Long-Term Liabilities
Chapter 15
Bonds: An Introduction
Groups of notes payable issued to
multiple lenders
• principal
• interest rate
• interest payment dates
Advantages of Bonds
• Do not affect stockholder control.
• Interest on bonds is tax deductible.
• Can increase return on equity.
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.
Types of Bonds
• Secured bonds
• Unsecured bonds
Types of Bonds
• Term Bonds
• Serial Bonds
Types of Bonds
• Convertible bonds
• Callable bonds
Bond Issuing Procedures
• Company sells bonds to underwriter
• Underwriter sells bonds to investors
• Trustee monitors bond issue
Bond Prices
Quoted as percent of its face value.
• What is the issue price of a $2,000 bond sold at
98-1/4?
$2,000 x .9825 = $1,965
• What is the issue price of a $6,000 bond sold at
101-1/2
$6,000 x 1.015 = $6,090
Bond Prices
Affected by...
– time to maturity.
– credit rating of issuer.
– interest rate.
Determining the
Market Value of Bonds
A function of three factors:
1) dollar amounts to be received
2) length of time until amounts are
received
3) market rate of interest - rate investors
demand for loaning funds
Determining the Market
Value of a Bond
Couric Company issues bonds with a par
value (face value) of $100,000. The
bonds mature in 3 years and pay 9%
annual interest in semiannual
payments. On the issue date, the
annual market rate for the bonds is
10%. How much is an investor willing to
pay?
Market Value of Bond
1. Determine dollar amounts to be paid in
the future.
2. Determine length of time until amounts
are to be received
3. Determine interest rate investors
demand.
Present value of a bond
1
2
3
4
5
6
$100,000
Present value of a bond
1
2
3
$4,500
$4,500
$4,500
4
$4,500
5
6
$4,500
$4,500
Present Value of a Bond
Present value of $100,000
Present value of annuity of $4,500
Total present value
$74,600
22,842
$97,442
PROBLEM 15A-4 a.
1. Dollar amounts to be paid in future?
 88,000 lump sum
 5,280 interest payments
2. Length of time until amounts are to be
received?
 88,000 in 20 periods
 5,280 semiannually. 20 times
3. What interest rate do investors
demand?
 6% every six months
PROBLEM 15A-4
PV 88,000 = 88,000 x 0.312 =
PVA 5,280 = 5,280 x 11.470 =
$27,456
60,562
$88,018
Note: the present value should be $88,000.
The difference of $18 is due to rounding to
three decimal places in the present value
tables.
PROBLEM 15A-4 b
1. Determine dollar amounts to be paid in the
This is the
future.
only
88,000 lump sum
difference
5,280 interest payments
2. Determine length of time until amounts are to be
received
88,000 in 20 periods
5,280 semiannually. 20 times
3. What interest rate do the investors demand?
7% every six months
PROBLEM 15A-4
PV 88,000 = 88,000 x 0.258 =
PVA 5,280 = 5,280 x 10.594 =
$22,704
55,936
$78,640
Discount
These bonds are issued at a _________
PROBLEM 15A-4
1. Determine dollar amounts to be paid in the
future.
88,000 lump sum
5,280 interest payments
2. Determine length of time until amounts are to be
received
88,000 in 20 periods
5,280 semiannually. 20 times
3. What interest rate do the investors demand?
5% every six months
PROBLEM 15A-4
PV 88,000 = 88,000 x 0.377 =
PVA 5,280 = 5,280 x 12.462 =
$33,176
65,799
$98,975
Premium
These bonds are issued at a _________
Interest rates and bond prices
Issued Market Rates
when:
8%
BOND
CONTRACT
INTEREST
RATE 9%
9%
10%
Bonds Sell at:
Premium
Face (Par)
Value
Discount
Issuing Bonds at Par –
Exercise 15-1
Date
GENERAL JOURNAL
Description
Mar 31 Cash
Bonds Payable
Debit
Credit
500,000
500,000
Sep 30Interest
Interest=Expense
500,000 x .08 x ½20,000
= 20,000
Cash
20,000
Dec 31 Interest Expense
10,000
Interest = 500,000 x .08 x 3/12 = 10,000
Interest Payable
10,000
Exercise 15-4
a.
b.
c.
d.
e.
Discount price
Premium price
Price equal to maturity (par) value
Premium price
Discount price
Bond Discount – Exercise 15-5
Date
GENERAL JOURNAL
Description
Jan 2 Cash
Discount on Bonds Payable
Bonds Payable
Debit
Credit
279,600
20,400
Contra-Liability
Account
300,000
Effective-Interest
Amortization
• Preferred method over straight-line
• When amounts are materially different, GAAP
requires effective-interest method
• Allocates bond interest expense over life of
bonds in a way that yields constant rate of
interest.
• In this course, we will use the effective
interest method
Effective-interest Method
• Interest expense =
Carrying value x market rate of interest
• Cash =
Face Value x stated rate of interest
• Difference is amount of premium or
discount to amortize.
Amortization table
Amortization Table
Semiannual
Discount
Bond
Interest
Interest
Interest
Discount
Account
Carrying
Period
Payment
Expense
Amortization
Balance
Amount
Exercise 15-5
Amortization Table
Semi.
Interest
Interest
Interest
Period Payment Expense
2-Jan-04
2-Jul-04
$10,500 $11,184
2-Jan-05 $10,500 $11,211
Discount
Amort
$684
$711
Discount Bond
Account Carrying
Balance Amount
$20,400 $279,600
19,716 280,284
19,005 280,995
Bond Discount – Exercise 15-5
Date
GENERAL JOURNAL
Description
Jul 2 Interest Expense
Cash
Discount on Bonds
Payable
Debit
Credit
11,184
10,500
684
Balance Sheet Presentation
as of July 2
Long-term liabilities:
Bond payable
Less Discount on Bonds
Face Value
Carrying Value
$300,000
19,716
$280,284
Bond Premium – Exercise 15-6
GENERAL JOURNAL
Description
Date
Mar 31 Cash
Debit
Credit
220,000
Premium on Bonds
Payable
Bonds Payable
Adjunct Account
20,000
200,000
Exercise 15-6
Amortization Table
Semi.
Interest
Interest
Interest
Period
Payment Expense
31-Mar-02
30-Sep-02
$8,000
$7,700
31-Mar-03
$8,000
$7,690
Premium Bond
Premium Account Carrying
Amort
$300
$310
Balance Amount
$20,000 $220,000
19,700 219,700
19,390 219,380
Bond Premium – Exercise 15-6
GENERAL JOURNAL
Description
Date
Sep 30 Interest Expense
Premium on Bonds Payable
Cash
Debit
Credit
7,700
300
8,000
Balance Sheet Presentation
as of Sep 30
Long-term liabilities:
Bond payable
Plus: Premium on bonds
Face Value
Carrying Value
$200,000
19,700
$219,700
Issuing Bonds & Notes
Payable Between Interest
Dates
Exercise 15-9
April 30
Bond Date
May 31
Issue Date
Investor pays face value +
Accrued interest
Oct 31
Interest
Payment
Date
Corp. pays full 6 months’
of interest
Exercise 15-9
Date
GENERAL JOURNAL
Description
Debit
May 31 Cash
Bonds payable
Interest payable
402,000
Oct 31 Interest Expense
Interest Payable
Cash
10,000
2,000
Credit
400,000
2,000
12,000
Retirement of Bonds
Payable
• To retire a bond early, issuer can ...
– purchase bonds in the open market
– exercise a call option
• A call option is …..
Early Retirement of Bonds
• Recognize interest expense and amortize
discount or premium up to date of retirement
• 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
Exercise 15-12 a.
Bonds payable
400,000
Carrying value of bonds
Bonds payable
400,000
Less discount
(12,000)
388,000
Retire half
x½
194,000
Discount on bonds
12,000
Cash paid to retire debt
200,000 x 1.01 = 202,000
Exercise 15-12 - retirement
Date
Oct 1
GENERAL JOURNAL
Description
Bonds payable
Loss on retirement of
bonds payable
Discount on bonds
payable
Cash
Debit
Credit
200,000
8,000
6,000
202,000
Convertible Bonds and
Notes
• 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.
Exercise 15-12 - conversion
Date
Oct
GENERAL JOURNAL
Description
1 Bonds payable
Discount on bonds
payable
Common stock
Paid in capital in
excess of par, common
Debit
Credit
200,000
6,000
50,000
144,000
Current Portion of LongTerm Debt
Report Liabilities on the
Balance Sheet
Reported as either current or long-term
Current Liabilities:
Notes payable, current………$200,000
Long-term Liabilities
Notes payable, long-term…… $300,000
Exercise 15-13
Current liabilities:
Accounts payable………………….$ 50,000
Bonds payable, current…………… 30,000
Salary payable………………………. 14,000
Income tax payable………………….. 8,000
Interest payable……………………… 7,000
Long-term liabilities:
Bonds payable…………………….. $270,000
End of Chapter 15
Problem 15-4A
Problem 15-5A
Problem 15-6A
Problem 15-6B