Accounting for Long-Term Liabilities
Chapter 10
Wild, Shaw, and Chiappetta
Financial & Managerial Accounting
6th Edition
Copyright © 2016 McGraw-Hill Education. All rights reserved. No
reproduction or distribution without the prior written consent of
McGraw-Hill Education.
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Bond Financing
Transactions during the bond life
Bond Interest Payments
Corporation
Bond Interest Payments
A1
Bond Issue
Date
Investors
Interest Payment = Bond Par Value ×
Stated Interest Rate x Time
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Bond Financing
Advantages
Disadvantages
Bonds do not affect
owner control.
Bonds require
payment of both
periodic interest and
par value at maturity.
Interest on bonds is
tax deductible.
Bonds can increase
return on equity.
A1
Bonds can decrease
return on equity.
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Bond Trading
Bonds are securities that can be purchased or
sold in the securities markets. They have a
market value which is expressed as a percent
of their par value. The closing price indicates
that the IBM stock is being sold at 121.18% of
face value.
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Bond Issuing Procedures
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Issuing Bonds at Par
On Jan. 1, 2015, a company issued the following bonds:
Par Value: $800,000
Stated Interest Rate: 9%
Interest Dates: 6/30 and 12/31
Maturity Date = Dec. 31, 2034 (20 years)
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Issuing Bonds at Par
On June 30, 2015, the issuer of the bond pays the first
semiannual interest payment of $36,000.
$800,000 × 9% × ½ year = $36,000
This entry is made every six months until the bonds mature.
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Issuing Bonds at Par
On December 31, 2034, the bonds mature and the
issuer of the bond pays face value of $800,000 to the
bondholders.
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Bond Discount or Premium
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Issuing Bonds at a Discount
Fila issues bonds with the following provisions:
Par Value: $100,000
Issue Price: 96.454% of par value
Stated Interest Rate: 8%
Bond will sell at a discount.
Market Interest Rate: 10%
Interest Dates: 6/30 and 12/31
Bond Date: Dec. 31, 2015
Maturity Date: Dec. 31, 2017 (2 years)
}
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Issuing Bonds at a Discount
On Dec. 31, 2015, Fila should record the bond issue.
Par value
Cash proceeds
Discount
$ 100,000
96,454 *
$ 3,546
*$100,000 x 96.454%
Contra-Liability
Account
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Issuing Bonds at a Discount
Partial Balance Sheet as of Dec. 31, 2015
Long-term Liabilities:
Bonds Payable
Less: Discount on Bonds Payable
100,000
3,546
Maturity Value
P2
96,454
Carrying Value
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Amortizing a Bond Discount
Fila will make the following entry every six
months to record the cash interest payment
and the amortization of the discount.
$3,546 ÷ 4 periods = $887 (rounded)
P2
$100,000 × 8% × ½ = $4,000
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Amortizing a Bond Discount
Date
12/31/2015
6/30/2016
12/31/2016
6/30/2017
12/31/2017
Straight-Line Amortization Table
Interest
Interest
Discount
Unamortized Carrying
Payment
Expense Amortization* Discount
Value
$
3,546 $ 96,454
$
4,000 $
4,887 $
887
2,659
97,341
4,000
4,887
887
1,772
98,228
4,000
4,887
887
885
99,115
4,000
4,885
885
100,000
$ 16,000 $ 19,546 $
3,546
* Rounded.
These two columns always
sum to par value for a
discount bond.
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Issuing Bonds at a Premium
Adidas issues bonds with the following provisions:
Par Value: $100,000
Issue Price: 103.546% of par value
Stated Interest Rate: 12%
Bond will sell at a premium.
Market Interest Rate: 10%
Interest Dates: 6/30 and 12/31
Bond Date: Dec. 31, 2015
Maturity Date: Dec. 31, 2017 (2 years)
}
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Issuing Bonds at a Premium
On Dec. 31, 2013, Adidas will record the bond issue as:
Par value
Cash proceeds
Premium
$ 100,000
103,546 *
$ 3,546
*$100,000 x 103.546%
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Adjunct-Liability
Account
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Issuing Bonds at a Premium
Partial Balance Sheet as of Dec. 31, 2015
Long-term Liabilities:
Bonds Payable
Plus: Premum on Bonds Payable
100,000
3,546
103,546
Maturity Value
Carrying Value
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Amortizing a Bond Premium
Adidas will make the following entry every six
months to record the cash interest payment
and the amortization of the discount.
$3,546 ÷ 4 periods = $887 (rounded)
$100,000 × 12% × ½ = $6,000
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Amortizing a Bond Premium
Interest
Payment
Date
12/31/2015
6/30/2016 $ 6,000
12/31/2016
6,000
6/30/2017
6,000
12/31/2017
6,000
$ 24,000
Straight-Line Amortization Table
Interest
Premium
Unamortized
Carrying
Expense Amortization*
Premium
Value
$
3,546 $ 103,546
$ 5,113 $
887
2,659
102,659
5,113
887
1,772
101,772
5,113
887
885
100,885
5,115
885
100,000
$ 20,454 $
3,546
* Rounded.
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Bond Pricing
Cash Outflows related to Interest Payments
Cash Outflows for par value at end of Bond life
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Present Value of a Discount Bond
Fila issues bonds with the following provisions:
Par Value: $100,000
Issue Price: ?
Stated Interest Rate: 8%
Market Interest Rate: 10%
Interest Dates: 6/30 and 12/31
Bond Date: Dec. 31, 2015
Maturity Date: Dec. 31, 2017 (2 years)
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Present Value of a Discount Bond
To calculate Present Value, we need relevant interest rate
and number of periods.
Semiannual rate = 5% (Market rate 10% ÷ 2)
Semiannual periods = 4 (Bond life 2 years × 2)
$100,000 × 8% × ½ = $4,000
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Bond Retirement
Retirement of the Fila bonds at maturity for
$100,000 cash.
Because any discount or premium will be fully amortized at
maturity, the carrying value of the bonds will be equal to par value.
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Bond Retirement
Retirement of Bonds before Maturity
Carrying Value > Retirement Price = Gain
Carrying Value < Retirement Price = Loss
Assume that $100,000 of callable bonds will be retired
on July 1, 2015, after the first interest payment. The
bond carrying value is $104,500.The bonds have a call
premium of $3,000.
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Bond Retirement
Conversion of Bonds to Stock
On January 1, $100,000 par value bonds of Converse,
with a carrying value of $100,000, are converted to
15,000 shares of $2 par value common stock.
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15,000 shares × $2 par value per share
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Long-Term Notes Payable
Cash
Company
Note Payable
Lender
When is the repayment of the principal
and interest going to be made?
Note Date
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Note Maturity
Date
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Long-Term Notes Payable
Single Payment of
Principal plus Interest
Company
Lender
Single Payment of
Principal plus
Interest
Note Date
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Note Maturity
Date
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Long-Term Notes Payable
Regular Payments of
Principal plus Interest
Company
Lender
Regular Payments of Principal plus Interest
Note Date
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Note Maturity
Date
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Installment Notes
On January 1, 2015, Foghog borrows $60,000 from a
bank to purchase equipment. It signs an 8%
installment note requiring 6 annual payments of
principal plus interest.
Compute the periodic payment by dividing the face
amount of the note by the present value factor.
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Computation
Principal divided
by PV factor
Table
PV of
Annuity of
$1 (B.3)
Table
Value
Present
Value Payment
4.6229 60,000
12,979
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Installment Notes with Equal Payments
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Installment Notes with Equal Payments
Let’s record the first payment made on
December 31, 2015 by Foghog to the bank.
Refer back to the amortization schedule to make
the December 31, 2016 payment on the note.
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Mortgage Notes and Bonds
A mortgage is a legal agreement that helps protect
the lender if the borrower fails to make the
required payments.
It gives the lender the right to be paid out of the
cash proceeds from the sale of the borrower’s
assets specifically identified in the mortgage
contract.
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Global View
Accounting for Bonds and Notes
The definitions and characteristics of bonds and notes are broadly
similar for both U.S. GAAP and IFRS. The accounting for issuances of
bonds, market pricing, and retirement of both bonds and notes is similar.
Both U.S. GAAP and IFRS also allow companies to account for bonds
and notes using fair value.
Accounting for Leases and Pensions
Both U.S. GAAP and IFRS require companies to distinguish between
operating leases and capital leases; with IFRS calling the latter finance
leases. The accounting and reporting for leases are broadly similar,
with the main difference that the criteria for identifying a lease as a
capital or finance lease is more general under IFRS. For pensions, the
methods of accounting and reporting are similar for both U.S. GAAP and
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IFRS.
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Features of Bonds and Notes
Secured and
Unsecured
Term and
Serial
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Convertible
and Callable
Registered
and Bearer
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Debt-to-Equity Ratio
Debt-toequity ratio
=
Total liabilities
Total equity
This ratio helps investors determine the risk of
investing in a company by dividing its total liabilities
by total equity.
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Appendix 10A:
Present Values of Bonds and Notes
Present Value of $1
Rate
Periods
3%
4%
1
0.9709 0.9615
2
0.9426 0.9246
3
0.9151 0.8890
4
0.8885 0.8548
5
0.8626 0.8219
6
0.8375 0.7903
7
0.8131 0.7599
8
0.7894 0.7307
9
0.7664 0.7026
10
0.7441 0.6756
C2
5%
0.9524
0.9070
0.8638
0.8227
0.7835
0.7462
0.7107
0.6768
0.6446
0.6139
Face amount = $100,000
Contract rate = 8%
Market rate = 10%
Interest paid semiannually
First, we calculate the present
value of the principal
repayment in 4 periods (2 years
× 2 payments per year, using
5% market rate (10% annual
rate ÷ 2 payments per year).
$100,000 × 0.8227 = $82,270
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Appendix 10A:
Present Values of Bonds and Notes
Semiannual Interest Annuity
$100,000 × 8% × ½ = $4,000
$4,000 × 3.5460 = $14,184
C2
Amount
Principal
$ 100,000
Interest
4,000
Issue price of debt
Present Value of Annuity of $1
Rate
Periods
3%
4%
5%
1
0.9709 0.9615 0.9524
2
1.9135 1.8861 1.8594
3
2.8286 2.7751 2.7232
4
3.7171 3.6299 3.5460
5
4.5797 4.4518 4.3295
6
5.4172 5.2421 5.0757
7
6.2303 6.0021 5.7864
8
7.0197 6.7327 6.4632
9
7.7861 7.4353 7.1078
10
8.5302
Present 8.1109 7.7217
PV Factor
0.8227
3.5460
Value
$ 82,270
14,184
$ 96,454
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Appendix 10B:
Effective Interest Amortization
Effective Interest
Amortization of Bond
Discount
Stated Rate: 8%
Effective Rate: 10%
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Appendix 10B:
Effective Interest Amortization
Effective Interest
Amortization of
Bond Premium
Stated Rate: 12%
Effective Rate:
10%
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Appendix 10C:
Issuing Bonds Between Interest Dates
Avia sells $100,000 of its 9% bonds at par on March 1, 2015, 60 days
after the stated issue date. The interest on Avia bonds is payable
semiannual on each June 30 and December 31.
Stated Issue
date 1/1
Date of sale 3/1
$1,500 accrued
Bondholder pays
$1,500 to issuer
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First Interest
date 6/30
$3,000 earned
Issuer pays $4,500 to
bondholder
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Appendix 10D: Leases and Pensions
A lease is a contractual agreement between the lessor (asset owner) and
the lessee (asset renter or tenant) that grants the lessee the right to use
the asset for a period of time in return for cash (rent) payments.
Operating Leases
Operating leases are short-term (or cancelable) leases in which the
lessor retains the risks and rewards of ownership. Examples include
most car and apartment rental agreements.
Capital Leases
Capital leases are long-term (or non-cancelable) leases by which the
lessor transfers substantially all risks and rewards of ownership to the
lessee. Examples include leases of airplanes and department store
buildings.
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Appendix 10D: Leases and Pensions
A pension is a contractual agreement between an
employer and its employees for the employer to provide
benefits (payments) to employees after they retire.
Defined Benefit Plans
The employer’s contributions vary, depending on
assumptions about future pension assets and liabilities.
A pension liability is reported when the accumulated
benefit obligation is more than the plan assets, a
so-called underfunded plan.
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