Long-Term Debt and Other
Financing Issues
Chapter 22
Loan Payments and
Interest
Periodic loan payments consist of two
components:
• Interest expense
• A portion of the principal balance
Calculating Loan Payments
Periodic Payment =
Amount Borrowed 
Present Value of Annuity Factor Based on
the Interest Rate and the Life of the Loan
Calculating Interest Expense
Interest Expense =
Book Value of Loan at the
Periodic Interest Rate X
Beginning of the Period
Calculating Repayment of
Principal
Repayment of Principal =
Cash payment -
Interest expense
Bond Characteristics
•
•
•
•
Face Value
Maturity date
Contract rate
Bond certificate
Reasons for Issuing Bonds
The main reason for issuing bonds is that the
earnings available to the common stockholders
can be increased through leverage.
Leverage is the use of borrowing
to increase the return to common
stockholders.
It is also call trading on equity.
Use of Leverage Through
Bond Financing Exhibit 22-2
Before
Expansion
Bond
Financing
Stock
Financing
Earnings before interest and
income taxes
$100,000
$150,000
$150,000
Interest expense
---(30,000)
----__
Income before income taxes $100,000
$120,000
$150,000
Income tax expense
(40,000)
(48,000)
(60,000)
Net Income
$ 60,000
$ 72,000
$ 90,000
Number of shares
10,000
10,000
16,000
Earnings per share
$6.00
$7.20
$5.63
Recording Bonds
Issued at Face Value
Cash
200,000
Bonds Payable
200,000
Interest Expense
Face Value of Bonds X
(Annual Contract Rate  Number of Interest
Payments per Year)
Example:
$200,000 X (10%  2) = $10,000
Recording Interest
Expense
Cash
Interest Expense
10,000
10,000
Accrual of Interest
Semiannual Interest
X Fraction of Period since Interest Last Paid
Example:
$300,000 X (12%  2) X 4/6 = $12,000
Recording Interest
Expense
Interest Payable
12,000
Interest Expense
12,000
Factors Affecting
Bond Interest Rates
• The risk-free rate
• The expected inflation rate
• The risk premium
Bonds Issued at Less
Than or More Than
Face Value
• Premium - bonds sold when market rate of
interest is lower than the contract rate
• Discount - bonds sold when market rate of
interest is higher than the contract rate
• Yield - the market rate at which the bonds
are issued
Bonds Issued at Less
Than or More Than
Face Value
The issuance of bonds sold at a discount or
premium is usually quoted as a percentage of the
face value.
Face Value X Quoted Percentage = Selling Price
$200,000 X 97% = $194,000
$200,000 X 102% = $204,000
Bond Interest Expense
Interest Expense for Period =
Book Value at Beginning of Period X Yield
Relationship Between
Bond Selling Prices
and Interest Expense
Exhibit 22-3
Yield Compared to
Contract Rate
Bonds
Sell at
Annual Interest Expense
Compared to Annual
Interest Payment
Yield > Contract Rate
Discount
Interest Expense > Interest Paid
Yield = Contract Rate
Face Value Interest Expense = Interest Paid
Yield < Contract Rate
Premium
Interest Expense < Interest Paid
Zero-Coupon Bonds
•
•
•
•
Bonds pay no interest each period
Amount borrowed is less than face value
Face value is paid on the maturity date
Selling price is the present value of the face
value using the annual yield
• Effective interest method is used for
computing yearly interest expense
Effective Interest
Method
Selling Price of Bond Issue = Face Value X
Present Value Factor
Example:
$1,000,000 X 0.3855 (PV of $1 factor for 10 periods
at 10%)
= $385,500
Interest Expense for
Zero-Coupon Bonds
Interest Expense =
Book value at beginning of period X Annual yield
Example:
$385,500 X 10% = $38,550
Recording Interest
Expense
Bonds Payable
Bal. 385,500
38,550
Bal. 424,050
Interest Expense
38,550
Recording Retirement
of Bonds
Cash
Bonds Payable
Bal. 198,000
205,000
198,000
Bal. 0
Extraordinary Loss
7,000
Evaluation of LongTerm Debt and
Interest Expense
• Financial flexibility
• Risk
• Long-term liquidity
Leases
• Lease - an agreement giving the right to use
property, plant, or equipment without
transferring legal ownership
• Lessee - the company that acquires the right
to use the item
• Lessor - the company that gives up the use
of the item
Types of Leases
• Capital Lease - transfers the risks and
benefits of ownership from the lessor to the
lessee
• Operating Lease - does not transfer the risks
and benefits of ownership
Capital Lease
The lessee records an operating asset and a longterm liability at the present value of the lease
payments.
Present value of lease payments =
Periodic lease payment
X Present value of annuity factor
Recording a Capital
Lease
Leased Property
15,163
Capital Lease Obligation
15,163
Recording Depreciation
on Leased Asset
Leased Property
Bal. 15,163
Bal. 12,130
3,033
Depreciation Expense
3,033
Interest Expense for
Capital Leases
Interest Expense =
Book value of lease obligation X Interest rate
Example:
$15,163 X 10% = $1,516
Reduction of Lease
Obligation
Reduction of lease obligation =
Cash payment to lessor - Interest expense
Example:
$4,000 - $1,516 = $2,484
Recording Lease
Payment
Cash
Capital Lease Obligation
Bal. 15,163
4,000
2,484
Bal. 12,679
Interest Expense
1,516
Mortgage Payable
A mortgage payable is a long-term liability for
which the lender has a specific claim against an
asset of the borrower.
Accounting for a mortgage payable is similar to
accounting for a lease obligation.
Deferred Income Taxes
• A temporary difference occurs when a
corporation uses different depreciation methods
between the accounting records and tax records
• Deferred Tax Liability - balance sheet account
showing future additional income taxes
• Deferred Tax Asset - balance sheet account
showing the amount by which future income
taxes will be reduced
Retirement Benefits
• Pension plan - an agreement by a company
to provide income to its employees after
they retire
• Defined-contribution plan - specifies the
amount that the company must contribute to
the plan while the employees are working
• Defined-benefit plan - specifies the amount
that the company must pay to its employees
during retirement
Conclusion
A bond is a type of note in which a company
agrees to pay the holder the face value at the
maturity date and to pay interest periodically at a
specified rate on the face value.
A lease is an agreement giving a company the
right to use property, plant, or equipment without
transferring legal ownership of the item.
Problem 22-23
Present Value = Periodic Amount of X Present Value of
of annuity
annuity
Annuity Factor
$10,000 = Periodic Amount of Annuity X 3.4651
Periodic Amount of Annuity = $2,885.92
Problem 22-23
Beginning
Balance
Interest
Principal
Ending
Balance
1999 $10,000.00
$600.00
$2,285.92
$7,714.08
2000
7,714.08
462.84
2,423.08
5,291.00
2001
5,291.00
317.46
2,568.46
2,722.54
2002
2,722.54
163.38
2,722.54
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