Learning Objectives Understand the Business – LO1 Explain the role of liabilities in financing a business. Study the accounting methods – LO2 Explain how to account for common types of current liabilities. – LO3 Analyze and record bond liability transactions. – LO4 Describe how to account for contingent liabilities. Evaluate the results – LO5 Calculate and interpret the quick ratio and the times interest earned ratio. Review the chapter 1© McGraw-Hill Ryerson. All rights reserved.

Long-Term Liabilities Bonds are financial instruments that outline the future payments a company promises to make in exchange for receiving a sum of money now. © McGraw-Hill Ryerson. All rights reserved.2 Bonds Maturity Date The date on which a bond is due to be paid in full. Face Value The amount payable on a bond’s maturity date. Stated Interest Rate The rate stated on the face of the bond, which is used to compute interest payments. LO3

© McGraw-Hill Ryerson. All rights reserved.3 Bond Pricing Present Value is a mathematical calculation to determine how much future payments are worth today. Issue Price is the amount of money the company receives when a bond is issued. The amount may be equal to face value ($1,000), or the amount may be higher or lower than face value. LO3

© McGraw-Hill Ryerson. All rights reserved.4 Accounting for a Bond Issue Bonds Issued at Face Value General Mills receives $100,000 cash in exchange for issuing 100 bonds at their $1,000 face value. 1 Analyze 2 Record LO3

© McGraw-Hill Ryerson. All rights reserved.5 Bonds Issued at a Premium A Premium is the amount by which a bond’s issue price exceeds its face value. General Mills receives $107,260 cash in exchange for issuing 100 bonds at their $1,000 face value. The bond price is $100,000 is the face value and $7,260 is a premium. 1 Analyze 2 Record LO3

© McGraw-Hill Ryerson. All rights reserved.6 Bonds Issued at a Discount A Discount is the amount by which a bond’s issue price is less than its face value. General Mills receives $93,376 cash in exchange for issuing 100 bonds at their $1,000 face value. The bond price is $100,000 is the face value and $6,624 is a discount. 1 Analyze 2 Record Discount on Bonds Payable is a contra-liability. LO3

© McGraw-Hill Ryerson. All rights reserved.7 Relationships between Interest Rates and Bond Pricing 6% Stated Interest Rate on Bond 8% Market Interest Rate 6% Market Interest Rate 4% Market Interest Rate Investors will pay less than face value Investors will pay face value Investors will pay more than face value Bond Issued at a Discount Bond Issued at Face Value Bond Issued at a Premium Market Interest Rate is the rate that investors demand from a bond. Balance Sheet Reporting of Bond Liabilities LO3

© McGraw-Hill Ryerson. All rights reserved.8 Interest Expense Interest on Bonds Issued at Face Value General Mills issued $100,000 6% bonds January 2, After one month, on January 31, 2012, interest expense will be $100,000 x 6% x 1/12 = $500 1 Analyze 2 Record LO3

© McGraw-Hill Ryerson. All rights reserved.9 Interest on Bonds Issued at a Premium General Mills issued $100,000 6% bonds January 2, 2012 and received $107,260. General Mills received $107,260, but must pay back only $100,000 at maturity. The premium, $7,260, is a reduction in the cost of borrowing. Bond Amortization will reduce the interest expense. Bond Amortization is explained in the Supplements at the end of this chapter. LO3

© McGraw-Hill Ryerson. All rights reserved.10 Interest on Bonds Issued at a Discount General Mills issued $100,000 6% bonds January 2, 2012 and received $93,376. General Mills received $93,376, but must pay back only $100,000 at maturity. The discount, $6,624, is an increase in the cost of borrowing. Bond Amortization will increase the interest expense. Bond Amortization is explained in the Supplements at the end of this chapter. LO3

© McGraw-Hill Ryerson. All rights reserved.11 Bond Retirements Retirement at Maturity Most bonds are retired (paid off) at maturity. General Mills pays $100,000 cash to retire bonds at maturity. LO3 1 Analyze 2 Record

© McGraw-Hill Ryerson. All rights reserved.12 Early Retirement Bonds may be retired early, sometimes to reduce future interest expense, especially if interest rates have fallen. LO3 If bonds are retired early, a gain will arise if the cash paid to retire the bonds is less than the carrying value; a loss will arise if the cash paid is more than the carrying value. General Mills pays $103,000 cash to retire bonds early. 1 Analyze 2 Record