Long-Term Liabilities
Chapter 13
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1
Objective 1
Account for bonds payable
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2
Bonds: An Introduction
• Groups of notes payable issued to multiple
lenders
• Principal (maturity value, par value)
• Maturity date
• Stated interest rate
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3
Types of Bonds
• Term bonds - mature at a single specified
future date
• Serial bonds - mature in installments
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4
Types of Bonds
• Secured bonds - specific assets are
pledged as collateral
• Debenture bonds - backed by the good
faith of the issuer
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5
Bond Prices
• Maturity value (par)
• Discount
• Premium
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6
Bond Prices
Quoted as percent of its face value
• What is the issue price of a $1,000 bond sold at
98?
$1,000 x .98 = $980
• What is the issue price of a $5,000 bond sold at
101?
$5,000 x 1.01 = $5,050
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7
Present Value
• Time value of money
• Amount a person would invest today to
receive a greater amount in the future
• Difference between present value and
future value = Interest
Yr 1
Yr 2
Yr 3
Yr 4
Yr 5
Yr 6
Future Value
$100,000
Present Value
$97,000
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8
Bond Interest Rates
• Stated interest rate
– Printed on bond
– Determines cash interest payments
• Market interest rate (effective rate)
– Rate in effect when bonds are issued
– Rate investors demand for loaning money
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Bond Interest Rates
Bond Stated Rate = 9%
Market Rate =
8%
Market Rate =
9%
Market Rate =
10%
Bonds Sell at
a Premium
Bonds Sell At
Par (Face)
Bonds Sell at
a Discount
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10
Issuing Bonds at Par
E13-17
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
2006
Mar 31 Cash
Bonds Payable
400,000
Sep 30 Interest Expense
Cash
14,000
400,000
14,000
Interest = 400,000 x .07 x ½ = 14,000
Dec 31 Interest Expense
Interest Payable
7,000
7,000
Interest = 400,000 x .07 x 3/12 = 7,000
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E13-17
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
2007
Mar 31 Interest Expense
Interest Payable
Cash
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7,000
7,000
14,000
12
E13-18 a
GENERAL JOURNAL
DATE
DESCRIPTION
REF
Jan 1 Cash
Bonds Payable
Jul
1 Interest Expense
Cash
DEBIT
CREDIT
50,000
50,000
1,500
1,500
Cash = $50,000 x 6% x ½ = $1,500
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13
Objective 2
Measure interest expense by the
straight-line amortization method
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14
Bond Discount – E13-18 b
GENERAL JOURNAL
DATE
DESCRIPTION
REF
Jan 1 Cash
Discount on Bonds Payable
Bonds Payable
DEBIT
CREDIT
47,500
2,500
50,000
Contra-Liability
Account
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15
Balance Sheet Presentation as of
January 1
Long-term liabilities:
Bond payable
Less Discount on Bonds
$50,000
2,500
$47,500
Face Value
Carrying Value
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Straight-Line Amortization
E13-18 b
GENERAL JOURNAL
DATE
DESCRIPTION
REF
Jan 1 Cash
Discount on Bonds Payable
Bonds Payable
Jul
DEBIT
CREDIT
47,500
2,500
50,000
1 Interest Expense
125
Discount on Bonds
Payable
125
Amortization of discount = $2,500 / 20 periods
1 Interest Expense
1,500
Cash
1,500
Cash = $50,000 x 6% x ½ = $1,500
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Balance Sheet Presentation
January 1
Long-term liabilities:
Bond payable
$50,000
Less Discount on
Bonds
2,500
$ 47,500
July 1
Long-term liabilities:
Bond payable
$50,000
Less Discount on
Bonds
2,375
$ 47,625
Notice that the carrying value of the
bond increases, approaching the face
value
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18
Bond Premium – E13-18 c
GENERAL JOURNAL
DATE
DESCRIPTION
REF
Jan 1 Cash
Premium on Bonds
Payable
Bonds Payable
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DEBIT
CREDIT
52,500
2,500
50,000
19
Balance Sheet Presentation as of
January 1
Long-term liabilities:
Bond payable
Plus Premium on Bonds
$50,000
2,500
$52,500
Face Value
Carrying Value
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Straight-Line Amortization
E13-18 c
GENERAL JOURNAL
DATE
DESCRIPTION
REF
Jan 1 Cash
Premium on Bonds
Payable
Bonds Payable
Jul
DEBIT
CREDIT
52,500
2,500
50,000
1 Premium on Bonds Payable
125
Interest Expense
Amortization
of premium = $2,500 / 20 periods 125
1 Interest Expense
Cash
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1,500
1,500
21
Balance Sheet Presentation
January 1
Long-term liabilities:
Bond payable
$50,000
Plus Premium on
Bonds
2,500
$52,500
July 1
Long-term liabilities:
Bond payable
$50,000
Plus Premium on
Bonds
2,375
$52,375
Notice that the carrying value of
the bond decreases,
approaching the face value
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22
Adjusting Entries
• When bonds are issued at a discount or
premium, accrual includes amortization
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23
Issuing Bonds Payable
Between Interest Dates
• Bonds can be issued between interest
payment dates
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24
Exercise 13-21
April 30
Bond Date
May 31
Issue Date
Investor pays face value +
Accrued interest
$100,000 + $500
($100,000 x 6% x 1/12)
Oct 31
Interest
Payment
Date
Corp. pays full 6 months’
of interest of $3,000
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25
Exercise 13-21
GENERAL JOURNAL
DATE
DESCRIPTION
REF
May 31 Cash
Bonds Payable
Interest Payable
Oct 31 Interest Expense
Interest Payable
Cash
DEBIT
CREDIT
100,500
100,000
500
2,500
500
3,000
Interest payable =
$100,000 x .06 x 1/12
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Objective 3
Account for retirement and
conversion of bonds payable
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Bonds Features
• Convertible bonds - bondholders can
convert bonds into common stock
• Callable bonds
– Corporation can call and retire bonds before
maturity date
– Corporation usually pays a “call price” which
is a few percentage points above par value
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Retirement of Bonds Payable
• To retire a bond early, issuer can
– Purchase bonds in the open market
– Exercise a call option
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Early Retirement of Bonds
• Record interest expense and amortize discount
or premium up to retirement date
• If carrying value of bond > cash paid = gain on
early retirement of bonds
• If carrying value of bond < cash paid = loss on
early retirement of bonds
• Gains or losses on early retirement of debt (if
material in amount) are extraordinary items
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30
E13-24
Discount on bonds
Bonds payable
200,000
12,000
200,000 x ½
12,000 x ½
Carrying value of bonds
Bonds payable
100,000
Less discount
(6,000)
94,000
Cash paid to retire debt
100,000 x 1.01 = 101,000
Loss of 7,000
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31
E13-24 (1)
GENERAL JOURNAL
DATE
DESCRIPTION
REF
Oct 1 Bonds Payable
Loss on Retirement of Bonds
Payable
Discount on Bonds
Payable
Cash
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DEBIT
CREDIT
100,000
7,000
6,000
101,000
32
Convertible Bonds
• Holder has option of exchanging bond for
specified number of shares of common
stock
• When converted - stockholders’ equity
increased by carrying amount of bonds
converted
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The bondholders would convert their
bonds into stock when the market
value of the stock to be received from
GENERAL JOURNAL
conversion exceeds the
market value
DESCRIPTION
REF
DEBIT
CREDIT
ofDATE
the bonds
Oct 1 Bonds Payable
100,000
Discount on Bonds
Payable
6,000
Common Stock
10,000
Paid-in Capital in Excess
of Par, Common
84,000
E13-24 (2)
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34
Objective 4
Report liabilities on the balance
sheet
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Reporting Liabilities
• Current:
– Interest Payable
– Current portions of long-term liabilities
• Long-term:
– Mortgage Payable
– Capital Lease Payable
– Bonds Payable
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Exercise 13-25
Current liabilities:
Accounts payable…………………….$ 50,000
Bonds payable, current……………… 20,000
Salary payable……………………….. 10,000
Income tax payable………………….. 8,000
Interest payable……………….…..…. 7,000
Total current liabilities……………… $95,000
Long-term liabilities:
Bonds payable……………….……... $180,000
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37
Objective 5
Show the advantages and
disadvantages of borrowing
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Advantages of Bonds
• Do not affect stockholder control
• Interest on bonds is tax deductible
• Can increase return on equity
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Disadvantages of Bonds
• Require payment of both periodic interest
and par value at maturity
• Can decrease return on equity when
company pays more in interest than it
earns on the borrowed funds
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40
End of Chapter 13
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