1. Long Term Liabilities and Receivables14
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Long Term Liabilities and Receivables
Intermediate Accounting 10th edition
Nikolai Bazley Jones
An electronic presentation
by Norman Sunderman
Angelo State University
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

2. Bonds
A bond is a debt security that is issued to obtain large amounts of cash on a long term basis.
A bond indenture is the formal agreement which specifies the terms of the bonds.

3. Reasons for Issuance of Long-Term Liabilities
Debt financing may be the only available source of funds.
Debt financing may have a lower cost.
Debt financing offers an income tax advantage.
The voting privilege is not shared.
Debt financing offers the opportunity for leverage.

4. Characteristics of Bonds
Debenture bonds
Mortgage bonds
Registered bonds
Coupon bonds
Zero-coupon bonds
Callable bonds
Convertible bonds
Serial bonds

5. Bond Terminology
The principal, face, par or maturity value is the amount that the corporation will pay the bond holder at the maturity of a term bond.
The stated rate, coupon rate, nominal rate, or contractual rate is the interest rate printed on the bond.
The market rate, effective rate, or yield is the interest rate at which the bonds are actually sold.

6. Recording the Issuance of Bonds
Company J sells bonds with a face value of $400,000 on the authorization date at 102.
Cash ($400,000 x 1.02) 408,000
Bonds Payable 400,000
Premium on Bonds Payable 8,000
Company M sells bonds with a face value of $400,000 on the authorization date at 97.
Cash ($400,000 x .97) 388,000
Discount on Bonds Payable 12,000
Bonds Payable 400,000

7. Bonds Issued Between Interest Paying Dates
On March 1, 2007, Grimes Corporation issues $800,000 of 10-year bonds dated January 1, 2007, at par. The bonds have a contract (stated) interest rate of 12% and pay interest semiannually.
Cash 816,000
Bonds Payable 800,000
Interest Expense 16,000
$800,000 x 0.12 x 2/12
Continued

8. Bonds Issued Between Interest Paying Dates
On July 1, 2007, Grimes Corporation records the semiannual interest payment.
Interest Expense 48,000
Cash 48,000
$800,000 x 0.12 x 6/12
Interest Expense
48, ,000
The balance of $32,000 represents the interest cost since the bonds were issued.
32,000

9. Bonds Issued Between Interest Paying Dates
Alternative Method
March 1 Cash 816,000
Interest Payable
($800,000 X 0.12 X 6/12) 16,000
Bonds Payable 800,000
July 1 Interest Expense
($800,000 X 0.12 X 4/12) $ 32,000
Interest Payable 16,000
Cash $ 48,000

10. Straight-Line
Method

11. Issuing Bonds at a Discount
Jet Company sells bonds for $92, on January 1, The bonds have a face value of $100,000 and a 12% stated annual interest rate and a 14% effective rate. Interest is paid semiannually and the bonds mature on December 31, 2011.
Cash 92,976.39
Discount on Bonds Payable 7,023.61
Bonds Payable 100,000.00
Continued

12. Bonds Issued at a Discount
Straight-Line Method
Jet Company records the first interest payment on June 30, 2007.
$7, ÷ 10
Interest Expense 6,702.36
Discount on Bonds Payable
Cash 6,000.00
$6,000 + $702.36
$100,000 x 0.12 x 1/2

13. Bonds Issued at a Premium
Straight-Line Method
Jet Company sold the 5-year bonds on January 1, 2007, for $107, Interest is paid semiannually.
Cash 107,721.71
Bonds Payable 100,000.00
Premium on Bonds Payable 7,721.71
Continued

14. Bonds Issued at a Premium
Straight-Line Method
The first interest payment is made on June 30.
Interest Expense 5,227.83
Premium on Bonds Payable
Cash ($100,0000 x 0.12 x 1/2) 6,000.00
$7, ÷ 10
Continued

15. Determining the Selling Price
Jet Company desires to sell $100,000 of 5-year bonds paying semiannual interest with a stated rate of 12%. The current effective interest rate is 14%.
Present value of principal
($100,000 x ) $ 50,834.90
Present value of interest
($6,000 x ) 42,141.49
$ 92,976.39
Less face value (100, )
Discount $ 7,023.61

16. Determining the Selling Price
Jet Company desires to sell $100,000 of 5-year bonds paying semiannual interest with a stated rate of 12%. The bonds are sold to yield 14% interest.
Present value of principal
($100,000 x ) $ 61,391.30
Present value of interest
($6,000 x ) ,330.41
$107,721.71
Less face value (100, )
Premium $ 7,721.71

17. Effective Interest Method

18. Effective Interest Method
Using the straight-line method, Interest Expense is the same every year—which is not realistic when a premium or discount is involved. Instead, the effective-interest method allows for a stable interest rate per year.

19. Issuing Bonds at a Discount
Effective Interest
Jet Company sells bonds for $92, on January 1, The bonds have a face value of $100,000 and a 12% stated annual interest rate and a 14% effective rate. Interest is paid semiannually and the bonds mature on December 31, 2011.
Cash 92,976.39
Discount on Bonds Payable 7,023.61
Bonds Payable 100,000.00
Continued

20. Issuing Bonds at a Discount
Effective Interest
Jet Company records the first interest payment on June 30, 2007.
$6, $6,000.00
Interest Expense 6,508.35
Discount on Bonds Payable
Cash 6,000.00
$92, x 0.14 x 1/2
$100,000 x 0.12 x 1/2

21. Issuing Bonds at a Discount
Effective Interest
Jet Company records the second interest payment on December 31, 2007.
$6, ,000.00
Interest Expense 6,543.93
Discount on Bonds Payable
Cash 6,000.00
($92, $508.35) x 0.14 x 1/2
$100,000 x 0.12 x 1/2

22. Issuing Bonds at a Premium
Effective Interest
Jet Company sold bonds on January 1, 2007, for $107, Interest is paid semiannually.
Cash 107,721.71
Bonds Payable 100,000.00
Premium on Bonds Payable 7,721.71
Continued

23. Issuing Bonds at a Premium
Effective Interest
The first interest payment is made on June 30.
$6, –
$5,386.09
Premium on Bonds Payable
Interest Expense 5,386.09
Cash 6,000.00
$107, x 0.10 x 1/2
$100,000 x
0.12 x 1/2
Continued

24. Issuing Bonds at a Premium
Effective Interest
Jet Company records the second interest payment on December 31, 2007.
($107, $613.91) x 0.10 x 1/2
Interest Expense 5,355.39
Premium on Bonds Payable
Cash 6,000.00
$6, $5,355.39
$100,000 x 0.12 x 1/2

25. Bond Issue Costs
On January 1, 2007, Bergen Company issues 10-year bonds with a face value of $500,000 at Expenditures connected with the issue totaled $8,000.
Cash ($520,000 - $8,000) 512,000
Deferred Bond Issue Costs 8,000
Bonds Payable 500,000 Premium on Bonds Payable 20,000
0.04 x $500,000

26. Bond Issue Costs
However, the FASB is planning to change GAAP, so that all debt issue costs are expensed as incurred.
Each year for the ten years Deferred Bond Issue Costs is amortized on a straight-line basis by charging Bond Interest Expense for $800.

27. Accruing Bond Interest
McAdams Company issues $200,000 of 10%, 5-year bonds on October 1, 2007, for $185, Interest on these bonds is payable each October 1 and April 1.
Cash 185,279.87
Discount on Bonds Payable 14,720.13
Bonds Payable 200,000.00
Continued

28. Accruing Bond Interest
At the end of the fiscal year, December 31, 2007, an adjusting entry is required to record interest for three months (assume straight-line amortization).
($14, ÷ 5) x 3/12
Interest Expense (plug) 5,736.01
Discount on Bonds Payable
Interest Payable 5,000.00
$200,000 x 0.10 x 3/12

29. Accruing Bond Interest
At the end of the fiscal year, December 31, 2007, an adjusting entry is required to record interest for 3 months (assume the effective-interest amortization).
$185,279 x 0.12 x 3/12
Interest Expense 5,558.40
Interest Payable 5,000.00
Discount on Bonds Payable (plug)
$5, $5,000.00

30. Extinguishment of Debt
Under FASB Statement No. 140, a liability is considered extinguished for financial reporting purposes if either of the following occurs:
The debtor pays the creditor and is relieved of its obligation for the liability.
The debtor is released legally from being the primary obligor under the liability, either judicially or by the creditor.

31. Bonds Retired Prior to Maturity
Conceptually, gains or losses from refundings could be recognized either--
Over the remaining life of the old issue.
Over the life of the new bond issue.
In the current period.

32. Bonds Retired Prior to Maturity
Whether bonds are recalled, retired, or refunded prior to maturity, any gain or loss is reported as a component of income from continuing operations in the current period.

33. Bonds Retired Prior to Maturity
Channing Corporation originally issued $100,000 of 12% bonds at 97 on January 1, The bonds have a 10-year life, pay interest on January 1 and July 1, and are callable at 105 plus accrued interest. The company amortizes the discount by the straight-line method.
On June 30, 2007, the company recalls the bonds.
Continued

34. Bonds Retired Prior to Maturity
First, Channing records the current interest expense and liability, including the amortization of the discount that expired since the last interest payment.
($3,000 ÷ 10) x 1/2
Interest Expense 6,150
Discount on Bonds Payable 150
Interest Payable 6,000
$100,000 x 0.12 x 1/2

35. Bonds Retired Prior to Maturity
Channing then records the reacquisition of the bonds at 105 plus accrued interest of $6,000.
Bonds Payable 100,000
Interest Payable 6,000
Loss on Bond Redemption 6,350
Discount on Bonds Payable 1,350
Cash 111,000
Original discount $ 3,000
Less: Amortization
for 5 1/2 years (1,650)
Unamortized discount $1,350

36. Bonds with Equity Characteristics
By acquiring bonds with detachable stock warrants or with a conversion feature, the bondholder has--
the right to receive interest on the bonds, and…
the right to acquire common stock and to participate in the potential appreciation of the market value of the company’s common stock.

37. Bonds with Equity Characteristics
Some bonds are issued with rights, warrants, to acquire capital stock. If the warrants are detachable, a portion of the proceeds from selling the bonds must be allocated to the warrants.
Proportional method
Incremental method

38. Bonds Issued with Detachable Stock Warrants
Amount Assigned to Bonds =
Market Value of Bonds Without Warrants +
Market Value of Warrants
Issuance Price x
Amount Assigned to Warrants =
Market Value of Warrants
Market Value of Bonds Without Warrants +
Issuance Price x

39. Bonds Issued with Detachable Stock Warrants
Paul Company sold $800,000 of 12% bonds at 101 ($808,000). Each bond carried 10 warrants, and each warrant allows the holder to acquire one share of $5 par common stock for $25 per share. The bonds are quoted at 99 ex rights and the warrants at $3 each.

40. Bonds Issued with Detachable Stock Warrants
Market Value of Bonds Without Warrants
Amount Assigned to Bonds
Issuance Price x =
Market Value of Bonds Without Warrants
Market Value of Warrants +
Amount Assigned to Bonds =
$990 per bond x 800 bonds
($990 x 800) +
($3 x 800 x 10)
$808,000 x
Amount Assigned to Bonds =
$784,235.29

41. Bonds Issued with Detachable Warrants
Amount Assigned to Warrants
Market Value of Warrants
Issuance Price x =
Market Value of Bonds Without Warrants
Market Value of Warrants +
Amount Assigned to Warrants =
$3 x 10 warrants x 800 bonds
($990 x 800) + ($3 x 800 x 10)
$808,000 x
Amount Assigned to Warrants =
$23,764.71

42. Bonds Issued with Detachable Stock Warrants
Cash 808,000.00
Discount on Bonds Payable 15,764.71
Bonds Payable 800,000.00
Common Stock Warrants 23,764.71
$800, $784,235.29
From last slide

43. Bonds Issued with Detachable Warrants
Later, 500 warrants are exercised at $25 each.
Cash 12,500.00
Common Stock Warrants 1,485.50
Common Stock 2,500.00
Additional Paid-in Capital
on Common Stock 11,485.50
($23, ÷ 8,000) x 500
The remaining warrants expire.
$23, $1,485.50
Common Stock Warrants 22,279.21
Additional Paid-in Capital
from Expired Warrants 22,279.21

44. Why issue convertible bonds?

45. Convertible Bonds
Avoid the downward price pressures on its stock that placing a large new issue of common stock on the market would cause.
Avoid the direct sale of common stock when it believes its stock currently is undervalued in the market.
Penetrate that segment of the capital market that is unwilling or unable to participate in a direct common stock issue.
Minimize the costs associated with selling securities.

46. Conversion Methods
Book value method. Record the stock at the book value of the convertible bonds and do not record a gain or loss. This method is the most widely used.
Market value method. Record the stock at the market value of the stock or debt, whichever is more reliable, and recognize a gain or loss.

47. Conversion Methods
Shannon Corporation has outstanding convertible bonds with a face value of $10,000 and a book value of $10,500. Each bond is convertible into 40 shares of $20 par common stock. The market price is $26.50 per share when the shares are converted.

48. Conversion Methods
Book Value Method- The market price is not considered.
Bonds Payable 10,000
Premium on Bonds Payable
Common Stock ,000
Additional-Paid-in Capital-plug ,500
Market Value Method-Equity accounts equal market price.
Bonds Payable 10,000
Premium on Bonds Payable
Loss on Conversion
Common Stock ,000
Additional-Paid-in Capital ,600

49. Induced Conversions
The debtor recognizes an expense equal to the fair value of the “sweetener” and is measured on the date the offer is accepted by the bondholders.
A company that has convertible bonds may desire bondholders to convert the bonds to common stock.
To induce conversion, the company may add a “sweetener” to the convertible bond.

50. Induced Conversions
Assume that Harmon Company had $10,000 of outstanding convertible bonds, which had been issued at par. The original terms of issuance allowed each bond to be converted into 40 shares of no-par common stock. To induce conversion, the terms were changed to offer 50 shares per bond. All shares were converted when the market price was $30 per share.
Bonds Payable 10,000
Bond Conversion Expense 3,000
Common Stock, no par 13,000

51. Notes Payable Issued for Cash
On January 1 of the current year, Johnson Company issues a 3-year, non-interest-bearing note with a face value of $8,000 and receives $5, in exchange.
Cash 5,694.24
Discount on Notes Payable 2,305.76
Notes Payable 8,000.00
Contra account to Notes Payable

52. Notes Payable Issued for Cash
Johnson Company records the interest expense on the note for the first year.
Interest Expense
Discount on Notes Payable
Notes payable $8,000.00
Less: Unamortized discount (2,305.76)
Carrying value at beginning of year $5,694.24
x Effective interest rate
Entry amount $

53. Notes Payable Exchanged for Property, Goods or Services
APB Opinion No. 21 states that the stipulated rate of interest should be presumed fair. This presumption can be overcome only if--
No interest is stated, or
The stated rate of interest is clearly unreasonable, or
The face value of the note is materially different from the cash sales price of the property, goods, or services, or the fair value of the note at the date of the transaction.

54. Long-Term Notes Receivable
A note receivable is recorded at the fair value of the property, goods, or services or the fair value of the note, whichever is more reliable.

55. Long-Term Notes Payable
On January 1, 2007, Marsden Company purchased used equipment from Joyce Company, issuing a 5 year, $10,000 non-interest-bearing note in exchange. Marsden’s incremental interest rate is 12%.
Present value
Equipment 5,574.27
Discount on Notes Payable 4,325.73
Equipment 10,000.00

56. Long-Term Notes Payable
Interest Expense
Discount on Notes Payable
December 31, 2007
($10,000 – $4,325.73) x 0.12
Depreciation Expense Accumulated Depreciation
Interest Expense
Discount on Notes Payable
December 31, 2008
$10,000 – ($4, – $680.91) x 0.12

57. Long-Term Notes Receivable
A note receivable is recorded at the fair value of the property, goods, or services or the fair value of the note, whichever is more reliable.

58. Long-Term Notes Receivable
On January 1, 2007, Joyce Company accepted a $10,000 non-interest-bearing, 5-year note in exchange for used equipment it sold to Marsden Company (12%).
Notes Receivable 10,000.00
Accumulated Depreciation 3,000.00
Discount on Notes Receivable 4,325.73
Equipment 8,000.00
Gain on Sale of Equipment
$10,000 – $5,674.27
(present value of equipment)

59. Long-Term Notes Receivable
Discount on Notes Receivable
Interest Revenue
December 31, 2007
($10,000 – $4,325.73) x 0.12
Discount on Notes Receivable
Interest Revenue
December 31, 2008
$10,000 – ($4, – $680.91) x 0.12

60. Impairment of a Loan
A loan is impaired if it is probable that the creditor will not be able to collect all amounts due according to the contract terms.

61. Impairment of a Loan
Snook Company has a $100,000 note receivable from the Ullman Company that it is carrying at face value. The loan agreement called for Ullman to pay 8% interest each December 31 and the principal on December 31, Ullman paid the December 31, 2007, interest, but informed Snook that it probably would miss the next two year’s interest payments because of financial difficulties. In addition, the principal payment would be one year late.

62. Impairment of a Loan
Snook Company computes the present value of the impaired loan.
Value of the impaired loan is $85, ($63, $22,716.93)
Present value of the principal = $100,000 x present value of a single sum for 6 years at 8%
= $100,000 x
= $63,017.00
Present value of the interest = $8,000 x present value of an annuity for 4 years at 8% deferred 2 years
= $8,000 x x
= $22,716.93

63. Impairment of a Loan December 31, 2007, (Snook Company)
Bad Debt Expense 14,266.07
Allowance for Doubtful Accts. 14,266.07
December 31, 2007, (Snook Company)
$100,000 – $85,733.93
Allowance for Doubtful Accounts 6,858.71
Interest Revenue 6,858.71
December 31, 2008, (Snook Company)
8% x $85,733.93

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The End
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