Chapter 15
Part 2
Long Term
Liabilities
Accounting for Bond Retirements
Redeeming Bonds at Maturity
Assuming that the company pays and records separately the interest for
the last interest period, Candlestick records the redemption of its bonds
at maturity as follows:
Bond payable
Cash
100,000
100,000
SO 3 Describe the entries when bonds are redeemed or converted.
Accounting for Bond Retirements
Redeeming Bonds before Maturity
When a company retires bonds before maturity, it is
necessary to:
1. eliminate the carrying value of the bonds at the
redemption date;
2. record the cash paid; and
3. recognize the gain or loss on redemption.
The carrying value of the bonds is the face value of the bonds
less unamortized bond discount or plus unamortized bond premium
at the redemption date.
SO 3 Describe the entries when bonds are redeemed or converted.
Accounting for Bond Retirements
Question
When bonds are redeemed before maturity, the gain or loss on
redemption is the difference between the cash paid and the:
a.
carrying value of the bonds.
b.
face value of the bonds.
c.
original selling price of the bonds.
d.
maturity value of the bonds.
SO 3 Describe the entries when bonds are redeemed or converted.
Accounting for Bond Retirements
Illustration: Assume Candlestick, Inc. has sold its bonds at a
premium. At the end of the eighth period, Candlestick
retires these bonds at 103 after paying the semiannual
interest. The carrying value of the bonds at the redemption
date is $101,623. Candlestick makes the following entry to
record the redemption at the end of the eighth interest
period (January 1, 2014):
Bonds payable
100,000
Premium on bonds payable
1,623
Loss on redemption
1,377
Cash
103,000
SO 3 Describe the entries when bonds are redeemed or converted.
Accounting for Bond Retirements
Converting Bonds into Common Stock
Until conversion, the bondholder receives interest on the
bond.
For the issuer, the bonds sell at a higher price and pay a
lower rate of interest than comparable debt securities
without the conversion option.
Upon conversion, the company transfers the carrying value
of the bonds to paid-in capital accounts. No gain or loss is
recognized.
SO 3 Describe the entries when bonds are redeemed or converted.
Accounting for Bond Retirements
Illustration: Assume that on July 1 Saunders Associates converts
$100,000 bonds sold at face value into 2,000 shares of $10 par value
common stock. Both the bonds and the common stock have a market value
of $130,000. Saunders makes the following entry to record the
conversion:
Bonds payable
100,000
Common stock (2,000 x $10)
20,000
Paid-in capital in excess of par
80,000
SO 3 Describe the entries when bonds are redeemed or converted.
Accounting for Bond Retirements
Question
When bonds are converted into common stock:
a.
a gain or loss is recognized.
b.
the carrying value of the bonds is transferred to paid-in capital
accounts.
c.
the market price of the stock is considered in the entry.
d.
the market price of the bonds is transferred to paid-in capital.
SO 3 Describe the entries when bonds are redeemed or converted.
Accounting for Other Long-Term Liabilities
Long-Term Notes Payable
May be secured by a mortgage that pledges title to
specific assets as security for a loan
Typically, the terms require the borrower to make
installment payments over the term of the loan. Each
payment consists of
1. interest on the unpaid balance of the loan and
2. a reduction of loan principal.
Companies initially record mortgage notes payable at
face value.
SO 4 Describe the accounting for long-term notes payable.
Accounting for Other Long-Term Liabilities
Illustration: Porter Technology Inc. issues a $500,000,
12%, 20-year mortgage note on December 31, 2010. The
terms provide for semiannual installment payments of
$33,231 (not including real estate taxes and insurance). The
installment payment schedule for the first two years is as
follows.
Illustration 15-12
SO 4 Describe the accounting for long-term notes payable.
Accounting for Other Long-Term Liabilities
Illustration: Porter Technology Inc. issues a $500,000,
12%, 20-year mortgage note on December 31, 2010. The
terms provide for semiannual installment payments of
$33,231 (not including real estate taxes and insurance). The
installment payment schedule for the first two years is as
follows. journal entry is for the note and the first interest
payment is
Dec. 31
Jun. 30
Cash
Mortgage notes payable
Interest expense
Mortgage notes payable
Cash
500,000
500,000
30,000
3,231
33,231
SO 4 Describe the accounting for long-term notes payable.
Accounting for Other Long-Term Liabilities
Question
Each payment on a mortgage note payable consists of:
a.
interest on the original balance of the loan.
b.
reduction of loan principal only.
c.
interest on the original balance of the loan and reduction of loan
principal.
d.
interest on the unpaid balance of the loan and reduction of loan
principal.
SO 4 Describe the accounting for long-term notes payable.
Accounting for Other Long-Term Liabilities
Lease Liabilities
A lease is a contractual arrangement between a lessor (owner of the
property) and a lessee (renter of the property).
Illustration 15-13
SO 5 Contrast the accounting for operating and capital leases.
Accounting for Other Long-Term Liabilities
The issue of how to report leases is the case of substance versus
form. Although technically legal title may not pass, the benefits
from the use of the property do.
Operating Lease
Capital Lease
Journal Entry:
Rent expense
Cash
Journal Entry:
Leased equipment
Lease liability
xxx
xxx
xxx
xxx
A lease that transfers substantially all of the benefits and risks of
property ownership should be capitalized (only noncancellable leases
may be capitalized).
Statement of Financial Accounting Standard No. 13,
“Accounting for Leases,” 1976
SO 5 Contrast the accounting for operating and capital leases.
Accounting for Other Long-Term Liabilities
To capitalize a lease, one or more of four criteria must be met:
1.
Transfers ownership to the lessee.
2. Contains a bargain purchase option.
3. Lease term is equal to or greater than 75 percent of
the estimated economic life of the leased property.
4. The present value of the minimum lease payments
(excluding executory costs) equals or exceeds 90
percent of the fair value of the leased property.
SO 5 Contrast the accounting for operating and capital leases.
Accounting for Other Long-Term Liabilities
Exercise: Gonzalez Company decides to lease new
equipment. The lease period is four years; the economic life
of the leased equipment is estimated to be five years. The
present value of the lease payments is $190,000, which
is equal to the fair market value of the equipment. There is
no transfer of ownership during the lease term, nor is there
any bargain purchase option.
Instructions:
(a) What type of lease is this? Explain.
(b) Prepare the journal entry to record the lease.
SO 5 Contrast the accounting for operating and capital leases.
Accounting for Other Long-Term Liabilities
Exercise: (a) What type of lease is this? Explain.
Capitalization Criteria:
Capital Lease?
1. Transfer of ownership
NO
2. Bargain purchase option
NO
3. Lease term => 75% of
economic life of leased
property
4. Present value of minimum
lease payments => 90% of
FMV of property
Lease term
Economic life
YES
4 yrs.
5 yrs.
80%
- PV and FMV
are the same.
YES
SO 5 Contrast the accounting for operating and capital leases.
Accounting for Other Long-Term Liabilities
Exercise: (b) Prepare the journal entry to record the lease.
Leased asset - equipment
Lease liability
190,000
190,000
The portion of the lease liability expected to be paid in the
next year is a current liability. The remainder is classified
as a long-term liability.
SO 5 Contrast the accounting for operating and capital leases.
Accounting for Other Long-Term Liabilities
Question
The lessee must record a lease as an asset if the lease:
a.
transfers ownership of the property to the lessor.
b.
contains any purchase option.
c.
term is 75% or more of the useful life of the leased property.
d.
payments equal or exceed 90% of the fair market value of the
leased property.
SO 5 Contrast the accounting for operating and capital leases.
Statement Analysis and Presentation
Presentation
Illustration 15-14
SO 6 Identify the methods for the presentation
and analysis of long-term liabilities.
Statement Analysis and Presentation
Analysis of Long-Term Debt
Two ratios that provide information about debt-paying ability and
long-run solvency are:
1.
Debt to total
assets
Total debt
=
Total assets
The higher the percentage of debt to total assets, the greater the
risk that the company may be unable to meet its maturing obligations.
SO 6 Identify the methods for the presentation
and analysis of long-term liabilities.
Statement Analysis and Presentation
Analysis of Long-Term Debt
Two ratios that provide information about debt-paying ability and
long-run solvency are:
2.Times interest
earned
Income before income taxes and interest
expense
=
Interest expense
Indicates the company’s ability to meet interest payments as they
come due.
SO 6 Identify the methods for the presentation
and analysis of long-term liabilities.