Slide
10-1
Chapter
10
Liabilities
Financial Accounting,
Seventh Edition
Slide
10-2
Study Objectives
Slide
10-3
1.
Explain a current liability, and identify the major types of
current liabilities.
2.
Describe the accounting for notes payable.
3.
Explain the accounting for other current liabilities.
4.
Explain why bonds are issued, and identify the types of bonds.
5.
Prepare the entries for the issuance of bonds and interest
expense.
6.
Describe the entries when bonds are redeemed or converted.
7.
Describe the accounting for long-term notes payable.
8.
Identify the methods for the presentation and analysis of
long-term liabilities.
Liabilities
Current Liabilities
Slide
10-4
Long-Term Liabilities
Notes payable
Bond basics
Sales taxes payable
Accounting for bond issues
Payroll and payroll taxes
Unearned revenues
Accounting for bond
retirements
Current maturities of longterm debt
Accounting for long-term
notes payable
Statement presentation and
analysis
Statement presentation and
analysis
Section 1 Current Liabilities
What is a Current Liability?
Current liability is debt with two key features:
1.
Company expects to pay the debt from existing
current assets or through the creation of other
current liabilities.
2. Company will pay the debt within one year or the
operating cycle, whichever is longer.
Current liabilities include notes payable, accounts payable, unearned
revenues, and accrued liabilities such as taxes payable, salaries payable,
and interest payable.
Slide
10-5
SO 1 Explain a current liability, and identify
the major types of current liabilities.
What is a Current Liability?
Question
To be classified as a current liability, a debt must be
expected to be paid:
a. out of existing current assets.
b. by creating other current liabilities.
c. within 2 years.
d. both (a) and (b).
Slide
10-6
SO 1 Explain a current liability, and identify
the major types of current liabilities.
What is a Current Liability?
Notes Payable
Written promissory note.
Require the borrower to pay interest.
Issued for varying periods.
Slide
10-7
SO 2 Describe the accounting for notes payable.
What is a Current Liability?
Illustration: On March 1, 2011, Cole Williams borrows
$100,000 from First National Bank on a 4-month, 12% note.
Instructions
a) Prepare the entry on March 1.
b) Prepare the adjusting entry on June 30, assuming
monthly adjusting entries have not been made.
c) Prepare the entry at maturity (July 1).
Slide
10-8
SO 2 Describe the accounting for notes payable.
What is a Current Liability?
Illustration: On March 1, 2011, Cole Williams borrows
$100,000 from First National Bank on a 4-month, 12% note.
a) Prepare the entry on March 1.
Cash
100,000
Notes payable
100,000
b) Prepare the adjusting entry on June 30.
$100,000 x 12% x 4/12 = $4,000
Interest expense
Interest payable
Slide
10-9
4,000
4,000
SO 2 Describe the accounting for notes payable.
What is a Current Liability?
Illustration: On March 1, 2011, Cole Williams borrows
$100,000 from First National Bank on a 4-month, 12% note.
c) Prepare the entry at maturity (July 1).
Notes payable
Interest payable
Cash
Slide
10-10
100,000
4,000
104,000
SO 2 Describe the accounting for notes payable.
What is a Current Liability?
Sales Tax Payable
Sales taxes are expressed as a stated percentage
of the sales price.
Either rung up separately or included in total
receipts.
Retailer collects tax from the customer.
Retailer remits the collections to the state’s
department of revenue.
Slide
10-11
SO 3 Explain the accounting for other current liabilities.
What is a Current Liability?
Illustration: The March 25 cash register reading for
Cooley Grocery shows sales of $10,000 and sales taxes of
$600 (sales tax rate of 6%), the journal entry is:
Cash
10,600
Sales
10,000
Sales tax payable
Slide
10-12
600
SO 3 Explain the accounting for other current liabilities.
What is a Current Liability?
Payroll and Payroll Taxes Payable
The term “payroll” pertains to both:
Salaries - managerial, administrative, and sales
personnel (monthly or yearly rate).
Wages - store clerks, factory employees, and manual
laborers (rate per hour).
Determining the payroll involves computing three
amounts: (1) gross earnings, (2) payroll deductions, and
(3) net pay.
Slide
10-13
SO 3 Explain the accounting for other current liabilities.
What is a Current Liability?
Illustration: Assume a corporation records its payroll
for the week of March 7 as follows:
Mar. 7 Salaries and wages expense
FICA tax payable
Federal income tax payable
State income tax payable
Salaries and wages payable
100,000
7,650
21,864
2,922
67,564
Record the payment of this payroll on March 11.
Mar. 11 Salaries and wages payable
Cash
Slide
10-14
67,564
67,564
SO 3 Explain the accounting for other current liabilities.
What is a Current Liability?
Payroll tax expense results from three taxes that
governmental agencies levy on employers.
These taxes are:
FICA tax
Federal unemployment tax
State unemployment tax
Slide
10-15
SO 3 Explain the accounting for other current liabilities.
What is a Current Liability?
Illustration: Based on the corporation’s $100,000
payroll, the company would record the employer’s
expense and liability for these payroll taxes as follows.
Payroll tax expense
13,850
FICA tax payable
Federal unemployment tax payable
State unemployment tax payable
Slide
10-16
7,650
800
5,400
SO 3 Explain the accounting for other current liabilities.
What is a Current Liability?
Question
Employer payroll taxes do not include:
a. Federal unemployment taxes.
b. State unemployment taxes.
c. Federal income taxes.
d. FICA taxes.
Slide
10-17
SO 3 Explain the accounting for other current liabilities.
Slide
10-18
What is a Current Liability?
Unearned Revenue
Revenues that are received before the company
delivers goods or provides services.
1. Company debits Cash, and
credits a current liability
account (unearned revenue).
2. When the company earns the
revenue, it debits the
Unearned Revenue account, and
credits a revenue account.
Slide
10-19
SO 3 Explain the accounting for other current liabilities.
What is a Current Liability?
Illustration: Assume that Superior University sells 10,000
season football tickets at $50 each for its five-game home
schedule. The university makes the following entry for the
sale of season tickets:
Aug. 6
Cash
Unearned revenue
500,000
500,000
As the school completes each of the five home games, it
would record the revenue earned.
Sept. 7
Slide
10-20
Unearned revenue
Ticket revenue
100,000
100,000
SO 3 Explain the accounting for other current liabilities.
What is a Current Liability?
Current Maturities of Long-Term Debt
Portion of long-term debt that comes due in the
current year.
No adjusting entry required.
Slide
10-21
SO 3 Explain the accounting for other current liabilities.
Statement Presentation and Analysis
Illustration 10-5
Slide
10-22
SO 3
Statement Presentation and Analysis
Question
Working capital is calculated as:
a. current assets minus current liabilities.
b. total assets minus total liabilities.
c. long-term liabilities minus current liabilities.
d. both (b) and (c).
Slide
10-23
SO 3 Explain the accounting for other current liabilities.
Statement Presentation and Analysis
Analysis
Illustration 10-6
The current ratio
permits us to compare
the liquidity of
different-sized
companies and of a single
company at different
times.
Slide
10-24
Liquidity refers to the
ability to pay maturing
obligations and meet
unexpected needs for
cash.
Illustration 10-7
SO 3 Explain the accounting for other current liabilities.
Section 2 Long-Term Liabilities
Bond Basics
Bonds are a form of interest-bearing notes
payable.
Three advantages over common stock:
1.
Stockholder control is not affected.
2. Tax savings result.
3. Earnings per share may be higher.
Slide
10-25
SO 4 Explain why bonds are issued, and identify the types of bonds.
Bond Basics
Effects on earnings per share—stocks vs. bonds.
Illustration 10-9
Slide
10-26
SO 4 Explain why bonds are issued, and identify the types of bonds.
Bond Basics
Question
The major disadvantages resulting from the use of
bonds are:
a. that interest is not tax deductible and the
principal must be repaid.
b. that the principal is tax deductible and interest
must be paid.
c. that neither interest nor principal is tax
deductible.
d. that interest must be paid and principal repaid.
Slide
10-27
SO 4 Explain why bonds are issued, and identify the types of bonds.
Bond Basics
Types of Bonds
Secured and Unsecured (debenture) bonds.
Term and Serial bonds.
Registered and Bearer (or coupon) bonds.
Convertible and Callable bonds.
Slide
10-28
SO 4 Explain why bonds are issued, and identify the types of bonds.
Bond Basics
Issuing Procedures
Bond contract known as a bond indenture.
Represents a promise to pay:
(1) sum of money at designated maturity date, plus
(2) periodic interest at a contractual (stated) rate on the
maturity amount (face value).
Paper certificate, typically a $1,000 face value.
Interest payments usually made semiannually.
Generally issued when the amount of capital needed is
too large for one lender to supply.
Slide
10-29
SO 4 Explain why bonds are issued, and identify the types of bonds.
Bond Basics
Issuer of
Bonds
Illustration 10-10
Maturity
Date
2013
DUE 2013
DUE 2013
Contractual
Interest
Rate
Slide
10-30
Face or
Par Value
SO 4
Bond Basics
Bond Trading
Bonds traded on national securities exchanges.
Newspapers and the financial press publish bond prices
and trading activity daily.
Read as: Outstanding 5.125%, $1,000 bonds that mature in 2014.
Currently yield a 5.747% return. On this day, $33,965,000 of
these bonds were traded. Closing price was 96.595% of face value,
or $965.95.
Slide
10-31
SO 4 Explain why bonds are issued, and identify the types of bonds.
Bond Basics
Determining the Market Value of Bonds
Market value is a function of the three factors that
determine present value:
1. the dollar amounts to be received,
2. the length of time until the amounts are received, and
3. the market rate of interest.
The features of a bond (callable, convertible, and so on) affect
the market rate of the bond.
Slide
10-32
SO 4 Explain why bonds are issued, and identify the types of bonds.
Slide
10-33
SO 4 Explain why bonds are issued, and identify the types of bonds.
Accounting for Bond Issues
Question
The rate of interest investors demand for loaning
funds to a corporation is the:
a. contractual interest rate.
b. face value rate.
c. market interest rate.
d. stated interest rate.
Slide
10-34
SO 4 Explain why bonds are issued, and identify the types of bonds.
Accounting for Bond Issues
Question
Karson Inc. issues 10-year bonds with a maturity value of
$200,000. If the bonds are issued at a premium, this
indicates that:
a. the contractual interest rate exceeds the market
interest rate.
b. the market interest rate exceeds the contractual
interest rate.
c. the contractual interest rate and the market
interest rate are the same.
d. no relationship exists between the two rates.
Slide
10-35
SO 4 Explain why bonds are issued, and identify the types of bonds.
Accounting for Bond Issues
Issuing Bonds at Face Value
Illustration: On January 1, 2011, Candlestick
Corporation issues $100,000, five-year, 10% bonds at
100 (100% of face value). The entry to record the sale
is:
Jan. 1
Cash
Bonds payable
Slide
10-36
100,000
100,000
SO 4 Explain why bonds are issued, and identify the types of bonds.
Issuing Bonds at Face Value
Illustration: On January 1, 2011, Candlestick
Corporation issues $100,000, five-year, 10% bonds at
100 (100% of face value). Assume that interest is
payable semiannually on January 1 and July 1. Prepare
the entry to record the payment of interest on July 1,
2011, assume no previous accrual.
July 1
Bond interest expense
Cash
Slide
10-37
5,000
5,000
SO 4 Explain why bonds are issued, and identify the types of bonds.
Issuing Bonds at Face Value
Illustration: On January 1, 2011, Candlestick
Corporation issues $100,000, five-year, 10% bonds at
100 (100% of face value). Assume that interest is
payable semiannually on January 1 and July 1. Prepare
the entry to record the accrual of interest on
December 31, 2011, assume no previous accrual.
Dec. 31
Bond interest expense
Bond interest payable
Slide
10-38
5,000
5,000
SO 4 Explain why bonds are issued, and identify the types of bonds.
Accounting for Bond Issues
Assume Contractual Rate of 8%
Slide
10-39
Market Interest
Bonds Sold At
6%
Premium
8%
Face Value
10%
Discount
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Accounting for Bond Issues
Issuing Bonds at a Discount
Illustration: On January 1, 2011, Candlestick, Inc. sells
$100,000, five-year, 10% bonds for $92,639 (92.639%
of face value). Interest is payable on July 1 and
January 1. The entry to record the issuance is:
Jan. 1
Cash
Discount on bonds payable
Bond payable
Slide
10-40
92,639
7,361
100,000
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing Bonds at a Discount
Statement Presentation
Illustration 10-13
Slide
10-41
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing Bonds at a Discount
Total Cost of Borrowing
Illustration 10-14
Illustration 10-15
Slide
10-42
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing Bonds at a Discount
Question
Discount on Bonds Payable:
a. has a credit balance.
b. is a contra account.
c. is added to bonds payable on the balance sheet.
d. increases over the term of the bonds.
Slide
10-43
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Accounting for Bond Issues
Issuing Bonds at a Premium
Illustration: On January 1, 2011, Candlestick, Inc. sells
$100,000, five-year, 10% bonds for $108,111 (108.111%
of face value). Interest is payable on July 1 and
January 1. The entry to record the issuance is:
Jan. 1
Cash
Bonds payable
Premium on bond payable
Slide
10-44
108,111
100,000
8,111
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing Bonds at a Premium
Statement Presentation
Illustration 10-16
Issuing bonds at an amount different from face value is
quite common. By the time a company prints the bond
certificates and markets the bonds, it will be a coincidence
if the market rate and the contractual rate are the same.
Slide
10-45
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Issuing Bonds at a Premium
Total Cost of Borrowing
Illustration 10-17
Illustration 10-18
Slide
10-46
SO 5 Prepare the entries for the issuance of bonds and interest expense.
Accounting for Bond Retirements
Redeeming Bonds at Maturity
Assuming that the company pays and records separately
the interest for the last interest period, Candlestick
records the redemption of its bonds at maturity as
follows:
Bond payable
Cash
Slide
10-47
100,000
100,000
SO 6 Describe the entries when bonds are redeemed or converted.
Accounting for Bond Retirements
Redeeming Bonds before Maturity
When a company retires bonds before maturity, it is
necessary to:
1. eliminate the carrying value of the bonds at the
redemption date;
2. record the cash paid; and
3. recognize the gain or loss on redemption.
The carrying value of the bonds is the face value of the bonds
less unamortized bond discount or plus unamortized bond premium
at the redemption date.
Slide
10-48
SO 6 Describe the entries when bonds are redeemed or converted.
Accounting for Bond Retirements
Question
When bonds are redeemed before maturity, the gain
or loss on redemption is the difference between the
cash paid and the:
a. carrying value of the bonds.
b. face value of the bonds.
c. original selling price of the bonds.
d. maturity value of the bonds.
Slide
10-49
SO 6 Describe the entries when bonds are redeemed or converted.
Accounting for Bond Retirements
Illustration: Assume Candlestick, Inc. has sold its bonds at a
premium. At the end of the eighth period, Candlestick
retires these bonds at 103 after paying the semiannual
interest. The carrying value of the bonds at the redemption
date is $101,623. Candlestick makes the following entry to
record the redemption at the end of the eighth interest
period (January 1, 2015):
Bonds payable
Premium on bonds payable
1,623
Loss on redemption
1,377
Cash
Slide
10-50
100,000
103,000
SO 6 Describe the entries when bonds are redeemed or converted.
Accounting for Bond Retirements
Converting Bonds into Common Stock
Until conversion, the bondholder receives interest on the
bond.
For the issuer, the bonds sell at a higher price and pay a
lower rate of interest than comparable debt securities
without the conversion option.
Upon conversion, the company transfers the carrying value
of the bonds to paid-in capital accounts. No gain or loss is
recognized.
Slide
10-51
SO 6 Describe the entries when bonds are redeemed or converted.
Accounting for Bond Retirements
Illustration: Assume that on July 1 Saunders Associates
converts $100,000 bonds sold at face value into 2,000
shares of $10 par value common stock. Both the bonds and
the common stock have a market value of $130,000.
Saunders makes the following entry to record the
conversion:
Bonds payable
Slide
10-52
100,000
Common stock (2,000 x $10)
20,000
Paid-in capital in excess of par
80,000
SO 6 Describe the entries when bonds are redeemed or converted.
Accounting for Bond Retirements
Question
When bonds are converted into common stock:
a. a gain or loss is recognized.
b. the carrying value of the bonds is transferred
to paid-in capital accounts.
c. the market price of the stock is considered in
the entry.
d. the market price of the bonds is transferred to
paid-in capital.
Slide
10-53
SO 6 Describe the entries when bonds are redeemed or converted.
Accounting for Long-Term Notes Payable
Long-Term Notes Payable
May be secured by a mortgage that pledges title to
specific assets as security for a loan
Typically, the terms require the borrower to make
installment payments over the term of the loan. Each
payment consists of
1.
interest on the unpaid balance of the loan and
2. a reduction of loan principal.
Companies initially record mortgage notes payable at
face value.
Slide
10-54
SO 7 Describe the accounting for long-term notes payable.
Accounting for Long-Term Notes Payable
Illustration: Porter Technology Inc. issues a $500,000, 12%,
20-year mortgage note on December 31, 2011. The terms
provide for semiannual installment payments of $33,231 (not
including real estate taxes and insurance). The installment
payment schedule for the first two years is as follows.
Illustration 10-19
Slide
10-55
SO 7 Describe the accounting for long-term notes payable.
Accounting for Long-Term Notes Payable
Illustration: Porter Technology Inc. issues a $500,000, 12%,
20-year mortgage note on December 31, 2011. The terms
provide for semiannual installment payments of $33,231 (not
including real estate taxes and insurance). The installment
payment schedule for the first two years is as follows.
Dec. 31
Jun. 30
Slide
10-56
Cash
Mortgage notes payable
Interest expense
Mortgage notes payable
Cash
500,000
500,000
30,000
3,231
33,231
SO 7 Describe the accounting for long-term notes payable.
Accounting for Long-Term Notes Payable
Question
Each payment on a mortgage note payable consists
of:
a. interest on the original balance of the loan.
b. reduction of loan principal only.
c. interest on the original balance of the loan and
reduction of loan principal.
d. interest on the unpaid balance of the loan and
reduction of loan principal.
Slide
10-57
SO 7 Describe the accounting for long-term notes payable.
Slide
10-58
Statement Presentation and Analysis
Presentation
Illustration 10-20
Slide
10-59
SO 8 Identify the methods for the presentation
and analysis of long-term liabilities.
Statement Presentation and Analysis
Analysis
Two ratios that provide information about debtpaying ability and long-run solvency are:
1.
Debt to
total assets
=
Total debt
Total assets
The higher the percentage of debt to total assets,
the greater the risk that the company may be
unable to meet its maturing obligations.
Slide
10-60
SO 8 Identify the methods for the presentation
and analysis of long-term liabilities.
Statement Presentation and Analysis
Analysis
Two ratios that provide information about debtpaying ability and long-run solvency are:
2.
Times
interest
earned
=
Income before income taxes
and interest expense
Interest expense
Indicates the company’s ability to meet interest
payments as they come due.
Slide
10-61
SO 8 Identify the methods for the presentation
and analysis of long-term liabilities.
Statement Presentation and Analysis
Analysis
Illustrate: Kellogg Company had total liabilities of
$8,871 million, total assets of $11,397 million, interest
expense of $319 million, income taxes of $444 million,
and net income of $1,103 million.
Illustration 10-21
Slide
10-62
SO 8 Identify the methods for the presentation
and analysis of long-term liabilities.
Slide
10-63
Your Boss Wants to Know if you Ran Today
 For employers, the average cost of healthcare benefits per
employee is about $6,700 per year.
 The rate of increase of employer healthcare costs has slowed
somewhat as employers raised the employee share of premiums
and raised deductibles (the amount of a bill that the employee
pays before insurance coverage begins).
Slide
10-64
 In 2008, it is estimated that the percentage of persons that did
not have health insurance was 14.5% (43.3 million) for persons of
all ages. Approximately 19.4% of persons under 65 years of age
were covered by public health plans, and 65.5% were covered by
private insurance.
 Government is expected to become the largest source of funding
for health care by 2016 and is projected to pay more than half of
all national health spending by 2018.
 As a percentage of payroll, the employer cost of health benefits
has exploded over the past few decades. In addition, employer
health costs for manufacturing firms in the U.S., $2.38 per
worker per hour, were much higher than the foreign tradeweighted average of $0.96 per worker per hour in 2005. Employer
health costs make the U.S. less competitive than it could
otherwise be.
Slide
10-65
 The costs and performance of America’s healthcare system are
putting workers and companies at a “significant disadvantage” in
the global marketplace. The Business Roundtable, whose member
companies provide healthcare plans for more than 35 million
Americans, finds that compared with people in Canada, Japan,
Germany, the United Kingdom, and France, Americans receive 23%
less value from their healthcare system. When compared with
emerging competitors like Brazil, India, and China, the U.S.
receives 46% less value. This study finds that for every $1 the
U.S. spends on health care, its five leading competitors spend
$0.63, and the emerging competitors just $0.15. The study also
notes that “on the whole, our workforce is not as healthy” as that
of either group of competitors.
Slide
10-66
As the graph below
shows, private health
insurance, such as that
provided by
employers, pays for less
than half of healthcare
costs in the U.S. If
employers
continue to cut their
healthcare benefits,
more of the burden will
shift to the
government or to
individuals as out-ofpocket costs.
Slide
10-67
Suppose you own a business. About a quarter of your employees
smoke, and an even higher percentage are overweight. You decide
to implement a mandatory health program that requires employees
to quit smoking and to exercise regularly, with regular monitoring.
If employees do not participate in the program, they will have to
pay their own insurance premiums. Is this fair?
YES: It is the responsibility of management to try to maximize
a company’s profit. Employees with unhealthy habits drive up the
cost of health insurance because they require more frequent and
more costly medical attention.
NO: What people do on their own time is their own business.
This represents an invasion of privacy, and is a form of
discrimination.
Slide
10-68
Present Value Concepts Related to Bond Pricing
Present Value of Face Value
Appendix 10A
To illustrate present value concepts, assume that you are
willing to invest a sum of money that will yield $1,000 at
the end of one year, and you can earn 10% on your money.
What is the $1,000 worth today?
To compute the answer,
Slide
10-69

divide the future amount by 1 plus the interest rate
($1,000/1.10 = $909.09 OR

use a Present Value of 1 table. ($1,000 X .90909) =
$909.09 (10% per period, one period from now).
SO 9 Compute the market price of a bond.
Present Value Concepts Related to Bond Pricing
Present Value of Face Value
To compute the answer,

divide the future amount by 1 plus the interest rate
($1,000/1.10 = $909.09.
Illustration 10A-1
Slide
10-70
SO 9 Compute the market price of a bond.
Present Value Concepts Related to Bond Pricing
Present Value of Face Value
To compute the answer,

use a Present Value of 1 table. ($1,000 X .90909) =
$909.09 (10% per period, one period from now).
TABLE 10A-1
Slide
10-71
SO 9 Compute the market price of a bond.
Present Value Concepts Related to Bond Pricing
Present Value of Face Value
The future amount ($1,000), the interest rate (10%), and
the number of periods (1) are known
Illustration 10A-2
Slide
10-72
SO 9 Compute the market price of a bond.
Present Value Concepts Related to Bond Pricing
Present Value of Face Value
If you are to receive the single future amount of $1,000
in two years, discounted at 10%, its present value is
$826.45 [($1,000 1.10) 1.10].
Illustration 10A-3
Slide
10-73
SO 9 Compute the market price of a bond.
Present Value Concepts Related to Bond Pricing
Present Value of Face Value
To compute the answer using a Present Value of 1 table.
($1,000 X .82645) = $826.45 (10% per period, two
periods from now).
TABLE 10A-1
Slide
10-74
SO 9 Compute the market price of a bond.
Present Value Concepts Related to Bond Pricing
Present Value of Interest Payments (Annuities)
In addition to receiving the face value of a bond at
maturity, an investor also receives periodic interest
payments (annuities) over the life of the bonds.
To compute the present value of an annuity, we need to
know:
1)
interest rate,
2) number of interest periods, and
3) amount of the periodic receipts or payments.
Slide
10-75
SO 9 Compute the market price of a bond.
Present Value Concepts Related to Bond Pricing
Present Value of Interest Payments (Annuities)
Assume that you will receive $1,000 cash annually for
three years and the interest rate is 10%.
Illustration 10A-5
Slide
10-76
SO 9 Compute the market price of a bond.
Present Value Concepts Related to Bond Pricing
Present Value of Interest Payments (Annuities)
Assume that you will receive $1,000 cash annually for
three years and the interest rate is 10%.
Illustration 10A-6
Slide
10-77
SO 9 Compute the market price of a bond.
Present Value Concepts Related to Bond Pricing
Present Value of Interest Payments (Annuities)
Assume that you will receive $1,000 cash annually for
three years and the interest rate is 10%.
TABLE 10A-2
$1,000 annual payment x 2.48685 = $2,486.85
Slide
10-78
SO 9 Compute the market price of a bond.
Present Value Concepts Related to Bond Pricing
Computing the Present Value of a Bond
The selling price of a bond is equal to the sum of:
1) The present value of the face value of the bond
discounted at the investor’s required rate of return
PLUS
2) The present value of the periodic interest payments
discounted at the investor’s required rate of return
Slide
10-79
SO 9 Compute the market price of a bond.
Present Value Concepts Related to Bond Pricing
Assume a bond issue of 10%, five-year bonds with a face
value of $100,000 with interest payable semiannually on
January 1 and July 1.
Illustration 10A-8
Slide
10-80
SO 9 Compute the market price of a bond.
Present Value Concepts Related to Bond Pricing
Assume a bond issue of 10%, five-year bonds with a face
value of $100,000 with interest payable semiannually on
January 1 and July 1.
Illustration 10A-9
Contractual Rate = Discount Rate
Slide
10-81
Issued at Face Value
SO 9 Compute the market price of a bond.
Present Value Concepts Related to Bond Pricing
Assume a bond issue of 10%, five-year bonds with a face
value of $100,000 with interest payable semiannually on
January 1 and July 1.
Illustration 10A-10
Contractual Rate < Discount Rate
Slide
10-82
Issued at a Discount
SO 9 Compute the market price of a bond.
Present Value Concepts Related to Bond Pricing
Assume a bond issue of 10%, five-year bonds with a face
value of $100,000 with interest payable semiannually on
January 1 and July 1.
Illustration 10A-11
Contractual Rate > Discount Rate
Slide
10-83
Issued at a Premium
SO 9 Compute the market price of a bond.
Effective-Interest Method of Bond Amortization
Appendix 10B
Under the effective-interest method, the amortization
of bond discount or bond premium results in period
interest expense equal to a constant percentage of the
carrying value of the bonds.
Required steps:
1. Compute the bond interest expense.
2. Compute the bond interest paid or accrued.
3. Compute the amortization amount.
Slide
10-84
SO 10 Apply the effective-interest method of
amortizing bond discount and bond premium.
Effective-Interest Method of Bond Amortization
Amortizing Bond Discount
Assume Candlestick, Inc. issues $100,000 of 10%, five-year
bonds on January 1, 2011, for $92,639, with interest payable
each July 1 and January 1. This results in a discount of $7,361.
Illustration 10B-2
Slide
10-85
SO 10 Apply the effective-interest method of
amortizing bond discount and bond premium.
Effective-Interest Method of Bond Amortization
Amortizing Bond Discount
Assume Candlestick, Inc. issues $100,000 of 10%, five-year
bonds on January 1, 2011, for $92,639, with interest payable
each July 1 and January 1. This results in a discount of $7,361.
Journal entry on July 1, 2011, to record the interest payment
and amortization of discount is as follows:
July 1
Interest Expense
Cash
5,000
Discount on Bonds Payable
Slide
10-86
5,558
558
SO 10 Apply the effective-interest method of
amortizing bond discount and bond premium.
Effective-Interest Method of Bond Amortization
Amortizing Bond Premium
Assume Candlestick, Inc. issues $100,000 of 10%, five-year
bonds on January 1, 2011, for $108,111, with interest payable
each July 1 and January 1. This results in a premium of $8,111.
Illustration 10B-4
Slide
10-87
SO 10 Apply the effective-interest method of
amortizing bond discount and bond premium.
Effective-Interest Method of Bond Amortization
Amortizing Bond Premium
Assume Candlestick, Inc. issues $100,000 of 10%, five-year
bonds on January 1, 2011, for $108,111, with interest payable
each July 1 and January 1. This results in a premium of $8,111.
Journal entry on July 1, 2011, to record the interest payment
and amortization of premium is as follows:
July 1
Interest Expense
Premium on Bonds Payable
Cash
Slide
10-88
4,324
676
5,000
SO 10 Apply the effective-interest method of
amortizing bond discount and bond premium.
Straight-Line Amortization
Amortizing Bond Discount
Appendix 10C
Candlestick, Inc., sold $100,000, five-year, 10% bonds on
January 1, 2011, for $92,639 (discount of $7,361). Interest is
payable on July 1 and January 1. The bond discount amortization
for each interest period is $736 ($7,361/10).
Illustration 10C-2
Slide
10-89
SO 11 Apply the straight-line method of amortizing
bond discount and bond premium.
Straight-Line Amortization
Amortizing Bond Discount
Candlestick, Inc., sold $100,000, five-year, 10% bonds on
January 1, 2011, for $92,639 (discount of $7,361). Interest is
payable on July 1 and January 1. The bond discount amortization
for each interest period is $736 ($7,361/10).
Journal entry on July 1, 2011, to record the interest payment
and amortization of discount is as follows:
July 1
Interest Expense
Discount on Bonds Payable
Cash
Slide
10-90
5,736
736
5,000
SO 11 Apply the straight-line method of amortizing
bond discount and bond premium.
Copyright
“Copyright © 2010 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted
in Section 117 of the 1976 United States Copyright Act without
the express written permission of the copyright owner is
unlawful. Request for further information should be addressed
to the Permissions Department, John Wiley & Sons, Inc. The
purchaser may make back-up copies for his/her own use only
and not for distribution or resale. The Publisher assumes no
responsibility for errors, omissions, or damages, caused by the
use of these programs or from the use of the information
contained herein.”
Slide
10-91