Accounting 2
Chapter 11 Notes
Long Term Liabilities and Bonds
Notes Payable
1.
2.
3.
4.
Long term notes payable are frequently paid in installments.
The current installment of a long term not is always classified as a current liability.
Interest is also usually paid in installments (at least annually).
Computations of interest is the same as for current notes.
Interest = Principal x Rate x Time (Time is no of days divided by 360)
OR
Time (Time is no of months divided by 12)
Example
Ajax Company Borrows $80,000 at 8% on June 30 of the current year. Interest is payable
every 6 months. In addition the borrower must pay $5,000 of principal every 6 months.
General Journal
Date
Account
Jan 1
Cash
Dec 31
Page 16
Post
Debit
Credit
80,000
Note Payable – Long Term
70,000
Note Payable – Current Portion
10,000
Interest Expense
3,200
Notes Payable
5,000
Cash
Mortgage Notes Payable
Mortgages as the same as other notes except that the Company receiving the loan has
pledged real estate as collateral for the repayment of the loan.
8,200
-2-
Corporate Bonds
Characteristics of Bonds
1.
Bonds are liabilities of the Corporation they are actually a form of a promissory note.
2.
Bonds are issued in large quantities
3.
Bonds have a face value which is normally $1,000 or some multiple of $1,000.
4.
Bonds have a term which typically varies from 5 to 30 years (Disney issued 100 year
Bonds in the early 1990's)
5.
Liquidity - Many bonds are traded in the securities markets. (This means you don’t have
to own a bond until its maturity date to collect your money)
6.
Interest is paid to the owners most bonds.
7.
Bond prices are always quoted as a percentage of face value - a $1,000 bond selling at 98
is selling for 98% of its face value or $980.
8.
If you issue bonds you have a liability. If you buy bonds you have an asset (Investment)
Kinds of Bonds
1.
2.
3.
4.
5.
6.
7.
Registered Bonds - the name of the owner of the bond is maintained either by the issuing
Company or the brokerage Company – All new issued of U.S. Bonds are registered.
Term Bonds - all of the bonds mature at the same time.
Serial Bonds - the bonds mature in installments over a period of time.
Debenture Bonds - the bonds are unsecured.
Collateralized Bonds - the bonds are secured by some type real or personal property
Callable Bonds - the corporation may redeem the bonds at its discretion by paying the
bond owner the call price.
Convertible Bonds - the bonds can be converted into a stated number of shares of the
common stock of the company. This option is at the discretion of the bond owner.
Accounting Issues Related to Bonds
1.
2.
3.
4.
5.
Recording the issuance of bonds including the related premium or discount
Recording the interest expense of the bonds including the amortization of the related
discount or premium.
Amortization using straight line method (this method will be used on test)
Recording the payment of the bond liability on the maturity date.
Recording the redemption of the bond liability prior to maturity.
Other Issues
1.
Adjusting Entries for Bonds.
2.
Issuing Bonds Between interest dates (not on test)
Interest Concepts
1.
Bonds pay interest at intervals during the year, or once a year, or at maturity.
2.
Some bonds pay interest at a rate below what is expected by the market. When that
happens, the market adjusts the rate by decreasing the market price of the bonds.
3.
Some bonds pay interest at a rate above what is expected by the market. When that
happens, the market adjusts the rate by increasing the market price of the bonds.
4.
Adjusting Bonds to market prices based on expected interest rates can be mathematically
accomplished using present value concepts.
-3$200,000 of 10-year Bonds are issued on January 1. The Bonds pay a contract rate of interest of
8% but the market rate of interest is 10% so the bonds are issued at a discount. Proceeds from
the issuance of these bonds amounts to $175,096. The interest is paid semiannually.
1.
2.
Entry to record issuance of Bonds – next page
Entry to record 1st interest payment – next page
A basic straight line Interest amortization Chart
Interest
Paid
Interest
Expense
Discount
Amortization
Discount
on Bonds
Bond
Carrying Value
24,904
175,096
1
8,000
9,245
1,245
23,659
176,341
2
8,000
9,245
1,245
22,414
177,586
3
8,000
9,245
1,245
21,169
178,831
4
8,000
9,245
1,245
19,924
180,076
5
8,000
9,245
1,245
18,679
181,321
6
8,000
9,245
1,245
17,434
182,566
7
8,000
9,245
1,245
16,189
183,811
8
8,000
9,245
1,245
14,944
185,056
9
8,000
9,245
1,245
13,699
186,301
10
8,000
9,245
1,245
12,454
187,546
11
8,000
9,245
1,245
11,209
188,791
12
8,000
9,245
1,245
9,964
190,036
13
8,000
9,245
1,245
8,719
191,281
14
8,000
9,245
1,245
7,474
192,526
15
8,000
9,245
1,245
6,229
193,771
16
8,000
9,245
1,245
4,984
195,016
17
8,000
9,245
1,245
3,739
196,261
18
8,000
9,245
1,245
2,494
197,506
19
8,000
9,245
1,245
1,249
198,751
20
8,000
9,245
1,249
200,000
-4General Journal
Date
Account
Jan 1
Cash
Page 16
Post
Discount on Bonds
Debit
175,096
24,904
Bonds Payable
Jun 30
Interest Expense
Credit
200,000
9,245
Discount on Bonds
1,245
Cash
8,000
Financial Statement Presentation - Bonds, and Notes Payable
1.
Bonds are usually long term. Bond discount or premium should be listed on the Balance
Sheet in the same section as the related debt. Bonds discount or premium is subtracted
(discount) or added (premium) to get the total book value of the bonds. The book value
is also called the carrying value of the bonds.
2.
When debt is paid in installments, that part of the principal that will be paid within the
next year is considered the current portion of the debt and should be included with the
current liabilities - the remaining part of the debt is classified as long term.