1. Chapter 10, Slide #1 Using Financial Accounting Information: The Alternative to Debits and Credits Fifth Edition Gary A. Porter and Curtis L. Norton Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

2. Chapter 10, Slide #2 Balance Sheet Classifications Current liabilities: Long-term liabilities: Due within one year of the balance sheet date Due beyond one year LO1

3. Chapter 10, Slide #3 Long-Term Liabilities  Bonds payable  Notes payable  Leases  Deferred taxes  Pensions  Postretirement benefits

4. Chapter 10, Slide #4 Interest for Investor Borrower Bonds $10,000, 9% bond due 2019  Long-term borrowing arrangement  Interest paid at stated rate and times  Principal repaid at maturity date 1,000 Investor Borrower LO2

5. Chapter 10, Slide #5 Bond Features Collateralized backed by specific assets in event of default Debentures backed only by general creditworthiness of issuer

6. Chapter 10, Slide #6 Bond Features Term entire principal due on a specific single date Serial principal repaid in installments over time

7. Chapter 10, Slide #7 Bond Features Convertible into common stock Callable / Redeemable may be retired before maturity date

8. Chapter 10, Slide #8 Bonds Sold at Face Value Balance Sheet Income Statement Assets = Liabilities + Stockholders’+ Revenues - Expenses Equity Cash= Bonds Payable 10,000 To record the issuance of bonds at face value. Face value of bonds = Sales price

9. Chapter 10, Slide #9 Bond Interest Rates Face rate the rate specified on the bond certificate Market rate the rate that investors could obtain by investing in other bonds similar to the issuing firm’s bonds Paycheck for Date Dept.. of Treasurer Jane Doe LO3

10. Chapter 10, Slide #10 Two sets of cash flows PV = ? Calculating Bond Prices $$ ( 2 ) Principal due at maturity PV = ? $$$$$ ( 1 ) Interest payments made each period etc. $$

11. Chapter 10, Slide #11 Determining Bond Prices On 1/1/07, Discount Firm issues:  $10,000, 8% bonds  Due December 31, 2010  Interest payable annually  Market rate of interest = 10% Calculate the issue price of the bonds. Example:

12. PV = ? Calculating Bond Prices $800 ( 1 ) Interest payments (4 payments @ $800) 2007 200820092010 $800 Interest is always paid at rate stated on bonds ($10,000 @ 8%) $800

13. Calculating Bond Prices ( 2 ) Principal of $10,000 due at end of 2010 2010 PV = ? $10,000 ( 1 ) Interest payments (4 payments @ $800) PV = ? 2007 200820092010 $800

14. Chapter 10, Slide #14 Present value: Interest payments: $800 × 3.170 = $2,536 (PV; n = 4; i = 10%) Principal payment: $10,000 × 0.683 = 6,830 (PV; n = 4; i = 10%) Bond issue price: $9,366 Example of Price Calculation …but discount @ market rate Compute interest payment at stated rate (i.e., 8%)...

15. Chapter 10, Slide #15 Recording Bond Discounts Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Cash = Discount on Bonds Payable 9,366 (634) Bonds Payable 10,000 To record the issuance of bonds payable. LO4

16. Chapter 10, Slide #16 Balance Sheet Presentation of Bond Discount Long-term liabilities: Bonds payable $10,000 Less: Discount on bonds payable 634 $ 9,366

17. Chapter 10, Slide #17 Determining Bond Prices Assume Premium Firm sells the same $10,000, 8% bonds when the market rate on similar bonds is 6%.

18. Chapter 10, Slide #18 Present value: Interest payments: $800 × 3.465 = $ 2,772 (PV; n = 4; i = 6%) Principal payment: $10,000 × 0.792 = 7,920 (PV; n = 4; i = 6%) Bond issue price: $10,692 Example of Price Calculation …but discount @ market rate Compute interest payment at stated rate (i.e., 8%)...

19. Chapter 10, Slide #19 Recording Bond Premiums To record the issuance of bonds payable. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Cash = Bonds Payable 10,692 10,000 Premium on Bonds Payable 692

20. Chapter 10, Slide #20 Balance Sheet Presentation of Bond Premium Long-term liabilities: Bonds payable $10,000 Plus: Premium on bonds payable 692 $10,692

21. Chapter 10, Slide #21 Interest Rates and Bond Prices Above face value (at a premium) At face value Below face value (at a discount) = MARKET RATE BONDS ISSUED:IF STATED RATE: > MARKET RATE < MARKET RATE

22. Chapter 10, Slide #22 Amortization of Bond Premiums and Discounts Transferring an amount from the discount or premium account to interest expense over the life of the bond using the effective interest method Discount increases interest expense Premium reduces interest expense LO5

23. Amortization Schedule – Discount Cash Interest DiscountCarrying Date Interest Expense Amortized Value 1/1/07 — — — $ 9,366 12/31/07 $800 $937 $137 9,503 12/31/08 800 950 150 9,653 12/31/09 800 965 165 9,818 12/31/10 800 982 182 10,000 (rounded)

24. Chapter 10, Slide #24 Amortization Schedule – Premium Cash Interest DiscountCarrying Date Interest Expense Amortized Value 1/1/07 — — — $10,692 12/31/07 $800 $642 $158 10,534 12/31/08 800 632 168 10,366 12/31/09 800 622 178 10,188 12/31/10 800 612 188 10,000 (rounded)

25. Chapter 10, Slide #25 Redemption of Bonds  Reasons for early redemption: Excess cash Changing interest rates Gain = Carrying Value – Redemption Price Loss = Redemption Price – Carrying Value LO6

26. Chapter 10, Slide #26 Leases  Contractual arrangement  Grants right to use asset in exchange for payments  Form of financing LO7

27. Chapter 10, Slide #27 Capital Lease  Record as asset and corresponding liability (as if purchased through borrowings)  Depreciate asset over lease term  Separate payments into principal and interest components using the effective interest method

28. Chapter 10, Slide #28 Criteria for Lease Capitalization  Transfers ownership of property  Contains a bargain-purchase option  Term is > 75% of property’s life  Present value of payments is > 90% of property’s fair market value Lease meets one or more:

29. Chapter 10, Slide #29 Operating Leases  Record as rent (lease) expense each period  Disclose future lease obligations in financial statement notes

30. Chapter 10, Slide #30 Debt-to-Equity Ratio Total Liabilities Total Stockholders’ Equity How much have creditors contributed as compared to owners?

31. Chapter 10, Slide #31 Times Interest Earned Ratio Income Before Interest and Tax Interest Expense Will they be able to pay the interest on their debt?

32. Chapter 10, Slide #32 Debt Service Coverage Ratio Cash Flow from Operations Before Interest and Tax Interest and Principal Payments Will they be able to repay the principal on their loan?

33. Long-Term Liabilities on the Statement of Cash Flows Operating Activities Net income xxx Increase in current liability + Decrease in current liability – Investing Activities Financing Activities Increase in long-term liability + Decrease in long-term liability – LO8

34. Chapter 10, Slide #34 Appendix Accounting Tools: Other Liabilities

35. Chapter 10, Slide #35 Deferred Tax  Used to reconcile the differences between the accounting for book purposes and for tax purposes  Should reflect temporary differences but not permanent differences LO9 Permanent difference – affects the tax records but not the accounting records, or vice versa Temporary difference – affects both book and tax records but not in the same period

36. Chapter 10, Slide #36 Deferred Income Taxes Sales Depreciation Expense Taxable Income × Tax Rate Tax Payable to IRS Book Tax$6,000 2,500 4,000 3,500 2,000 40% 40% $1,400$ 800 $ 600 Difference recorded as deferred tax

37. Chapter 10, Slide #37 Deferred Income Taxes Income tax Book Tax $1,400$ 800 Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues – Expenses Equity Tax Payable 800 Tax Expense (1,400) Deferred Tax 600 To record income tax for the year. $ 600

38. Chapter 10, Slide #38 End of Chapter 10