1. Long-Term Liabilities
Chapter 10
Long-Term Liabilities
1,000
Financial Accounting, Alternate 4e by Porter and Norton 1

2. Balance Sheet Classifications1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 28 29 30 31 27
Current Liabilities:
Long-Term Liabilities:
due within one year of the balance sheet date
due beyond one year

3. Long-Term Liabilities
Bonds Payable
Notes Payable
Leases
Deferred Taxes
Pensions
Other Postretirement Benefits

4. Bonds 1,000 Investor Borrower Long-term borrowing arrangement
Due 2019
Investor
Borrower
Interest for
Investor
Borrower
Long-term borrowing arrangement
Interest paid at stated rate and times
Principal repaid at maturity date

5. Bond Features
Collateralized - backed by specific assets in event of default
Debentures - backed only by general credit- worthiness of issuer

6. Bond Features Term - Entire principal due on a specific single date
Serial - Principal repaid in installments over time 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 28 29 30 31 27

7. Bond Features Convertible - into common stock
Callable / Redeemable - may be retired before maturity date
Common
Stock
1,000

8. Bond Interest Rates Face Rate -
interest is paid at the rate specified on the bond
Market Rate -
the interest rate the bond will yield after selling at a discount or premium
Paycheck for
Date
Dept.. of Treasurer
Jane Doe
8% Return

9. Interest Rates and Bond Prices
BONDS ISSUED: IF STATED RATE:
Above face value (at a premium)
At face value
Below face value (at a discount)
> MARKET RATE
= MARKET RATE
< MARKET RATE

10. Bonds Sold at Face Value
Issuance of bonds at face value:
Assets = Liab O/E + Rev. – Exp.
Cash 10, Bonds Pay. 10,000
Face Value of Bonds = Sales Price

11. Relationship of Interest Rates and Bond Prices
Market
Interest
Rates
Bond
Prices
Market
Interest
Rates
Bond
Prices

12. Calculating Bond Prices - two sets of cash flows
(1) Interest Payments made each period (annuity)
PV = ?
etc. $$ $$ $$ $$
(2) Principal due at maturity(single sum)
$$$$$
PV = ? 1

13. Determining Bond Prices
Example:
On 1/1/04, Discount Firm issues:
$10,000; 8% bonds.
due December 31, 2007
Interest payable annually
Market rate of interest = 10%
Calculate the issue price of the bonds.

14. Interest is always paid at rate stated on bonds
Calculating Bond Prices
(1) Interest Payments (4 $800)
2004
2005
2006
2007
PV = ?
$800
$800
$800
$800
Interest is always paid at rate stated on bonds
8%) 14 1

15. Calculating Bond Prices
(1) Interest Payments (4 $800)
2004
2005
2006
2007
PV = ?
$800
$800
$800
$800
(2) Principal of $10,000 due at end of 2007
2007
$10,000
PV = ? 15 1

16. payment at stated rate (i.e. 8%) ...
Example of Price Calculation
Compute interest
payment at stated rate (i.e. 8%) ...
Present value:
interest payments -
$ x = $ 2,536
(PV; n=4; i = 10%)
principal payment -
$ 10,000 x = 6,830
Bond issue price: $ 9,366
…but
discount
@ market rate 2

17. Recording Bond Discounts
Issue bonds at a discount:
Assets = Liab O/E + Rev. – Exp.
Cash 9, Bonds Pay. 10,000
Discount on
Bonds Pay. (634)

18. Balance Sheet Presentation of Bond Discount
At Date Upon
of Sale Maturity
Long-term Liabilities:
Bonds Payable $10,000 $10,000
Less: Discount on
Bonds Payable (634)
$ 9,366 $10,000
amortize to Interest Expense
over the life of the bond

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

20. payment at stated rate (i.e. 8%) ...
Example of Price Calculation
Compute interest
payment at stated rate (i.e. 8%) ...
Present value:
interest payments -
$ x = $ 2,772
(PV; n=4; i = 6%)
principal payment -
$ 10,000 x = ,920
Bond issue price: $10,692
…but
discount
@ market rate 2

21. Recording Bond Premiums
Issue bonds at a premium:
Assets = Liab O/E + Rev. – Exp.
Cash 10, Bonds Pay. 10,000
Discount on
Bonds Pay

22. Balance Sheet Presentation of Bond Premium
At Date Upon
of Sale Maturity
Long-term Liabilities:
Bonds Payable $10,000 $10,000
Plus: Premium on
Bonds Payable
$10,692 $10,000
amortize to Interest Expense
over the life of the bond

23. Amortization of Bond Premiums and Discounts
Transfer to interest expense over the life of the bond using effective interest method
Premium
reduces
interest
expense
Discount
increases
interest
expense

24. Amortization Schedule - Discount
Cash Interest Discount Carrying
Date Interest Expense Amortized Value
8% % Col. 2 - Col. 1
1/1/ – – – $ 9,366
12/31/04 $ $ $ ,503
12/31/ ,653
12/31/ ,818
12/31/ ,000
(rounded) 24 13

25. Amortization Schedule - Premium
Cash Interest Premium Carrying
Date Interest Expense Amortized Value
8% % Col. 1 - Col. 2
1/1/ – – – $ 10,692
12/31/04 $ $ $ ,534
12/31/ ,366
12/31/ ,188
12/31/ ,000
(rounded) 25 13

26. Redemption of Bonds Reasons for early redemption: Excess cash
Changing interest rates
Gain = Carrying Value - Redemption Price
(Loss) = Redemption Price - Carrying Value

27. Leases Lessor Lessee Contractual arrangement
Grants right to use asset in exchange for payment
Form of financing
Lessor
Lessee
Rights

28. 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

29. Criteria for Lease Capitalization
Lease meets one or more:
Title
Transfers ownership of property
Contains bargain purchase option
Term is > 75% of property’s life
PV of payments > 90% of property FMV 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 28 29 30 31 27
Paycheck for
Date
Dept. of Treasurer
Jane Doe

30. Operating Leases Record as rent (lease) expense each period
Disclose future lease obligations in footnotes
OFFICE
SPACE
FOR LEASE

31. 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 – 31

32. Debt-to-Equity Ratio Total Liabilities Total Stockholders’ Equity
How much have creditors contributed as compared to owners?

33. Accounting Tools: Other Liabilities
Appendix
Accounting Tools:
Other Liabilities

34. Deferred Taxes
Reflects temporary differences between book and tax accounting methods
Book tax expense Cash paid to IRS =
Income
Statement
Expense
Tax
Return
Liability
Pay to the order of:
IRS
ABC Co.

35. Deferred Income Taxes Sales Depreciation expense Income before tax
Tax rate
Income tax
Book Tax
$6,000 $6,000
2, ,000
3, ,000
40% 40%
$1,400 $ 800
Difference recorded
as deferred tax
$ 600

36. Deferred Income Taxes Income tax Book Tax $1,400 $ 800 $ 600
$1,400 $ 800
$ 600
Effect on financial statements:
Assets = Liab O/E + Rev. – Exp.
Tax Pay Tax Exp. (1,400)
Deferred Tax 600
Balance Sheet
Income Statement

37. Pensions Pays benefits Employer to retired contributes Pension
employees
Employer
contributes to
Pension
Fund
Date
Dept. of Treasurer
Pension Fund
XYZ Corp.
Paycheck for
Date
Dept. of Treasurer
Jane Doe

38. Pensions
Expense accrued in period employee earns benefits (regardless of when paid)
Expense may amount funded =

39. Pensions on the Balance Sheet
ASSETS
Prepaid Pension Cost $$
LIABILITIES
Accrued Pension Cost $$
Funding
>
Expense
Expense
>
Funding

40. Postretirement Benefits
Benefits paid to employees after retirement
e.g., health costs
Record expense when employee earns benefits, not when paid (matching principle)

41. End of Chapter 10
1,000