Chapter 15-1

Chapter 15-2 Chapter 15 Accounting Principles, Ninth Edition Long-Term Liabilities

Chapter Explain why bonds are issued Prepare the entries for the issuance of bonds and interest expense Describe the entries when bonds are redeemed or converted Describe the accounting for long-term notes payable Contrast the accounting for operating and capital leases Identify the methods for the presentation and analysis of long-term liabilities. Study Objectives

Chapter 15-4 Issuing bonds at face value Discount or premium Issuing bonds at a discount Issuing bonds at a premium Bonds Basics Bond Issues Bond Retirements Other Long- Term Liabilities Statement Presentation and Analysis Types of bonds Issuing procedures Trading Market value Redeeming bonds at maturity Redeeming bonds before maturity Converting bonds into common stock Long-term notes payable Lease liabilities PresentationAnalysis Long-Term Liabilities

Chapter 15-5 Bonds are a form of interest-bearing notes payable. Three advantages over common stock: Bond Basics SO 1 Explain why bonds are issued. 1. Stockholder control is not affected. 2. Tax savings result. 3. Earnings per share may be higher.

Chapter 15-6 Effects on earnings per share—stocks vs. bonds. Bond Basics SO 1 Explain why bonds are issued. Illustration 15-2

Chapter 15-7 The major disadvantages resulting from the use of bonds are: a.that interest is not tax deductible and the principal must be repaid. b.that the principal is tax deductible and interest must be paid. c.that neither interest nor principal is tax deductible. d.that interest must be paid and principal repaid. Question Bond Basics SO 1 Explain why bonds are issued.

Chapter 15-8 Types of Bonds Secured and Unsecured (debenture) bonds. Term and Serial bonds. Registered and Bearer (or coupon) bonds. Convertible and Callable bonds. Bond Basics SO 1 Explain why bonds are issued.

Chapter 15-9 Issuing Procedures Bond contract known as a bond indenture. Represents a promise to pay: (1) sum of money at designated maturity date, plus (2) periodic interest at a contractual (stated) rate on the maturity amount (face value). Paper certificate, typically a $1,000 face value. Interest payments usually made semiannually. Generally issued when the amount of capital needed is too large for one lender to supply. Bond Basics SO 1 Explain why bonds are issued.

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

Chapter Bond Trading Bonds traded on national securities exchanges. Newspapers and the financial press publish bond prices and trading activity daily. Bond Basics SO 1 Explain why bonds are issued. Read as: Outstanding 5.125%, $1,000 bonds that mature in Currently yield a 5.747% return. On this day, $33,965,000 of these bonds were traded. Closing price was % of face value, or $

Chapter Determining the Market Value of Bonds Market value is a function of the three factors that determine present value: 1.the dollar amounts to be received, 2.the length of time until the amounts are received, and 3.the market rate of interest. Bond Basics SO 1 Explain why bonds are issued. The features of a bond (callable, convertible, and so on) affect the market rate of the bond.

Chapter % 8% 10% Premium Face Value Discount Assume Contractual Rate of 8% Accounting for Bond Issues SO 2 Prepare the entries for the issuance of bonds and interest expense. Bonds Sold AtMarket Interest

Chapter SO 2 Prepare the entries for the issuance of bonds and interest expense. The rate of interest investors demand for loaning funds to a corporation is the: a.contractual interest rate. b.face value rate. c.market interest rate. d.stated interest rate. Question Accounting for Bond Issues

Chapter SO 2 Prepare the entries for the issuance of bonds and interest expense. Karson Inc. issues 10-year bonds with a maturity value of $200,000. If the bonds are issued at a premium, this indicates that: a.the contractual interest rate exceeds the market interest rate. b.the market interest rate exceeds the contractual interest rate. c.the contractual interest rate and the market interest rate are the same. d.no relationship exists between the two rates. Question Accounting for Bond Issues

Chapter 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. Issuing Bonds at Face Value SO 2 Prepare the entries for the issuance of bonds and interest expense. Jan. 1Cash 100,000 Bonds payable100,000 Dec. 31Interest expense8,000 Cash8,000

Chapter Illustration: On January 1, 2010, San Marcos HS issues $100,000, three-year, 8% bonds for $95,027 (95.027% of face value). Issuing Bonds at a Discount SO 2 Prepare the entries for the issuance of bonds and interest expense. Jan. 1Cash 95,027 Discount on bonds payable4,973 Bonds payable100,000

Chapter Statement Presentation Issuing Bonds at a Discount SO 2 Prepare the entries for the issuance of bonds and interest expense.

Chapter SO 2 Prepare the entries for the issuance of bonds and interest expense. Discount on Bonds Payable: a.has a credit balance. b.is a contra account. c.is added to bonds payable on the balance sheet. d.increases over the term of the bonds. Question Issuing Bonds at a Discount

Chapter Illustration: On January 1, 2010, San Marcos HS issues $100,000, three-year, 8% bonds for $105,346 ( % of face value). Issuing Bonds at a Premium SO 2 Prepare the entries for the issuance of bonds and interest expense. Jan. 1Cash 105,346 Premium on bonds payable5,346 Bonds payable100,000

Chapter Statement Presentation Issuing Bonds at a Discount SO 2 Prepare the entries for the issuance of bonds and interest expense. Issuing bonds at an amount different from face value is quite common. 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 rate are the same.

Chapter Redeeming Bonds at Maturity Accounting for Bond Retirements SO 3 Describe the entries when bonds are redeemed or converted. San Marcos HS records the redemption of its bonds at maturity as follows: Bonds payable 100,000 Cash100,000

Chapter Redeeming Bonds before Maturity When a company retires bonds before maturity, it is necessary to: 1.eliminate the carrying value of the bonds at the redemption date; 2.record the cash paid; and 3.recognize the gain or loss on redemption. The carrying value of the bonds is the face value of the bonds less unamortized bond discount or plus unamortized bond premium at the redemption date. Accounting for Bond Retirements SO 3 Describe the entries when bonds are redeemed or converted.

Chapter SO 3 Describe the entries when bonds are redeemed or converted. When bonds are redeemed before maturity, the gain or loss on redemption is the difference between the cash paid and the: a.carrying value of the bonds. b.face value of the bonds. c.original selling price of the bonds. d.maturity value of the bonds. Question Accounting for Bond Retirements

Chapter Illustration: The San Marcos HS, 8% bonds of $100,000 issued on Jan. 1, 2010, are recalled at 105 on Dec. 31, Assume that the carrying value of the bonds at the redemption date is $98,183. Journal entry at Dec. 31, 2011: Bonds payable 100,000 Loss on bond redemption6,817 Cash ($100,000 x 105%) 105,000 Discount on bonds payable1,817 Accounting for Bond Retirements SO 3 Describe the entries when bonds are redeemed or converted.

Chapter Converting Bonds into Common Stock Until conversion, the bondholder receives interest on the bond. For the issuer, the bonds sell at a higher price and pay a lower rate of interest than comparable debt securities without the conversion option. Upon conversion, the company transfers the carrying value of the bonds to paid-in capital accounts. No gain or loss is recognized. Accounting for Bond Retirements SO 3 Describe the entries when bonds are redeemed or converted.

Chapter E15-6 Nocioni Company issued $1,000,000 of bonds on January 1, Instructions: Prepare the journal entry to record the conversion of the bonds into 30,000 shares of $10 par value common stock. Assume the bonds were issued at par. Bonds payable 1,000,000 Common stock (30,000 x $10)300,000 Paid-in capital in excess of par700,000 Accounting for Bond Retirements SO 3 Describe the entries when bonds are redeemed or converted.

Chapter When bonds are converted into common stock: a.a gain or loss is recognized. b.the carrying value of the bonds is transferred to paid-in capital accounts. c.the market price of the stock is considered in the entry. d.the market price of the bonds is transferred to paid-in capital. Question Accounting for Bond Retirements SO 3 Describe the entries when bonds are redeemed or converted.

Chapter 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 1.interest on the unpaid balance of the loan and 2.a reduction of loan principal. Companies initially record mortgage notes payable at face value. Accounting for Other Long-Term Liabilities SO 4 Describe the accounting for long-term notes payable.

Chapter Exercise: Tucki Co. receives $240,000 when it issues a $240,000, 10%, mortgage note payable to finance the construction of a building at December 31, The terms provide for semiannual installment payments of $16,000 on June 30 and December 31. Prepare the journal entries to record the mortgage loan and the first installment payment. Accounting for Other Long-Term Liabilities Dec. 31Cash 240,000 Mortgage notes payable240,000 Jun. 30Interest expense12,000 Mortgage notes payable4,000 Cash16,000 * ($240,000 x 10% x 6/12 = $12,000) SO 4 Describe the accounting for long-term notes payable. *

Chapter Each payment on a mortgage note payable consists of: a.interest on the original balance of the loan. b.reduction of loan principal only. c.interest on the original balance of the loan and reduction of loan principal. d.interest on the unpaid balance of the loan and reduction of loan principal. Question Accounting for Other Long-Term Liabilities SO 4 Describe the accounting for long-term notes payable.

Chapter 15-32

Chapter Lease Liabilities A lease is a contractual arrangement between a lessor (owner of the property) and a lessee (renter of the property). Accounting for Other Long-Term Liabilities SO 5 Contrast the accounting for operating and capital leases. Illustration 15-13

Chapter Operating Lease Capital Lease Journal Entry: Rent expense xxx Rent expense xxx Cash xxx Cash xxx Journal Entry: Leased equipment xxx Leased equipment xxx Lease liability xxx Lease liability xxx The issue of how to report leases is the case of. Although technically legal title may not pass, the benefits from the use of the property do. The issue of how to report leases is the case of substance versus form. Although technically legal title may not pass, the benefits from the use of the property do. Statement of Financial Accounting Standard No. 13, “Accounting for Leases,” 1976 A lease that transfers substantially all of the benefits and risks of property ownership should be capitalized (only noncancellable leases may be capitalized). Accounting for Other Long-Term Liabilities SO 5 Contrast the accounting for operating and capital leases.

Chapter To capitalize a lease, one or more of four criteria must be met: 1. Transfers ownership to the lessee. 2. Contains a bargain purchase option. 3. Lease term is equal to or greater than 75 percent of the estimated economic life of the leased property. 4. The present value of the minimum lease payments (excluding executory costs) equals or exceeds 90 percent of the fair value of the leased property. Accounting for Other Long-Term Liabilities SO 5 Contrast the accounting for operating and capital leases.

Chapter Exercise: On January 1, 2010, Burke Corporation signed a 5-year noncancelable lease for a machine. The machine has an estimated useful life of 6 years and the present value of the lease payments is $36,144, which is equal to the fair market value of the equipment. There is no transfer of ownership during the lease term, nor is there any bargain purchase option. Instructions: (a) What type of lease is this? Explain. (b) Prepare the journal entry to record the lease on January 1, SO 5 Contrast the accounting for operating and capital leases. Accounting for Other Long-Term Liabilities

Chapter Exercise: (a) What type of lease is this? Explain. Capitalization Criteria: 1. Transfer of ownership 2. Bargain purchase option 3. Lease term => 75% of economic life of leased property 4. Present value of minimum lease payments => 90% of FMV of property NO NO Lease term 5 yrs. Economic life6 yrs. YES 83.3% YES - PV and FMV are the same. Capital Lease? SO 5 Contrast the accounting for operating and capital leases. Accounting for Other Long-Term Liabilities

Chapter Exercise: (b) Prepare the journal entry to record the lease on January 1, Jan. 1 Leased asset - equipment 36,144 Lease liability36,144 SO 5 Contrast the accounting for operating and capital leases. Accounting for Other Long-Term Liabilities The portion of the lease liability expected to be paid in the next year is a current liability. The remainder is classified as a long-term liability.

Chapter The lessee must record a lease as an asset if the lease: a.transfers ownership of the property to the lessor. b.contains any purchase option. c.term is 75% or more of the useful life of the leased property. d.payments equal or exceed 90% of the fair market value of the leased property. Question Accounting for Other Long-Term Liabilities SO 5 Contrast the accounting for operating and capital leases.

Chapter Presentation SO 6 Identify the methods for the presentation and analysis of long-term liabilities. Statement Analysis and Presentation Illustration 15-14

Chapter Analysis of Long-Term Debt Two ratios that provide information about debt- paying ability and long-run solvency are: Total debt Total assets Debt to total assets = The higher the percentage of debt to total assets, the greater the risk that the company may be unable to meet its maturing obligations. 1. SO 6 Identify the methods for the presentation and analysis of long-term liabilities. Statement Analysis and Presentation

Chapter Analysis of Long-Term Debt Two ratios that provide information about debt- paying ability and long-run solvency are: Income before income taxes and interest expense Interest expense Times interest earned = Indicates the company’s ability to meet interest payments as they come due. 2. SO 6 Identify the methods for the presentation and analysis of long-term liabilities. Statement Analysis and Presentation

Chapter 15-43

Chapter To illustrate present value concepts, assume that you are willing to invest a sum of money that will yield $1,000 at the end of one year, and you can earn 10% on your money. What is the $1,000 worth today? To compute the answer, divide the future amount by 1 plus the interest rate ($1,000/1.10 = $ OR use a Present Value of 1 table. ($1,000 X.90909) = $ (10% per period, one period from now). SO 7 Compute the market price of a bond. Present Value Concepts Related to Bond Pricing Appendix 15A Present Value of Face Value

Chapter To compute the answer, divide the future amount by 1 plus the interest rate ($1,000/1.10 = $ Present Value Concepts Related to Bond Pricing Present Value of Face Value Illustration 15A-1 SO 7 Compute the market price of a bond.

Chapter To compute the answer, use a Present Value of 1 table. ($1,000 X.90909) = $ (10% per period, one period from now). Present Value Concepts Related to Bond Pricing Present Value of Face Value SO 7 Compute the market price of a bond.

Chapter The future amount ($1,000), the interest rate (10%), and the number of periods (1) are known Present Value Concepts Related to Bond Pricing Present Value of Face Value SO 7 Compute the market price of a bond. Illustration 15A-2

Chapter If you are to receive the single future amount of $1,000 in two years, discounted at 10%, its present value is $ [($1, ) 1.10]. Present Value Concepts Related to Bond Pricing Present Value of Face Value SO 7 Compute the market price of a bond. Illustration 15A-3

Chapter To compute the answer using a Present Value of 1 table. ($1,000 X.82645) = $ (10% per period, two periods from now). Present Value Concepts Related to Bond Pricing Present Value of Face Value SO 7 Compute the market price of a bond.

Chapter In addition to receiving the face value of a bond at maturity, an investor also receives periodic interest payments (annuities) over the life of the bonds. To compute the present value of an annuity, we need to know: 1)interest rate, 2)number of interest periods, and 3)amount of the periodic receipts or payments. SO 7 Compute the market price of a bond. Present Value Concepts Related to Bond Pricing Present Value of Interest Payments (Annuities)

Chapter Assume that you will receive $1,000 cash annually for three years and the interest rate is 10%. SO 7 Compute the market price of a bond. Present Value Concepts Related to Bond Pricing Present Value of Interest Payments (Annuities) Illustration 15A-5

Chapter Assume that you will receive $1,000 cash annually for three years and the interest rate is 10%. SO 7 Compute the market price of a bond. Present Value Concepts Related to Bond Pricing Present Value of Interest Payments (Annuities) Illustration 15A-6

Chapter Assume that you will receive $1,000 cash annually for three years and the interest rate is 10%. SO 7 Compute the market price of a bond. Present Value Concepts Related to Bond Pricing Present Value of Interest Payments (Annuities) $1,000 annual payment x = $2,486.85

Chapter SO 7 Compute the market price of a bond. Present Value Concepts Related to Bond Pricing Computing the Present Value of a Bond The selling price of a bond is equal to the sum of: 1)The present value of the face value of the bond discounted at the investor’s required rate of return PLUS 2)The present value of the periodic interest payments discounted at the investor’s required rate of return

Chapter Assume a bond issue of 10%, five-year bonds with a face value of $100,000 with interest payable semiannually on January 1 and July 1. Illustration 15A-8 SO 7 Compute the market price of a bond. Present Value Concepts Related to Bond Pricing

Chapter Assume a bond issue of 10%, five-year bonds with a face value of $100,000 with interest payable semiannually on January 1 and July 1. Illustration 15A-9 SO 7 Compute the market price of a bond. Present Value Concepts Related to Bond Pricing Contractual Rate = Discount Rate Issued at Face Value

Chapter Assume a bond issue of 10%, five-year bonds with a face value of $100,000 with interest payable semiannually on January 1 and July 1. Illustration 15A-10 SO 7 Compute the market price of a bond. Present Value Concepts Related to Bond Pricing Contractual Rate < Discount Rate Issued at a Discount

Chapter Assume a bond issue of 10%, five-year bonds with a face value of $100,000 with interest payable semiannually on January 1 and July 1. Illustration 15A-11 SO 7 Compute the market price of a bond. Present Value Concepts Related to Bond Pricing Contractual Rate > Discount Rate Issued at a Premium

Chapter Under the effective-interest method, the amortization of bond discount or bond premium results in period interest expense equal to a constant percentage of the carrying value of the bonds. Required steps: SO 8 Apply the effective-interest method of amortizing bond discount and bond premium. 1.Compute the bond interest expense. 2.Compute the bond interest paid or accrued. 3.Compute the amortization amount. Effective-Interest Method of Bond Amortization Appendix 15B

Chapter Assume Candlestick, Inc. issues $100,000 of 10%, five-year bonds on January 1, 2010, for $92,639, with interest payable each July 1 and January 1. This results in a discount of $7,361. Illustration 15B-2 Amortizing Bond Discount Effective-Interest Method of Bond Amortization SO 8 Apply the effective-interest method of amortizing bond discount and bond premium.

Chapter Assume Candlestick, Inc. issues $100,000 of 10%, five-year bonds on January 1, 2010, for $92,639, with interest payable each July 1 and January 1. This results in a discount of $7,361. Journal entry on July 1, 2010, to record the interest payment and amortization of discount is as follows: Effective-Interest Method of Bond Amortization SO 8 Apply the effective-interest method of amortizing bond discount and bond premium. Interest Expense 5,558 Cash5,000 Discount on Bonds Payable 558 July 1 Amortizing Bond Discount

Chapter Illustration 15B-4 Effective-Interest Method of Bond Amortization SO 8 Apply the effective-interest method of amortizing bond discount and bond premium. Amortizing Bond Premium Assume Candlestick, Inc. issues $100,000 of 10%, five-year bonds on January 1, 2010, for $108,111, with interest payable each July 1 and January 1. This results in a premium of $8,111.

Chapter Effective-Interest Method of Bond Amortization SO 8 Apply the effective-interest method of amortizing bond discount and bond premium. Interest Expense 4,324 Cash5,000 Premium on Bonds Payable 676 July 1 Amortizing Bond Premium Assume Candlestick, Inc. issues $100,000 of 10%, five-year bonds on January 1, 2010, for $108,111, with interest payable each July 1 and January 1. This results in a premium of $8,111. Journal entry on July 1, 2010, to record the interest payment and amortization of premium is as follows:

Chapter Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2010, for $92,639 (discount of $7,361). Interest is payable on July 1 and January 1. The bond discount amortization for each interest period is $736 ($7,361/10). Illustration 15C-2 Amortizing Bond Discount Straight-Line Amortization SO 9 Apply the straight-line method of amortizing bond discount and bond premium. Appendix 15C

Chapter Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2010, for $92,639 (discount of $7,361). Interest is payable on July 1 and January 1. The bond discount amortization for each interest period is $736 ($7,361/10). Journal entry on July 1, 2010, to record the interest payment and amortization of discount is as follows: Interest Expense 5,736 Cash5,000 Discount on Bonds Payable 736 July 1 Amortizing Bond Discount Straight-Line Amortization SO 9 Apply the straight-line method of amortizing bond discount and bond premium.

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