1. Long-term Liabilities
Bonds Payable, Notes Payable

2. Characteristics of long-term financial liabilities
Maturity beyond 1 year from the balance sheet date (or beyond the normal operating cycle, if longer than 1 year).
Contractual obligation
Requires cash or other financial assets when matures
Raise money for operating and investing activities
In liquidation, creditors are paid off before stockholders, making debit investments less risky than equity investments
Some debt is secured by a lien against specific company assets (for example, a mortgage) vs. debenture bonds that are not
Interest is tax deductible, dividends paid to owners are not
Enhance stockholder ratios with favorable financial leverage
Offered to public or privately

3. Basic accounting terms
Bond – debt instrument with periodic interest payments and repayment of principal at maturity
Borrower (corporation often) “issues” the bond to lender and receives cash
Bond certificate(face of bond)–-- face value or principal ($1000), annual interest rate (stated or face or nominal or contract rate), interest dates, maturity date
Bond indenture – contract being rights of bondholders
Debenture bonds – not secured by a specific asset, general creditors
Zero coupon bonds – interest accrues and is paid at maturity, sold below face value
Callable bonds – bond issuers have right to “call” the bonds -- repay specified principal and accrued interest and cancel bonds, after a certain date
Convertible bonds – creditors can become stockholders
Serial bonds --- issued at one time, some of face value or principal matures and is paid periodically in addition to interest

4. How is the issue price calculated for a Bonds Payable?
Issued at par or face value of bond if the market rate of interest = the stated rate
Issued below par or face value of bond at a discount – the market rate of interest is greater than the stated rate
Issued above par or face value of bond at a premium – the market rate of interest is less than the stated rate
N=# of periods (semi-annual payments with 10 years = 20 periods)
I% = market rate of interest (6% annual market/2 = 3% semi-annual)
PV = solve for issue price of bonds
PMT = principal times stated interest rate/2 if semi- annual)
FV = principal amount of loan
P/Y = # of payments per year (P/Y = 1)
C/Y = compounding per year (C/Y = 1)
PMT: END (timing is end of period – payment happens one period after problem begins
IF sold to underwriter for public issue, underwriter determines effective rate
Look at the market rate of interest

5. Amortization of discount or premium on bonds payable (debit interest expense & credit discount or debit premium & credit interest expense)
Straight-line method
Effective interest method
Total amount of discount/# of periods = discount amortization amount
Total amount of premium/# of periods= premium amortization amount
Interest expense is interest paid or accrued plus amortization of discount or less amortization of premium.
Interest expense is the same per period but the carrying value of the bonds change
Carrying value increases as amortize discount, decreases as amortize premium
Balance sheet and income statement are not consistent
Interest expense = carrying value of bond times the effective interest rate
Discount or premium amortization is the difference between interest expense and interest paid or accrued.
Interest expense increases as the carrying value of the bonds increases
Interest expense decreases as the carrying value of the bonds decreases
Balance sheet and income statement are consistent

6. Bonds issued between interest payment dates
Often bonds are issued after the authorization date between interest dates (finding investors, sold to underwriter, waiting on change in interest rates, etc.)
Investors purchasing the bonds between interest dates will normally pay the interest that is attributed from the last interest date to the date of issue.
When the next interest date comes, a normal 6 month check will be paid.
Example –$100,000 6% bonds are prepared to be issued at par on 1/1 but are not issued until 4/1, with interest dates of 1/1 and 7/1, the entries would be:
4/1 Cash…………………………………………………..… $101,500
bonds payable………………………………………………………………………...$100,000
interest expense (or interest payable)…………………………………………..$1500 (100,000 * .06 * 3/12)
7/1 Interest expense ………… …………………….3,000 (100,000*.06*6/12)
cash………………………………………………………………………………… $3,000
or 7/1 Interest expense ………… ……………………1,500 (100,000*.06*3/12)
Interest payable…………………………………

7. Bond Issue Costs
Issue costs (legal, accounting ,printing, registration fees) are capitalized
Amortized over life of bonds using straight-line depreciation
Debit “deferred bond issue costs” and credit “cash” as part of bond issue entry
Amortization entry: debit bond interest expense and credit deferred bond issue costs
“Deferred bond issue costs” are listed under “other assets” or “deferred charges” on the balance sheet

8. Retirement of bonds At maturity Before maturity
Principal paid off earlier than maturity
Interest paid through early retirement
Unamortized discount/premium closed out
Gain or loss – compare carrying value of bond with cash proceeds
Adjusts true cost of borrowing
Call provision – often a % above face value
purchase in open market or call
Why? –reduce total debt, refinancing, drop restrictive bond covenants, more flexible in future, don’t need money any more
Principal is paid off at maturity
Discount and premium have been fully amortized
No gain or loss
Market rate of interest when issued the true cost of borrowing

9. Bonds with Equity Characteristics
Bonds with detachable warrants
Convertible bonds
Reasons –increase equity at later date, make bonds marketable, limit costs with issuing stock, avoid drop in stock prices
US GAAP – no equity valuation at issue
Book value method – equity recorded at carrying value of convertible bonds at conversion with no gain or loss
Market value method – record stock issued at market value at time of conversion , take off bonds and unamortized discount/premium, which usually results in a loss
Conversion entry below:
Bonds payable…………………………….…..XX
Premium on BP………………………..…..…..XX (or credit discount)
Loss on conversion……………………..….…..XX
Common stock……………………………………………………………XX
Additional paid in capital from bond conversion…………….XX
Improved marketability
Result in lower interest rate/greater cash proceeds
Detachable warrants trade separately
US GAAP – need equity valuation at issue, so allocate proceeds between equity and debt based on relative market values at issuance.
Issue entry below:
Cash…………………..XX
Discount on BP… XX (or credit premium)
Bonds Payable…………….…………...…XX
Common stock warrants……..…..XX

10. Non-interest bearing Notes Payable
Notes payable issued for cash
Notes payable issued for property, goods or services
Cash proceeds = present value
Discount = face value of note less proceeds (future interest expense. Contra liability)
Use effective interest method
Cash…………………..…..XX
Discount on NP………XX
Notes Payable…………………..XX
Each accounting period recognize interest expense
Interest expense………XX
Discount on Notes Payable…XX
Value of asset received = present value
Use incremental borrowing rate of purchaser if value of note or asset unknown
Asset……………………..XX
Discount on NP……….XX
Notes payable……………..XX
Each accounting period recognize interest expense and depreciate
Interest expense……..XX
Discount on Notes Payable…….XX
Depreciation expense…..XX
Accumulated Depreciation ……XX