Chapter 10
Long-Term Liabilities
10–1
McDonald’s Corporation
 In 2006, long-term
liabilities amounted to
approximately 66%
percent of total
stockholders’ equity
 Long-term obligations
include real estate
leases, employee
pension plans, and
health plans
42-15475604
© Royalty Free/ Corbis
For the latest McDonald’s press releases, click here.
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10–2
LO1: Funding Growth
Growth usually requires investment in longterm assets and research and development
How do companies raise long-term funds?
Issuance of
capital stock
Issuance of
long-term debt
Take on long-term debt?
How much debt to carry?
What types of debt to incur?
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10–3
Deciding to Issue Long-Term Debt
Advantages to
consider
Disadvantages to consider
No loss of stockholder control A high level of debt exposes a
as when issuing stock
company to financial risk
The interest on debt is taxdeductible
If earnings on funds borrowed
do not exceed interest on debt,
If earnings on funds borrowed negative financial leverage is
experienced
exceed interest on debt,
financial leverage is gained
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10–4
Average Debt to Equity for
Selected Industries
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10–5
Evaluating Long-Term Debt
Many companies use the debt to equity ratio
when assessing how much debt to carry
T otalLiabilities
Debt toEquity Ratio 
T otalStockholders’ Equity
$4,498.5 $9,613.4
McDonald’s Debt toEquity Ratio 
 0.9
$15,279.8
McDonald’s also has long-term leases
that do not appear on the balance sheet,
called off-balance sheet financing.
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10–6
Off-Balance Sheet Financing
A legal way of structuring a lease commitment
so that it does not have to be included on the
balance sheet as a liability
Financial statement users
should review the notes to
the financial statements for
information about any
leases that may have the
effect of long-term
liabilities
© Royalty Free/ Corbis
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10–7
Interest Coverage Ratio
Measures how much risk a company is
undertaking with its long-term debt
IncomeBeforeIncomeT axes InterestExpense
InterestCoverageRatio 
InterestExpense
Measures the degree of protection a company
has from default on interest payments
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10–8
Interest Coverage Ratio Illustrated
McDonald’s 2007 annual report shows that the
company had income before income taxes of $3,572.1
million and interest expense of $410.1 million.
IncomeBeforeT axes InterestExpense
InterestCoverageRatio 
InterestExpense
$3,572.1  $410.1

$410.1
 9.7 times
McDonald’s interest expense was covered 9.7 times in 2007. However,
management will add the company’s off-the-balance sheet rent expense of
$1,053.8 to its interest expense. This procedure decreases the coverage
ratio to less than 3.0 times, still adequate to cover interest payments.
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10–9
Types of Long-Term Debt
 Bonds payable
 Notes payable
 Mortgages payable
 Long-term leases
 Pensions
 Other postretirement
benefits
 Deferred income taxes
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10–10
Long-Term Debt
Bonds Payable
 Most common type of
long-term debt
 May be convertible to
common stock
 Involves a debt to many
creditors
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Notes Payable
 Represents a loan from a
bank or other creditor
Deutsche Telekom
International Finance
recently raised $14.6
billion by issuing a series
of long-term notes
denominated in dollars,
Euros, pounds, and yen.
10–11
Mortgages Payable
Long-term debt secured by real property. Usually repaid
in equal monthly installments that include interest on the
debt and a reduction in the initial debt.
Illustration: Monthly Payment Schedule on a $100,000, 12% mortgage
Payment Date
6/1
7/1
8/1
9/1
Unpaid Bal. At
Beg. of Period
$100,000
99,400
98,794
M onthly
Payment
$1,600
1,600
1,600
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Interest for 1
M onth at 1% on
Unpaid Bal.
$1,000
994
988
Reduction in Debt
Unpaid Bal. At
End of Period
$600
606
612
$100,000
99,400
98,794
98,182
10–12
Leases
• Companies may obtain an operating asset in
three ways:
Borrow the money and buy the asset
Rent the asset on a short-term lease (operating
lease; payments are treated as rent expense)
Obtain the asset on a long-term lease (may be
structured as a capital lease or an operating lease)
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10–13
Capital Leases
Accounting standards require that a lease be treated as a
capital lease if the lease:
 Cannot be cancelled
 Has about the same duration as the useful life of the
asset
 Stipulates that the lessee has the option to buy the
asset at a nominal price at the end of the lease
Accounting for a Capital Lease
The lessee should:
1) Record the asset
2) Record depreciation on the asset
3) Record at the PV of the total lease payments
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10–14
Capital Lease Illustrated
Polany’s Manufacturing Company enters into a long-term
lease for a machine. The lease terms call for an annual
payment of $8,000 for six years, which approximates the
useful life of the machine. At the end of the lease period,
the title to the machine passes to Polany.
Use present value techniques to place a value on the asset and on the
corresponding liability. Assume that the interest cost on the unpaid part
of the obligation is 16 percent.
$8,000 x 3.685 = $29,480
Capital Lease Equipment
Capital Lease Obligations
To record capital lease on
machinery
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29,480
29,480
10–15
Capital Lease Illustrated (cont’d)
Each year, Polany must record depreciation on the leased asset. Assume
the company uses the straight-line method and no salvage value.
Depreciation Expense, Capital Lease Equipment
Accum. Depreciation, Capital Lease Equip.
To record depr. expense on capital
lease machinery
4,914
4,914
Polany must also record interest expense for the lease. The interest
expense for each year is computed by multiplying the interest rate by
the amount of remaining lease obligation.
Interest Expense
Capital Lease Obligations
Cash
Made payment on capital lease
$29,480 x 16% = $2,358
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4,717
3,283
8,000
10–16
Discussion: Ethics on the Job
Cardle Industries plans to apply for a large loan
from United Bank in 20x9. In 20x7, the controller
recommends that the company renegotiate the
duration of its leases so that the company may
categorize them as operating leases. This will
improve the company’s debt to equity ratio.
Q. Do you think this recommendation is ethical?
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10–17
Pension Liabilities
Pension plans
 Require a company to pay Employer
Employee
benefits to employees
contributions contributions
after they retire
 Some companies pay full
cost of pension plan
Pension Fund
 Employees often share the
cost of pension plans
Pension benefits paid to
retired employees
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10–18
Pension Plans
Defined Contribution Plan
Defined Benefit Plan
 Employer makes fixed, agreedupon, annual contribution
 Retirement payments vary
depending on how much the
fund earns
 Employees usually control their
own accounts and can transfer
funds if they leave the firm
 Employer makes
variable payments
required to fund the
estimated future pension
liability arising from
current employment
 Retirement benefits are
fixed
 More complex
accounting required
Examples: 401(K) plans, profitsharing plans, and ESOPs
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10–19
Other Postretirement Benefits
Retired employees may also be provided health care
benefits and other postretirement benefits
postretirement benefits
should be estimated and
expensed during the time
that employees are
working in accordance
with the matching rule.
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 Estimates should account for
retirement age,
mortality,
future trends in health
 Future benefits should be in PV
10–20
Deferred Income Taxes
 Results from using different accounting methods to
calculate income taxes on the income statement and
income tax liability on the income tax return
 A company might use straight-line depreciation for
financial reporting and an accelerated method for
income tax purposes. The difference in taxes
resulting from the two methods is listed as a longterm liability.
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10–21
Stop & Review
True or False?
F
T
F
1. The cost of health care after an employee
retires is considered a bond payable.
2. Under a defined contribution plan, the
employer makes a fixed annual
contribution.
3. Mortgages payable are the most common
type of long-term liabilities.
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10–22
Stop & Review
Q. How are capital leases accounted for?
A. If a lease meets the requirements of a capital
lease: record the asset, record depreciation
on the asset, and record a liability equal to
the present value of the total lease payments
during the lease term.
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10–23
Stop & Review
Q. When comparing long-term debt to common stock
issuance as a means of raising capital, what issues
do companies consider?
A. Interest expense on long-term debt is deductible for
tax purposes. This advantage is not available when
issuing stock. Taking on long-term debt does not
involve a loss of ownership as does the issuance of
stock. Yet, companies must consider the risk
involved in taking on long-term debt.
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10–24
LO2: Bonds
A security, usually long term, representing money that
a corporation borrows from the investing public
Governments and foreign countries
also issue bonds to raise money
Must be repaid at
a specified time
and require
periodic payments
of interest at a
specified rate at
specified times
© Royalty Free PhotoDisc/ Getty Images
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10–25
What Is a Bond Issue?
A bond issue is the
total value of bonds
issued at one time
Prices of Bonds
• Stated in terms of a
percentage of face value
• Bonds selling at 100
Sell at face or par value
For example, a
$1,000,000 bond issue
could consist of one
thousand, $1,000 bonds
• Bonds selling above 100
Sell at a premium
• Bonds selling below 100
Sell at a discount
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10–26
Selling Price of Bond Illustrated
A bond issue is quoted at 103 ½
What is the selling price of a $1,000 bond?
A bond issue quoted at 103 ½ means that the bond sells at 103.5
percent of its face value
BondSelling Price Face Value  QuotedPercentageof Face Value
 $1,000 1.035
 $1,035
This bond sells at a premium and would cost the buyer $1,035
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10–27
Interest Rates
 Face Interest Rate
Fixed rate of interest paid to bondholders based on
the face value of the bonds
 Market Interest Rate
Rate of interest paid in the market on bonds of
similar risk, also called the effective interest rate
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10–28
Discounts and Premiums
Discount
• Equals the excess of the face value over the issue price.
• The issue price will be less than the face value when the
market interest rate is higher than the face interest rate.
Premium
• the excess of the issue price over the face value.
• issue price will be more than the face value when
market interest rate is lower than the face interest rate.
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10–29
Bond Characteristics
Issued on the basis of a firm’s general credit
Carry a pledge of certain corporate assets as a
Secured guarantee of repayment
Term
All bonds of an issue mature at the same time
Bonds of an issue mature on different dates
Serial
Gives issuer the right to buy back and retire the
Callable
bonds before maturity at a specified call price
Allows bondholder to exchange a bond for a
Convertible
specified number of shares of common stock
Registered Issued to a specific bondholder
Not registered with the organization
Coupon
Unsecured
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10–30
Stop & Review
Q. What is the difference between a secured and
unsecured bond?
A. Secured bonds carry a pledge of certain
corporate assets as a guarantee of repayment.
Unsecured bonds do not carry this pledge.
They are issued only on the corporation’s
general credit standing.
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10–31
Stop & Review
Q. A bond issue is quoted at 95. What does this
mean?
A. The bond sells at 95 percent of its face value.
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10–32
Stop & Review
Q. If you were looking for a bond that could be
exchanged into common stock at a specified point
in time, what kind of bond are you looking for?
A. Convertible bond
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10–33
LO3: Issuing Bonds Payable
The board of directors must submit the appropriate
legal documents to the Securities and Exchange
Commission (SEC) for approval to issue bonds
 No journal entry is
required for the
authorization of the
bond issue (most
companies disclose
in the notes to the
financial
statements)
© Royalty Free/ Corbis
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10–34
Bonds Issued at Face Value
Bharath Corporation issues $200,000 of 9 percent, 5-year
bonds on January 1, 2010 and sells them on the same date
for their face value. The bond indenture states that interest
is to be paid on January 1 and July 1 of each year.
Jan. 1
Cash
200,000
Bonds Payable
Sold $200,000 of 9%, 5-year
bonds at face value
200,000
Record a semiannual interest payment:
Bond Interest Expense
Cash (Interest Payable)
Paid (or accrued) semiannual
interest to bondholders of 9%, 5year bonds
9,000
9,000
Interest Principal Rate T ime
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 $200,000 .09 6/12 year
 $9,000
10–35
Bonds Issued at a Discount
Bharath Corporation issues $200,000 of 9 percent, 5-year
bonds at 96.149 on January 1, 2010, when the market rate
is 10 percent.
Record the issuance of the bonds at a discount:
2010
Jan. 1
Cash
Unamortized Bond Discount
Bonds Payable
Sold $200,000 of 9%, 5-year
bonds at 96.149
Face amount of bonds
Less purchase price of bonds
($200,000 x .96149)
Unamortized bond discount
192,298
7,702
200,000
$200,000
192,298
$ 7,702
Unamortized Bond
Discount is a
contra-liability
account
Carrying Value of Bonds = Face Value – Unamortized Bond Discount
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10–36
Bonds Issued at a Premium
Bharath Corporation issues $200,000 of 9 percent, 5-year
bonds for $208,200 on January 1, 2010, when the market
rate is 8 percent.
Record the issuance of the bonds at a premium:
2010
Jan. 1
Cash
Unamortized Bond Premium
Bonds Payable
Sold $200,000 of 9%, 5-year
bonds at 104.1
($200,000 x 1.041)
Purchase price of bonds
Less face amount of bonds
Unamortized bond premium
208,200
8,200
200,000
$104,100
100,000
$ 4,100
Carrying Value of Bonds = Face Value + Unamortized Bond Premium
= $200,000 + $8,200 = $208,200
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10–37
Bond Issue Costs
 Can amount to as much as 5 percent
of a bond issue
 Establish an account for these costs and
amortize over life of bonds
 Or issue costs subtracted from the
proceeds of issuance
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10–38
Stop & Apply
Q. Markus Corporation issues $50,000 of 9 percent, 5year bonds at 96.5 on January 1, 20x4, when the
market rate is 10 percent. What amount is to be
debited to the Cash account when the bonds are
issued?
A. $50,000 x .965 = $48,250
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10–39
Stop & Apply
Q. Tracton Corporation issues $100,000 of 9 percent,
5-year bonds for 105 on January 1, 20x0, when the
market rate is 8 percent. What amount should be
credited to Unamortized Bond Premium upon
issuance?
A. $105,000 - $100,000 = $5,000
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10–40
LO4: Influence of the Market Interest
Rate on Bonds
The market interest rate varies from day to day
and therefore what investors are willing to pay
changes as well
 If current market interest rate > bond’s
interest rate, investors are willing to pay less
 If current market interest rate < bond’s
interest rate, investors are willing to pay more
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10–41
Case 1: Present Value
Market interest rate > Face interest rate
A bond has a face value of $20,000 and pays fixed interest of $900
every six months (a 9 percent annual rate). The bond is due in 5 years
and the market interest rate is 12 percent.
What is the present value of the bond?
Determine the interest rate and number of periods to use in the present value tables
• Divide the annual interest rate by the number of periods in the year
12% ÷ 2 = 6%
• Multiply the number of periods in one year by the number of years
2 x 5 = 10 periods
Present value of 10 periodic payments @ 6%
Present value of a single payment at the end
of 10 periods @ 6%
Present value of $20,000 bond
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Table 4
$900 x 7.360
$6,624.00
Table 3
$20,000 x .558
11,160.00
$17,784.00
10–42
Case 2: Present Value
Market interest rate < Face interest rate
A bond has a face value of $20,000 and pays fixed interest of $900
every six months (a 9 percent annual rate). The bond is due in 5 years
and the market interest rate is 8 percent.
What is the present value of the bond?
Present value of 10 periodic payments @ 4%
Table 2
$900 x 8.111
$7,299.90
Present value of a single payment at the end
of 10 periods @ 4%
Table 1
$20,000 x .676
13,520.00
Present value of $20,000 bond
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$20,819.90
10–43
Stop & Review
Q. If the market interest rate is less than the
bond’s interest rate, will investors be likely
to pay more or less for the bond?
A. Investors will be willing to pay more
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10–44
Stop & Review
Q. What two components go into computations
of present value for bonds?
A. Present value of periodic payments of
interest and present value of one single
payment of principal
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10–45
LO5: Bond Discounts or Premiums
Amount by which the total interest
cost is higher or lower than the
total interest payments
Amortized over the
life of the bonds
Use straight-line or
effective interest
method
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10–46
Straight-Line Method
Equal amortization of the bond discount for each
interest period
Face value = $200,000
Face interest rate = 9%
Life of bond = 5 years
Interest payments = Semiannual
Bond discount = $7,702
Step 1: Determine the total number of interest payments
T otalInterestPayments InterestPaymentsper Year  Life of Bonds
 2  5  10 periods
Step 2: Determine the amount of bond discount to amortize each
interest period
Bond Discount
Amortizati
on of Bond Discount per Period
T otalInterestPayments
$7,702

 $770(rounded)
10 periods
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10–47
Straight-Line Method (cont’d)
Step 3: Determine the cash interest payment amount
Cash InterestPayment Face Value  Face InterestRate T ime
6
 $200,000  .09   $9,000
12
Step 4: total interest expense per interest period is the difference
between the amortization and the cash payment
Record first semiannual interest payment and amortization of
bond discount
2010
July 1
Bond Interest Expense
9,770
Unamortized Bond Discount
Cash (or Interest Payable)
Paid (or accrued) semiannual interest
to bondholders and amortized
discount on 9%, 5-year bonds
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770
9,000
10–48
Weaknesses of theStraight-Line
When amortize discount, the carrying
value goes up each period, but the bond
interest expense stays the same; thus, the
rate of interest falls over time.
When used to amortize a premium, the
rate of interest rises over time.
Can be used only when it does not lead
to a material difference from the
effective interest method, per the APB.
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10–49
Effective Interest Method
Applies a constant interest rate to the carrying value of
bonds at the beginning of the interest period
 Rate equals the market, or effective, rate at the
time the bonds were issued.
 Amount amortized is the difference between
interest computed and actual interest paid to
bondholders
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10–50
Amortization of a Bond Discount:
Effective Interest Method
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10–51
Bond Amortization –
Effective Interest Method
Face value = $200,000
Face Interest rate = 9%
Life of bond = 5 years
Column A
Carrying value =
Face value –
Unamortized bond
discount
A
Semiannual
Interest
Period
0
1
Carrying
Value at
Beginning of
Period
$192,298
Interest payments = Semiannual
Bond discount = $7,702
Column B – Use market interest rate
($192,298 x .10 x 6/12 = $9,615)
Column C – Use face interest rate on bond
($200,00 x .09 x 6/12 = $9,000)
B
Semiannual
Interest
Expense at
10% to be
Recorded
(5% x A)
C
Semiannual
Interest to be
Paid to
Bondholders
(4.5% x
$100,000)
$9,615
$9,000
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D
E
F
Amortization
of Bond
Discount
(B – C)
Unamortized
Bond
Discount at
End of Period
(E – D)
$7,702
Carrying
Value at End
of Period
(A + D)
$192,298
10–52
Bond Amortization –
Effective Interest Method (cont’d)
Column D
Discount amortized =
Effective interest expense –
Actual interest payment to
bondholders
($9,615 – $9,000 = $615)
A
Semiannual
Interest
Period
0
1
Carrying
Value at
Beginning of
Period
$192,298
Column F
Carrying value at beg. of
period + Amort. during the
period
($192,298 + $615 =
$192,913)
B
Semiannual
Interest
Expense at
10% to be
Recorded
(5% x A)
C
Semiannual
Interest to be
Paid to
Bondholders
(4.5% x
$100,000)
$9,646
$9,000
Notice that the sum of the
carrying value and the
unamortized discount always
equals the face value of the bonds
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D
Amortization
of Bond
Discount
(B – C)
$615
E
F
Unamortized
Bond
Discount at
End of Period
(E – D)
$7,702
7,087
Carrying
Value at End
of Period
(A + D)
$192,298
192,913
Column E
Bond discount at beg. of period –
Current pd amort. ($7,702 – $615 = $7,087)
10–53
Bond Amortization –
Effective Interest Method (cont’d)
Record first semiannual interest payment and
amortization of bond discount:
2010
July 1
Bond Interest Expense
9,615
Unamortized Bond Discount
Cash (or Interest Payable)
Paid (or accrued) semiannual interest
to bondholders and amortized
discount on 9%, 5-year bonds
615
9,000
It is not necessary to prepare an interest
and amortization table to determine
amortization of a discount for the period
Amountof Interest ot Amortize (CarryingValue  EffectiveInterestRate) – InterestPayment
 ($192,298 .05) – $9,000 $615
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10–54
Carrying Value and Interest Expense –
Bonds Issued at a Discount
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10–55
Bond Premiums
 Bondholders pay more than face value for
bonds
 Premium is an amount that bondholders will
receive over the life of the bond issue (it
is a reduction, in advance, of the total interest
paid on the bonds over life of the issue)
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10–56
Amortization of a Bond Premium:
Effective Interest Method
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10–57
Bond Amortization – Effective Interest
Method (cont’d)
Record first semiannual interest payment and amortization of bond
premium:
2010
July 1
Bond Interest Expense
8,328
Unamortized Bond Premium
672
Cash (or Interest Payable)
Paid (or accrued) semiannual interest
to bondholders and amortized
premium on 9%, 5-year bonds
9,000
It is not necessary to prepare an interest
and amortization table to determine
amortization of a premium for the period
Amountof Interest ot Amortize InterestPayment- (CarryingValue  EffectiveInterestRate)
 $9,000– ($208,200 .04) $672
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10–58
Carrying Value and Interest Expense –
Bonds Issued at a Premium
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10–59
Stop & Review
Q. When using the effective interest method,
what amount is amortized?
A. Amount amortized is the difference between
interest computed and actual interest paid to
bondholders.
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10–60
Stop & Review
Q. Why is a bond discount considered a
component of total interest cost?
A. A bond discount represents the amount by
which the face value of the bond exceeds the
issue price. This amount must be paid by the
corporation at the time of maturity.
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10–61
Stop & Apply
Q. Bonds have been sold at 104.1. Is a bond
discount or a bond premium involved?
A. Bonds have been sold at a premium
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10–62
Stop & Review
Q. Which accounts are used to record the
interest payment for a bond issued at a
premium?
A. Cash, Bond Interest Expense, Unamortized
Bond Premium
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10–63
SO6: Calling Bonds
Why call bonds before their maturity date?
 If bond interest rates drop, the company can call the
bonds and reissue debt at a lower interest rate.
 Company has earned enough to pay off the debt.
 The reason for having the debt no longer exists.
 The company wants to restructure its debt to equity
ratio.
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10–64
Callable Bonds Illustrated
The issuer has the right to buy back and retire bonds at a
specified call price
Bharath Corporation can call or retire at 105 the $200,000 of bonds it
issued at a premium (104.1). It decides to do so on July 1, 2013. The
entry for the required interest payment and amortization of the
premium has already been made.
Record the retirement of the bonds:
2013
July 1
Bonds Payable
Unamortized Bond Premium
Loss on Retirement of Bonds
Cash
Retired 9% bonds at 105
200,000
2,892
7,108
210,000
The loss occurs because the call price of the bonds is greater than the carrying value
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10–65
Callable Bonds (Purchase)
Bharath Corporation can call or retire at 105 the $200,000 of bonds it
issued at a premium (104.1). Because of a rise in interest rates, Bharath is
able to purchase the $200,000 bond issue on the open market for 85. The
entry for the required interest payment and amortization of the premium
has already been made.
Record the purchase of the bonds:
2013
July 1
Bonds Payable
Unamortized Bond Premium
Cash
Gain on Retirement of Bonds
Purchased and retired 9%
bonds at 85
200,000
2,892
170,000
32,892
The gain occurs because the call price of the bonds is less than than the carrying
value
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10–66
Convertible Bonds Illustrated
Bharath Corporation issued $200,000 of convertible bonds on January
1, 2010, that can be converted to 40 shares of common stock for each
$1,000 bond. The bondholders decide to convert all the bonds to $8 par
value common stock on July 1, 2013.
Record the bond conversion:
2013
July 1
Bonds Payable
200,000
Unamortized Bond Premium
2,892
Common Stock
Additional Paid-in Capital
Converted 9% bonds payable into $8
par value common stock at a rate of
40 shares for each $1,000 bond
64,000
138,892
No loss or gain is recorded because the bond
liability and the associated unamortized discount
or premium are written off the books.
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10–67
Stop & Review
Q. For what reasons might a company call
bonds before their maturity date?
A. If bond interest rates drop or the company
can call the bonds and reissue debt at a
lower interest rate. A company might also
call its bonds if it has earned enough to pay
off the debt, if the reason for having the
debt no longer exists, or if it wants to
restructure its debt to equity ratio.
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10–68
SO7: Sale of Bonds Between Interest Dates
When a company
sells a bond
between interest
dates…
it collects the
interest that would
have accrued for
the partial period
preceding the
issue date, and…
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at the end of the
first period, it pays
the interest for the
entire period.
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10–69
Sale of Bonds Between
Interest Dates Illustrated
Bharath Corporation sold $200,000 of 9 percent, 5-year bonds on May 1,
2010 (after the January 1, 2010 issue date).
Record the sale of the bonds:
2010
May 1
Cash
206,000
Bond Interest Expense
Bonds Payable
Sold 9%, 5-year bonds at face value
plus 4 months’ accrued interest
($200,000 x .09 x 4/12 = $6,000)
Bondholder pays
interest that would
have accrued for the
partial period from
the issue date to the
sale date
6,000
200,000
Bond Interest Expense
Bal.
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0
May 1
6,000
10–70
Sale of Bonds Between Interest Dates
Illustrated (cont’d)
Bharath Corporation sold $200,000 of 9 percent, 5-year bonds on May 1,
2010 (after the January 1, 2010 issue date).
Record first semiannual interest payment:
2010
July 1
Bond Interest Expense
9,000
Cash (or Interest Payable)
Paid (or accrued) semiannual interest
($200,000 x .09 x 6/12 = $9,000)
Corporation pays
the bondholder
interest for the
entire period
Bond Interest Expense
July 1
0
9,000
Bal.
3,000
Bal.
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May 1
6,000
9,000
The bondholder is
reimbursed for the partial
interest payment made at
time of sale ($6,000) plus
paid interest for the partial
period the bond was held
($3,000)
10–71
Year-End Accrual of Interest Expense
Bond interest payment dates rarely correspond with a
company’s fiscal year. A year-end adjustment is required.
Bharath Corporation issues $200,000 of 9 percent, 5-year bonds at 104.1 on
January 1, 2010. The company’s fiscal year ends September 31, 2010
Interest and amortization were recorded on July 1, 2010. Three months of interest
has accrued since then.
Record the year-end accrual of bond interest expense:
2010
Sept. 30
Bond Interest Expense
4,150.50
Unamortized Bond Premium
349.50
Interest Payable
To record accrual of interest on 9%
bonds payable for 3 months and
amortization of ½ of premium for the
second interest payment period
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4,500
10–72
Year-End Accrual of Bond Interest
Record second semiannual interest payment and amortization
of bond premium:
2011
Jan. 1
Bond Interest Expense
4,150.50
Interest Payable
4,500.00
Unamortized Bond Premium
349.50
Cash
Paid semiannual interest, including
interest previously accrued, and
amortized the premium for the period
since the end of the fiscal year
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9,000.00
10–73
Chapter Review Problem
MKB Corporation issues $50,000 of 9 percent, 5-year
bonds at 97.12 on January 1, 20x5, when the market
rate is 10 percent.
Required:
1. Record the issuance of bonds.
2. Record the first semiannual interest payment and
amortization of discount using the effective-interest
method.
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10–74
Chapter Review Problem (Solution)
1.
20x5
Jan. 1
Cash
Unamortized Bond Discount
Bonds Payable
Sold $50,000 of 9%, 5-year bonds
at 97.12
Face amount of bonds
$50,000
Less purchase price of bonds
($50,000 x .9712)
48,560
Unamortized bond discount
$1,440
2.
20x5
July 1
Bond Interest Expense
Unamortized Bond Discount
Cash
Paid semiannual interest to bondholders
and amortized discount on 9%, 5-year
bonds
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48,560
1,440
50,000
2,500
250
2,250
10–75