1. PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Winston Kwok, Ph.D., CA Chapter 14 L ONG -T ERM L IABILITIES Copyright © 2015 by McGraw-Hill Education (Asia). All rights reserved

2. 14 - 2 B OND F INANCING Bonds do not affect owner control. Interest on bonds is tax deductible. Bonds can increase return on equity. Advantages Bonds require payment of both periodic interest and par value at maturity. Bonds can decrease return on equity. Disadvantages A1

3. 14 - 3 B OND T RADING A1 Bonds are securities that can be purchased or sold in the securities markets. They have a market value which is expressed as a percent of their par value. The closing price indicates that the IBM bond is being sold at 119.25% of face value.

4. 14 - 4 Bond Certificate Bond Certificate Bond Selling Price Corporation Investors B OND I SSUANCES P1 Transaction on the Bond Issue Date

5. 14 - 5 Bond Interest Payments CorporationInvestors Bond Issue Date Bond Interest Payments Interest Payment = Bond Par Value × Stated Interest Rate x Time B OND I SSUANCES Transactions during the bond life P1

6. 14 - 6 Bond Face Value Corporation Investors B OND I SSUANCES Transaction on the Maturity Date P1

7. 14 - 7 I SSUING B ONDS AT P AR On Jan. 1, 2011, a company issued the following bonds: Par Value: $800,000 Stated Interest Rate: 9% Interest Dates: 6/30 and 12/31 Maturity Date = Dec. 31, 2030 (20 years) P1

8. 14 - 8 $800,000 × 9% × ½ year = $36,000 I SSUING B ONDS AT P AR On June 30, 2011, the issuer of the bond pays the first semiannual interest payment of $36,000. P1 This entry is made every six months until the bonds mature.

9. 14 - 9 I SSUING B ONDS AT P AR On December 31, 2030, the bonds mature and the issuer of the bond pays face value of $800,000 to the bondholders. P1

10. 14 - 10 B OND D ISCOUNT OR P REMIUM P1

11. 14 - 11 Fila issues bonds with the following provisions: Fila issues bonds with the following provisions: Par Value: $100,000 Par Value: $100,000 Issue Price: 96.454% of par value Issue Price: 96.454% of par value Stated Interest Rate: 8% Stated Interest Rate: 8% Market Interest Rate: 10% Market Interest Rate: 10% Interest Dates: 6/30 and 12/31 Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years) Maturity Date: Dec. 31, 2013 (2 years) Fila issues bonds with the following provisions: Fila issues bonds with the following provisions: Par Value: $100,000 Par Value: $100,000 Issue Price: 96.454% of par value Issue Price: 96.454% of par value Stated Interest Rate: 8% Stated Interest Rate: 8% Market Interest Rate: 10% Market Interest Rate: 10% Interest Dates: 6/30 and 12/31 Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years) Maturity Date: Dec. 31, 2013 (2 years) I SSUING B ONDS AT A D ISCOUNT } } Bond will sell at a discount. P2

12. 14 - 12 On Dec. 31, 2011, Fila should record the bond issue. I SSUING B ONDS AT A D ISCOUNT Par value $ 100,000 Cash proceeds 96,454 Discount $ 3,546 *$100,000 x 96.454% Contra-LiabilityAccountContra-LiabilityAccount P2

13. 14 - 13 E FFECTIVE I NTEREST A MORTIZATION $96,454 × 5% = $4,823 $100,000 - $2,723 = $97,277 P2

14. 14 - 14 A MORTIZING A B OND D ISCOUNT P2

15. 14 - 15 Adidas issues bonds with the following provisions: Adidas issues bonds with the following provisions: Par Value: $100,000 Par Value: $100,000 Issue Price: 103.546% of par value Issue Price: 103.546% of par value Stated Interest Rate: 12% Stated Interest Rate: 12% Market Interest Rate: 10% Market Interest Rate: 10% Interest Dates: 6/30 and 12/31 Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years) Maturity Date: Dec. 31, 2013 (2 years) Adidas issues bonds with the following provisions: Adidas issues bonds with the following provisions: Par Value: $100,000 Par Value: $100,000 Issue Price: 103.546% of par value Issue Price: 103.546% of par value Stated Interest Rate: 12% Stated Interest Rate: 12% Market Interest Rate: 10% Market Interest Rate: 10% Interest Dates: 6/30 and 12/31 Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years) Maturity Date: Dec. 31, 2013 (2 years) I SSUING B ONDS AT A P REMIUM } } Bond will sell at a premium. P3

16. 14 - 16 I SSUING B ONDS AT A P REMIUM Par value $ 100,000 Cash proceeds 103,546* Premium $ 3,546 *$100,000 x 103.546% Adjunct-LiabilityAccountAdjunct-LiabilityAccount On Dec. 31, 2011, Adidas will record the bond issue as: P3

17. 14 - 17 A MORTIZING A B OND P REMIUM P3

18. 14 - 18 B OND P RICING P2 Cash Outflows related to Interest Payments Cash Outflows for par value at end of Bond life

19. 14 - 19 Fila issues bonds with the following provisions: Fila issues bonds with the following provisions: Par Value: $100,000 Par Value: $100,000 Issue Price: ? Issue Price: ? Stated Interest Rate: 8% Stated Interest Rate: 8% Market Interest Rate: 10% Market Interest Rate: 10% Interest Dates: 6/30 and 12/31 Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years) Maturity Date: Dec. 31, 2013 (2 years) Fila issues bonds with the following provisions: Fila issues bonds with the following provisions: Par Value: $100,000 Par Value: $100,000 Issue Price: ? Issue Price: ? Stated Interest Rate: 8% Stated Interest Rate: 8% Market Interest Rate: 10% Market Interest Rate: 10% Interest Dates: 6/30 and 12/31 Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years) Maturity Date: Dec. 31, 2013 (2 years) I SSUING B ONDS AT A D ISCOUNT P2

20. 14 - 20 P RESENT V ALUE OF A D ISCOUNT B OND To calculate Present Value, we need relevant interest rate and number of periods. Semiannual rate = 5% (Market rate 10% ÷ 2) Semiannual periods = 4 (Bond life 2 years × 2) To calculate Present Value, we need relevant interest rate and number of periods. Semiannual rate = 5% (Market rate 10% ÷ 2) Semiannual periods = 4 (Bond life 2 years × 2) $100,000 × 8% × ½ = $4,000 P2

21. 14 - 21 B OND R ETIREMENT Retirement of the Fila bonds at maturity for $100,000 cash. Because any discount or premium will be fully amortized at maturity, the carrying amount of the bonds will be equal to par value. P4

22. 14 - 22 B OND R ETIREMENT Retirement of Bonds before Maturity Carrying Amount > Retirement Price = Gain Carrying Amount < Retirement Price = Loss Assume that $100,000 of callable bonds will be retired on July 1, 2011, after the first interest payment. The bond carrying amount is $104,500.The bonds have a call premium of $3,000. P4

23. 14 - 23 B OND R ETIREMENT By Conversion On January 1, $100,000 par value bonds of Converse, with a carrying amount of $100,000, are converted to 15,000 ordinary shares of $2 par value. 15,000 shares × $2 par value per share P4

24. 14 - 24 Note Maturity Date Note Payable Cash CompanyLender Note Date When is the repayment of the principal and interest going to be made? L ONG -T ERM N OTES P AYABLE C1

25. 14 - 25 Note Maturity Date CompanyLender Note Date Single Payment of Principal plus Interest L ONG -T ERM N OTES P AYABLE C1

26. 14 - 26 Note Maturity Date CompanyLender Note Date Regular Payments of Principal plus Interest Payments either can be equal principal payments plus interest or equal payments. Regular Payments of Principal plus Interest L ONG -T ERM N OTES P AYABLE C1

27. 14 - 27 I NSTALLMENT N OTES On January 1, 2011, Foghog borrows $60,000 from a bank to purchase equipment. It signs an 8% installment note requiring 6 annual payments of principal plus interest. Compute the periodic payment by dividing the face amount of the note by the present value factor. C1

28. 14 - 28 I NSTALLMENT N OTES WITH E QUAL P AYMENTS C1

29. 14 - 29 I NSTALLMENT N OTES WITH E QUAL P AYMENTS Let’s record the first payment made on December 31, 2011 by Foghog to the bank. Refer back to the amortization schedule to make the December 31, 2012 payment on the note. P5

30. 14 - 30 M ORTGAGE N OTES AND B ONDS A legal agreement that helps protect the lender if the borrower fails to make the required payments. Gives the lender the right to be paid out of the cash proceeds from the sale of the borrower’s assets specifically identified in the mortgage contract. A legal agreement that helps protect the lender if the borrower fails to make the required payments. Gives the lender the right to be paid out of the cash proceeds from the sale of the borrower’s assets specifically identified in the mortgage contract. C1

31. 14 - 31 Secured and Unsecured Term and Serial Registered and Bearer Convertible and Callable F EATURES OF B ONDS AND N OTES A2

32. 14 - 32 This ratio helps investors determine the risk of investing in a company by dividing its total liabilities by total equity. D EBT - TO -E QUITY R ATIO Debt-to- Equity Ratio Total Liabilities Total Equity = A3 Adidas

33. 14 - 33 Present Value of $1 Rate Periods3%4%5% 1 0.9709 0.9615 0.9524 2 0.9426 0.9246 0.9070 3 0.9151 0.8890 0.8638 4 0.8885 0.8548 0.8227 5 0.8626 0.8219 0.7835 6 0.8375 0.7903 0.7462 7 0.8131 0.7599 0.7107 8 0.7894 0.7307 0.6768 9 0.7664 0.7026 0.6446 10 0.7441 0.6756 0.6139 A PPENDIX 14A: P RESENT V ALUES OF B ONDS AND N OTES Face amount = $100,000 Contract rate = 8% Market rate = 10% Interest paid semiannually First, we calculate the present value of the principal repayment in 4 periods (2 years ×2 payments per year, using 5% market rate (10% annual rate ÷ 2 payments per year). $100,000 × 0.8227 = $82,270 C2

34. 14 - 34 Present Value of Annuity of $1 Rate Periods3%4%5% 1 0.9709 0.9615 0.9524 2 1.9135 1.8861 1.8594 3 2.8286 2.7751 2.7232 4 3.7171 3.6299 3.5460 5 4.5797 4.4518 4.3295 6 5.4172 5.2421 5.0757 7 6.2303 6.0021 5.7864 8 7.0197 6.7327 6.4632 9 7.7861 7.4353 7.1078 10 8.5302 8.1109 7.7217 A PPENDIX 14A: P RESENT V ALUES OF B ONDS AND N OTES $100,000 × 8% × ½ = $4,000 Semiannual Interest Annuity Present AmountPV FactorValue Principal $ 100,000 0.8227 $ 82,270 Interest 8,000 3.5460 14,184 Issue price of debt $ 96,454 $4,000 × 3.5460 = $14,184 C2

35. 14 - 35 E ND OF C HAPTER 14