculation. Interest on Liability - Interest accrues each year on the PBO just as it does on any discounted debt. Actual Return on Plan Assets - Increase in pension funds from interest, dividends, and realized and unrealized changes in the fair market value of the plan assets. Amortization of Unrecognized Prior Service Cost - The cost of providing retroactive benefits is allocated to pension expense in the future, specifically to the remaining service-years of the affected employees. Gain or Loss - Volatility in pension expense can be caused by sudden and large changes in the market value of plan assets and by changes in the projected benefit obligation. Two items comprise the gain or loss: difference between the actual return and the expected return on plan assets and, amortization of the unrecognized net gain or loss from previous periods

Bond Basics Bonds are: interest-bearing notes payable issued by corporations, universities, and governmental agencies like common stock, can be sold in small denominations (usually a thousand dollars) attract many investors LO 1 Explain why bonds are issued.

2)Principal (face value) must be repaid at maturity 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: Stockholder control is not affected. Tax savings result. Earnings per share may be higher. Two disadvantages over common stock: 1)Interest must be paid on a periodic basis 2)Principal (face value) must be repaid at maturity LO 1 Explain why bonds are issued.

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

Types of Bonds: Secured and Unsecured Secured Bonds: also called debenture bonds are issued against the general credit of the barrower. Unsecured Bonds: have specific assets of the issuer pledged as collateral for the bonds Ex. Mortgage

Types of Bonds: Term and Serial Bonds 3) Term bonds - bonds that mature at a single specified future date 4) Serial bonds - bonds that mature in installments

Types of Bonds Convertible and Callable convert the bonds into common stock at holder’s option Callable subject to call and retirement at a stated dollar amount prior to maturity at the option of the issuer

Bond Basics Issuing Procedures Bond contract is 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 has a $1,000 face value. Interest payments are 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.

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

Bond Basics - Determining the Market Value of Bonds Market value is a function of the three factors that determine present value: the dollar amounts to be received, the length of time until the amounts are received, the market rate of interest. The features of a bond (callable, convertible, etc) affect the market rate of the bond. 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. LO 1 Explain why bonds are issued.

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 Cash 100,000 Bonds payable 100,000 Dec. 31 Interest expense 8,000 Cash 8,000 Companies classify bond interest payable as a current liability. LO 2 Prepare the entries for the issuance of bonds and interest expense.

The Real World 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? 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 (face) rate are the same.

Accounting for Bond Issues Assume Contractual (Face) Rate of 8% $1,000 Face Value Bonds Sold At… Market Interest 6% Premium 8% Face Value 10% Discount LO 2 Prepare the entries for the issuance of bonds and interest expense.

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 Cash 95,027 Discount on bonds payable 4,973 Bonds payable 100,000 Although discount on bonds payable has a debt balance, it is not an asset. LO 2 Prepare the entries for the issuance of bonds and interest expense.

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 Cash 105,346 Premium on bonds payable 5,346 Bonds payable 100,000 LO 2 Prepare the entries for the issuance of bonds and interest expense.

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.

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