Long-term Liabilities
ACCTG 5120
David Plumlee
1
Overview – L-t liabilities
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Terminology
Conceptual issues
Bond Valuation Examples
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Par, below par and above par
Journal entries
Interest methods
Between interest dates
page2
How are L-t Liabilities Measured?
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How are l-t liabilities valued on the
balance sheet?
What interest rate is used to find the
bond’s value?
page3
Bond Terminology
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Serial vs. term
Deep discount
Debenture
Bearer or coupon
Callable
Convertible
page4
Bond Interest
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Interest Payments equal….
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Interest Expense equals….
page5
Data for Example
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face value = $1,000,000
term = 5 years
issued January 1, year 1
interest paid semi-annually, June 30
and December 31
annual coupon rate = 10%
annual market (or effective) rate:
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Case: A = 10% B = 8% C = 12%
page6
Bond Issue-Time line
page7
Case A: Market = 10%
Price = PV of Maturity Value + PV of Interest Annuity
page8
Entry to Record Bond Issue
page9
Discount or premium?
Discounts or Premia arise if the stated
interest rate differs from the market
rate when the debt is issued
page10
Case B: Market = 8%
Price = PV of Maturity Value + PV of Interest Annuity
page11
Entry To Record Bond Issue
page12
Case C: Market = 12%
Price = PV of Maturity Value + PV of Interest Annuity
page13
Entry To Record Bond Issue
page14
What do you do with the
discount or premium?
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Discounts and premia are amortized
over the remaining life of the debt
Two amortization methods are possible
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straight-line
effective interest
page15
Straight-line Amortization
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Total discount or premium divided by
the number of remaining interest
periods is expensed each period
Interest expense is a constant amount
each period
Easy to use
page16
Effective Interest Amortization
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Discount or premium is amortized
over remaining life of bond
Interest Expense is a constant % of
carrying value
More representationally faithful
Required under GAAP, if materially
different
page17
A Bond Example
Alpha Corp. issued $100,000 of 8%
(payable semi-annually on June 30 and
December 31), 5 year bonds. The bonds
were dated and sold on January 1, 1998,
at an effective rate of 10 percent.
page18
Compute the price of the bond
Maturity value of bonds payable
 PV of $100,000 5 years at 10%
100,000 *.61391 (PVIF 10,5%)
 PV of $4,000 at 10% annually
4000*7.72173 (PVOA 10,5%)
Proceeds from sale of bonds
Discount on bonds payable
page19
Bond Discount Amortization-SL
Cash
Date Paid
1-1-00
7-1-00
1-1-01
7-1-01
1-1-02
-0-
Interest
Expense
-0-
Discount
Amortized
Carrying
Amt of Bonds
-0-
1-1-05
page20
Bond Discount Amortization-EI
Cash
Date Paid
1-1-00
7-1-00
1-1-01
7-1-01
1-1-02
-0-
Interest
Expense
-0-
Discount
Amortized
Carrying
Amt of Bonds
-0-
1-1-05
page21
Bond Discount Amortization-EI
Cash
Date Paid
1-1-00
7-1-00
1-1-01
7-1-01
1-1-02
-04,000
1-1-05
4,000
Interest
Expense
-0-
Discount
Amortized
Carrying
Amt of Bonds
-0-
4,000
4,000
4,000
page22
Journal entries - for sale and first
interest payment
page23
Other issues-
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Interest period and accounting period do not
coincide
Apportion interest/discount or premium
amounts to proper accounting periods
page24
Year end 10/31 instead of 12/31
page25
Extinguishment of debt
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Retirement of debt before maturity
In-substance defeasance
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Defeasance
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Irrevocably transfers assets sufficient to retire
debt
Debtor is legally released from payments
GAAP requires gain or loss to be reported as
EXTRAORDINARY item
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if material
reported separately on the income statement
reported net of related taxes
page26
Long-term notes payable
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Issued for cash and other rights
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Issued for property, goods….
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Need to record the discount and ‘rights’
Use present value of note or goods, whichever is
more ‘determinable’
Mortgage notes payable
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pledges title to property as security
page27
Off-balance-sheet financing
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Obligations that do not meet the strict
definition of debt
Leases prior to FABS 13
page28
Balance sheet presentation
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Long term debt-often single line item
Disclose next five years of debt payments
Off-balance sheet items...
Debt Extinguishment--income statement
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Describe transaction
Tax effect
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per share gain/loss
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Analysis of debt
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Times interest earned
Debt to total assets
page29
Appendix 14 A -- FAS 114 Loan Impairments
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Creditors perspective
Inability to collect loan and interest amounts
Creditor determines WHEN and in WHAT amount loan
is impaired based on present value of expected
future payments and recorded carrying value
Journal entries
Uncollectible accounts expense
Allowance account
DR
CR
page30