1. Long-Term Liabilities
Chapter 14
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Learning Objectives
Journalize transactions for long-term notes payable and mortgages payable
Describe bonds payable
Journalize transactions for bonds payable and interest expense using the straight-line amortization method
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Learning Objectives
Journalize transactions to retire bonds payable
Report liabilities on the balance sheet
Use the debt to equity ratio to evaluate business performance
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Learning Objectives
Use time value of money to compute the present value of future amounts (Appendix 14A)
Journalize transactions for bonds payable and interest expense using the effective-interest amortization method (Appendix 14B)
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Learning Objective 1
Journalize transactions for long-term notes payable and mortgages payable
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6. Long-Term Notes Payable
Notes are recorded at the amount borrowed.
Interest is not recorded until the end of the period.
Interest accruals are part of the adjusting process.
Notes that do not need to be paid within one year or one operating cycle, whichever is longer.
The portion due in the current year is reclassified as a current liability.
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7. Long-Term Notes Payable
On December 31, 2014, Smart Touch Learning signed a $20,000 note payable. It is due in 4 annual payments of $5,000 plus 6% interest each December 31.
Prepare the journal entry to record Smart Touch Learning’s note payable.
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8. Long-Term Notes Payable
On December 31, 2014, Smart Touch Learning signed a $20,000 note payable. It is due in 4 annual payments of $5,000 plus 6% interest each December 31.
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9. Notes Payable Interest
Interest on Notes Payable is computed as:
The beginning balance will decline each period by the amount of the principal payment.
Interest rates are always expressed as the rate for a whole year.
This is the portion of a year that the interest period covers.
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10. Notes Payable Interest
On December 31, 2014, Smart Touch Learning signed a $20,000 note payable. It is due in 4 annual payments of $5,000 plus 6% interest each December 31. Compute interest for 2015.
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11. Notes Payable Interest
On December 31, 2014, Smart Touch Learning signed a $20,000 note payable. It is due in 4 annual payments of $5,000 plus 6% interest each December 31. Compute interest for 2015.
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12. Interest Amortization
When a loan is taken out, an amortization schedule is prepared showing payments and interest over the term of the loan.
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13. Record the payment at December 31, 2015.
Recording Interest
Record the payment at December 31, 2015.
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14. Record the payment at December 31, 2015.
Recording Interest
Record the payment at December 31, 2015.
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15. Journalize the issuance of the note on January 1, 2014.
>TRY IT!
On January 1, 2014, Fox Corporation signed an $80,000, four-year, 4% note. The loan required Fox to make payments annually on December 31 of $20,000 principal plus interest.
Journalize the issuance of the note on January 1, 2014.
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>TRY IT!
On January 1, 2014, Fox Corporation signed an $80,000, four-year, 4% note. The loan required Fox to make payments annually on December 31 of $20,000 principal plus interest.
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17. Journalize the first payment on December 31, 2014.
>TRY IT!
On January 1, 2014, Fox Corporation signed an $80,000, four-year, 4% note. The loan required Fox to make payments annually on December 31 of $20,000 principal plus interest.
Journalize the first payment on December 31, 2014.
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>TRY IT!
On January 1, 2014, Fox Corporation signed an $80,000, four-year, 4% note. The loan required Fox to make payments annually on December 31 of $20,000 principal plus interest.
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19. Describe bonds payable
Learning Objective 2
Describe bonds payable
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Bonds
TERMINOLOGY:
Face value
Interest rate
Issue date
Maturity date
Payment terms
Long-term debt issued to multiple lenders.
Usually in $1,000 increments.
Each bondholder gets a bond certificate.
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22. Debentures (Unsecured Bonds)
Types of Bonds
Term Bond
The bond principal is due in full at a single maturity date.
Secured Bonds
Backed by specific assets that have been pledged as collateral.
Debentures (Unsecured Bonds)
No collateral.
Serial Bond
The bond principal is repaid in installments over the maturity period.
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Bond Prices
Bond Issued at:
Face value: stated rate = market rate
Discount: stated rate < market rate
Premium: stated rate > market rate
The face value of the bond defines how much principal will be paid at maturity.
The bond selling price on the issue date will depend on:
The stated interest rate on the bond, and
The market rate of interest of similar bonds on the date of issue.
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Bond Prices
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25. >TRY IT!
Determine whether the following bonds payable will be issued at face value, at a premium, or at a discount.
A 10% bonds payable is issued when the market interest rate = 8%.
A 10% bonds payable is issued when the market interest rate = 10%.
A 10% bonds payable is issued when the market interest rate = 12%.
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26. >TRY IT!
Determine whether the following bonds payable will be issued at face value, at a premium, or at a discount.
PREMIUM
A 10% bonds payable is issued when the market interest rate = 10%.
A 10% bonds payable is issued when the market interest rate = 12%.
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27. A 10% bonds payable is issued when the market interest rate = 12%.
>TRY IT!
Determine whether the following bonds payable will be issued at face value, at a premium, or at a discount.
PREMIUM
FACE VALUE
A 10% bonds payable is issued when the market interest rate = 12%.
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>TRY IT!
Determine whether the following bonds payable will be issued at face value, at a premium, or at a discount.
PREMIUM
FACE VALUE
DISCOUNT
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Learning Objective 3
Journalize transactions for bonds payable and interest expense using the straight-line amortization method
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30. Recording Bonds Payable at Face Value
Smart Touch Learning has $100,000 of 9% bonds payable that mature in five years. The company issues the bonds on January 1, 2014 when the market rate is 9%.
Journalize the issuance of the bonds on January 1, 2014.
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31. Recording Bonds Payable at Face Value
Smart Touch Learning has $100,000 of 9% bonds payable that mature in five years. The company issues the bonds on January 1, 2014 when the market rate is 9%.
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32. Recording Bonds Issued at a Discount
Interest Expense each period will be the sum of the computed interest payment + the amortized portion of the discount.
When the bond interest rate < the market rate, the bonds are issued at a discount.
The difference between the bonds payable and the cash received is recorded as a Bond Discount (a contra-liability)
The discount is amortized over the life of the bond.
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33. Recording Bonds Issued at a Discount
Smart Touch Learning issues $100,000 of 9%, 5-year bonds that pay interest semiannually. The market rate of interest is 10%. Smart Touch Learning actually receives $96,149, and records a discount of $3,851.
Journalize the issuance of the bonds on January 1, 2014.
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34. Recording Bonds Issued at a Discount
Smart Touch Learning issues $100,000 of 9%, 5-year bonds that pay interest semiannually. The market rate of interest is 10%. Smart Touch Learning actually receives $96,149, and records a discount of $3,851.
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35. Straight-Line Amortization of the Discount
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36. Straight-Line Amortization of the Discount
Using the discount amortization table, record Smart Touch Learning’s first interest payment on June 30, 2014.
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37. Straight-Line Amortization of the Discount
Using the discount amortization table, record Smart Touch Learning’s first interest payment on June 30, 2014.
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38. Journalize transactions to retire bonds payable
Learning Objective 4
Journalize transactions to retire bonds payable
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39. Retirement at Maturity
Smart Touch Learning has $100,000 of 9% bonds that mature on December 31, (Note that all interest has already been paid and the discount is fully amortized.)
Record the retirement of the bonds at December 31, 2018.
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40. Retirement at Maturity
Smart Touch Learning has $100,000 of 9% bonds that mature on December 31, (Note that all interest has already been paid and the discount is fully amortized.)
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41. Retirement Before Maturity
The full Bonds Payable will be retired.
The cash paid will not equal the face value.
The remaining discount or premium will be removed.
The difference will be recorded as either a
Gain on Retirement of Bonds
Loss on Retirement of Bonds
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42. Retirement Before Maturity
On December 31, 2014, Smart Touch Learning decides to retire its bonds by paying $95,000, after only two interest payments. The table indicates that the discount balance is now $3,081.
Record the early retirement of the bonds at December 31, 2014.
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43. Retirement Before Maturity
On December 31, 2014, Smart Touch Learning decides to retire its bonds by paying $95,000, after only two interest payments. The table indicates that the discount balance is now $3,081.
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44. Record the bond retirement and include the correct date.
>TRY IT!
Herrera Corporation issued a $400,000, 4.5%, 10-year bond payable on January 1, Journalize the retirement of the bond payable at maturity.
Record the bond retirement and include the correct date.
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>TRY IT!
Smart Touch Learning issued a $400,000, 4.5%, 10-year bond payable on January 1, Journalize the retirement of the bond payable at maturity.
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46. Report liabilities on the balance sheet
Learning Objective 5
Report liabilities on the balance sheet
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47. Reporting Liabilities
Liabilities are grouped on the Balance Sheet as either Current or Long-Term.
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48. Use the debt to equity ratio to evaluate business performance
Learning Objective 6
Use the debt to equity ratio to evaluate business performance
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Debt to Equity Ratio
Shows the proportion of total liabilities to total equity.
A measure of “financial leverage.”
A ratio > 1, the company is financing more assets with debt than with equity.
The higher the ratio, the more financial risk the company has.
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Debt to Equity Ratio
The information below is from the 2011 Annual Report for Green Mountain Coffee Roasters, Inc. Calculate the Debt to Equity Ratio for 2011.
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Debt to Equity Ratio
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52. Compute the Debt to Equity Ratio for Payne Corporation for 2014.
>TRY IT!
Compute the Debt to Equity Ratio for Payne Corporation for 2014.
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53. Compute the Debt to Equity Ratio for Payne Corporation for 2014.
>TRY IT!
Compute the Debt to Equity Ratio for Payne Corporation for 2014.
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54. ©2014 Pearson Education, Inc. Publishing as Prentice Hall
Learning Objective 7
Use time value of money to compute the present value of future amounts (Appendix 14A)
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Time Value of Money
Sometimes, we need to know how much an amount of money will grow if interest is applied for several years.
A mathematical formula will allow us to make the calculation:
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Time Value of Money
If we invest $10,000 today at 6% interest and leave it for 5 years, how much will we have at the end of the period?
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Time Value of Money
If we invest $10,000 today at 6% interest and leave it for 5 years, how much will we have at the end of the period?
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58. Present Value of a Lump Sum
The formula can also be worked backward to determine today’s value of a future amount.
Simply use the inverse of the future value multiplier.
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59. Present Value of a Lump Sum
At 6% interest, how much would we need to invest today in order to have $13,382 in 5 years?
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60. Present Value of a Lump Sum
At 6% interest, how much would we need to invest today in order to have $13,382 in 5 years?
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61. Present Value of an Annuity
The total grows faster, if we also add a fixed amount each period to the original investment.
The present value of an annuity factor can be found in a table (see Appendix B in the text).
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62. Present Value of an Annuity
What is the present day equivalent of an annuity of $2,000 per year for 5 years at 6%?
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63. Present Value of an Annuity
What is the present day equivalent of an annuity of $2,000 per year for 5 years at 6%?
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Pricing Bonds Payable
We can use the Present Value of a Lump Sum (PV) and the Present Value of an Annuity (PVA) concepts to determine the selling price of a bond.
Bonds sell at the present value of all of the related cash flows:
The periodic interest payments.
The payout of principal at the end of the bond term.
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Pricing Bonds Payable
Smart Touch Learning issues $100,000 of 5-year, 9% bonds that pay interest semi-annually. The market interest rate is 10%.
Maturity Payment = $100,000
Periodic Interest = $4,500
Interest rate = 5% (10% semiannually)
Number of periods = 10 (payments twice a year for 5 years)
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66. Step 1: Present Value of the Principal
This will be added to the present value of the interest payments.
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67. Step 2: Present Value of the Interest Payments
This will be added to the present value of the principal.
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68. Step 3: Present Value of the Bond Payable
This bond payable will sell at a discount of $3,851.
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Learning Objective 8
Journalize transactions for bonds payable and interest expense using the effective-interest amortization method (Appendix 14B)
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70. Effective Interest Method for Interest Amortization
Earlier we used a straight-line approach for amortizing the discount and determining interest expense.
The “effective interest method” computes interest expense based on the carrying amount of the bond, and “backs into” the discount amortization each period.
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71. Effective Interest Method for Interest Amortization
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72. Effective Interest Method for Interest Amortization
Using the discount amortization table, record Smart Touch Learning’s first interest payment on June 30, 2014.
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73. Effective Interest Method for Interest Amortization
Using the discount amortization table, record Smart Touch Learning’s first interest payment on June 30, 2014.
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End of Chapter 14
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