1. Long-Term Liabilities: Notes, Bonds, and Leases Presentations for Chapter 11 by Glenn Owen

2. Key Points Long-term notes payable, bonds payable, and leasehold obligations, and how companies use these instruments as important sources of financing. Economic consequences created by borrowing. Different forms of contractual obligations. The effective interest rate and how it is determined for contractual obligations. The effective interest method. How changes in market interest rates can lead to misstated balance sheet values for long-term liabilities. Operating leases, capital leases, and off-balance-sheet financing.

3. Long-Term Liabilities as a Percentage of Total Assets

4. Long-Term Liabilities as a Percentage of Total Liabilities

5. Long-Term Liabilities as a Percentage of Stockholders’ Equity

6. Basic Definitions and Different Contractual Forms Installment notes – Cash (bank loan) – Noncash (lease or real estate purchase) Non-interest-bearing notes – Cash (zero coupon bond) – Noncash (equipment purchase) Interest-bearing notes – Cash (bond) – Noncash (equipment purchase)

7. Effective Interest Rate Actual interest rate paid by issuer May or may not be same as the stated rate Determined by discount rate that sets the present value of the future cash outflows equal to the fair market value of that which is received in the exchange.

8. Effective Interest Rate Installment payment formula – Present Value = – Annuity Cash Payment – x (PV Table Factor Ordinary Annuity: n = period, i = ?) Non-interest bearing formula – Present Value = – Single Sum Cash Payment – x (PV Table Factor Single Sum: n = period, i = ?)

9. Effective Interest Rate Interest-bearing formula – Present Value = – Annuity Cash Payment (Interest Payment) – x (PV Table Factor Ordinary Annuity: n = period, i = ?) – + Single Sum Cash Payment – x (PV Table Factor Single Sum: n = period, i = ?)

10. Accounting for Long-Term Obligations Record the asset acquired in the exchange at its fair market value. Record the obligation at its face value. Record a discount if the obligation exceeds the fair market value of the asset acquired. Record interest expense for each period: Effective interest rate x Balance sheet value of the obligation at the beginning of the period.

11. Bonds Payable Terminology and terms of bond contracts – Life – Maturity date – Face value, principal, par value, or maturity value – Interest payment – Proceeds at issuance – Effective interest rate Other provisions – Restrictions – Security – Call provision

12. Leases Operating leases – Lessee assumes no risk of ownership – At end of lease term, right to use the property reverts to the owner Capital leases – Effectively an installment purchase – Lessee assumes rights and risks of ownership – Treated as purchases Off-balance-sheet financing

13. Review Problem Facts – 500 bonds issued, each with a $1,000 face value – Issued January 1, 2003 at 91.89 – Stated annual rate of 6% – Interest paid semiannually on Dec. 31 and June 30 – Called July 1, 2004 at 96 Cash Flow – Proceeds $459,450 (500 x $1,000 x 918.90) – Semi-annual interest payments $15,000 (500 x $1,000 x 6% x 1/2) – Redemption payment (7/1/04) $480,000 (500 x $1,000 x.96)

14. Review Problem Time Line and Solution +$459,450 (proceeds) 1/1/036/30/0312/31/036/30/04 Discount Balance Net Book Value

15. Review Problem Time Line and Solution Cash 459,450 Discount40,550 Bonds Payable500,000 Cash 459,450 Discount40,550 Bonds Payable500,000 +$459,450 (proceeds) Discount Balance Net Book Value 1/1/036/30/0312/31/036/30/04

16. Review Problem Time Line and Solution Cash 459,450 Discount40,550 Bonds Payable500,000 Cash 459,450 Discount40,550 Bonds Payable500,000 +$459,450 (proceeds) Discount$40,550 Balance Net Book Value$459,450 1/1/036/30/0312/31/036/30/04

17. Review Problem Time Line and Solution +$459,450 (proceeds) -$15,000 (interest) Discount$40,550 Balance Net Book Value$459,450 1/1/036/30/0312/31/036/30/04

18. Review Problem Time Line and Solution Interest Expense 18,378 Cash15,000 Discount3,378 Interest Expense 18,378 Cash15,000 Discount3,378 +$459,450 (proceeds) -$15,000 (interest) Discount$40,550 Balance Net Book Value$459,450 Net Book Value x Effective Interest Rate $459,450 x 8% x 1/2 = $18,378 1/1/036/30/0312/31/036/30/04

19. Review Problem Time Line and Solution Interest Expense 18,378 Cash15,000 Discount3,378 Interest Expense 18,378 Cash15,000 Discount3,378 +$459,450 (proceeds) -$15,000 (interest) Discount$40,550$37,172($40,550 - $3,378) Balance Net Book Value$459,450$462,828($500,000 - $37,172) 1/1/036/30/0312/31/036/30/04

20. Review Problem Time Line and Solution +$459,450 (proceeds) -$15,000 (interest) -$15,000 (interest) Discount$40,550$37,172 Balance Net Book Value$459,450$462,828 1/1/036/30/0312/31/036/30/04

21. Review Problem Time Line and Solution +$459,450 (proceeds) -$15,000 (interest) -$15,000 (interest) Discount$40,550$37,172 Balance Net Book Value$459,450$462,828 Interest Expense 18,513 Cash15,000 Discount3,513 Interest Expense 18,513 Cash15,000 Discount3,513 $462,828 x 8% x 1/2 = $18,513 1/1/036/30/0312/31/036/30/04

22. Review Problem Time Line and Solution +$459,450 (proceeds) -$15,000 (interest) -$15,000 (interest) Discount$40,550$37,172$33,669 Balance Net Book Value$459,450$462,828$466,341 Interest Expense 18,513 Cash15,000 Discount3,513 Interest Expense 18,513 Cash15,000 Discount3,513 1/1/036/30/0312/31/036/30/04

23. Review Problem Time Line and Solution +$459,450 (proceeds) -$15,000 (interest) -$15,000 (interest) -$15,000 (interest) Discount$40,550$37,172$33,669 Balance Net Book Value$459,450$462,828$466,341 1/1/036/30/0312/31/036/30/04

24. Review Problem Time Line and Solution +$459,450 (proceeds) -$15,000 (interest) -$15,000 (interest) -$15,000 (interest) Discount$40,550$37,172$33,669 Balance Net Book Value$459,450$462,828$466,341 Interest Expense 18,653 Cash15,000 Discount3,653 Interest Expense 18,653 Cash15,000 Discount3,653 1/1/036/30/0312/31/036/30/04

25. Review Problem Time Line and Solution +$459,450 (proceeds) -$15,000 (interest) -$15,000 (interest) -$15,000 (interest) Discount$40,550$37,172$33,669$30,006 Balance Net Book Value$459,450$462,828$466,341$469,994 Interest Expense 18,653 Cash15,000 Discount3,653 Interest Expense 18,653 Cash15,000 Discount3,653 1/1/036/30/0312/31/036/30/04

26. Review Problem Time Line and Solution +$459,450 (proceeds) -$15,000 (interest) -$15,000 (interest) -$15,000 (interest) -$480,000 (redemption) Discount$40,550$37,172$33,669 $30,006 Balance Net Book Value$459,450$462,828$466,341 $469,994 1/1/036/30/0312/31/036/30/04

27. Review Problem Time Line and Solution Bonds Payable 500,000 Loss on Retirement10,006 Discount30,006 Cash480,000 Bonds Payable 500,000 Loss on Retirement10,006 Discount30,006 Cash480,000 +$459,450 (proceeds) -$15,000 (interest) -$15,000 (interest) -$15,000 (interest) -$480,000 (redemption) Discount$40,550$37,172$33,669 $30,006 Balance Net Book Value$459,450$462,828$466,341 $469,994 1/1/036/30/0312/31/036/30/04

28. Review Problem Time Line and Solution Bonds Payable 500,000 Loss on Retirement10,006 Discount30,006 Cash480,000 Bonds Payable 500,000 Loss on Retirement10,006 Discount30,006 Cash480,000 +$459,450 (proceeds) -$15,000 (interest) -$15,000 (interest) -$15,000 (interest) -$480,000 (redemption) Discount$40,550$37,172$33,669$0 Balance Net Book Value$459,450$462,828$466,341$0 1/1/036/30/0312/31/036/30/04