Chapter 10
Current and Long-Term
Liabilities
ACCT 100
Objectives of the Chapter
1. Discuss the accounting for major types of
current liabilities.
2. Discuss the issuance of bonds (i.e., why
bonds are issued; the issuing procedures of
bonds, etc.)
3. Prepare the entries for the issuance of bonds
and the recording of the subsequent interest
payments.
4. Discuss the accounting for bond retirement
and bond conversion.
5. Debt to total assets ratio and time interest
earned ratio.
2
Liabilities
n
Legal obligations require the future
payments of cash or services as a result
of past transactions. In this chapter we
look at.
I. current liabilities as a result of business
transactions, and
II. long-term liabilities (i.e., bonds payable).
Current and Long-Term Liabilities
3
Current Liabilities:
n
Obligations must be fulfilled in one year
or one operating cycle, whichever is
longer.
Current and Long-Term Liabilities
4
I. Current Liabilities as a Result of
Business Transactions:
A. Current liabilities with definite
amount
B. Estimated liabilities
Current and Long-Term Liabilities
5
A. Current Liabilities with Definite
Amount
a. Accounts Payable (A/P)
b. Short-Term Notes Payable (N/P)
c. Sales Tax Payable
d. Current maturity portion of long-term
liability (i.e., bonds payable)
e. Accrued Liabilities (i.e., interest payable)
f. Payroll Taxes withholdings (payroll
liabilities)
g. Unearned Revenues
Current and Long-Term Liabilities
6
a. Accounts Payable:
n
Amounts owed to suppliers for products
or services purchased on account.
Current and Long-Term Liabilities
7
b. Short-Term Notes Payable:
n
Notes payable due in one year or one
operating cycle whichever is longer.
u
Companies often issue notes to borrow
money or to purchase inventory or other
assets.
u
If the note payable is an interest bearing
note, an accrued interest should also be
recognized at the end of the period, if
there is any.
Current and Long-Term Liabilities
8
Example of A Transaction Involving N/P:
J. E.
Inventory
N/P
or
Cash
N/P
XXX
XXX
XXX
XXX
Current and Long-Term Liabilities
9
b. Short-Term Notes Payable:
(contd..)
n
Short-term N/P can also be issued at
discount to borrow cash from a bank.
Bank will subtract the interest amount
from the note’s face value and the
borrower will receive the net amount.
Current and Long-Term Liabilities
10
Example:
n
P&G discounts a $200,000, 90-day
note payable to its bank on 12/1/x8.
The bank charges 12% annual interest
on the borrowing. P&G will receive
$200,000 - 200,000 x 12% x 90/360 =
200,000 - 6,000 =$194,000.
Current and Long-Term Liabilities
11
Example (coned)
P&G’s entries to record the discounting of the
note and related entries are as follows:
12/1/x8
Cash
194,000
Discount on N/P
6,000
N/P
200,000
12/31/x8 Interest Exp.*
2,000
Discount on N/P
2,000
* $200,000 x 12% x 30/360 = 2,000
Current and Long-Term Liabilities
12
Example (contd.)
B/S presentation:
B/S (12/31/x8)
Current Liabilities:
N/P - Short-term 200,000
Dis. on N/P
(4,000)
$196,000
Current and Long-Term Liabilities
13
Example (contd.)
At maturity (3/1/x9), the P&G’s entries are:
3/1/x9 Int. Exp.*
Dis. on N/P
4,000
4,000
* $200,000 x 12% x 60/360 = $4,000
3/1/x9 N/P
200,000
Cash
200,000
Current and Long-Term Liabilities
14
c. Sales Taxes Payable:
Sales taxes are taxes levied by states on
retail sales, not on manufacturers (i.e., GE,
GM, etc).
Every state, except Alaska, Delaware,
Montana, New Hampshire, and Oregon, levies
state sales taxes on retail sales.
The rate varies state by state (for example,
California has a statewide sales tax at 7.25% with a
local supplementary tax for up to 8.75%).
Current and Long-Term Liabilities
15
c. Sales Taxes Payable: (contd.)
Retailers charge their customers the
sales taxes in addition to the price of
the merchandise.
The retailers have to forward the
collected sales taxes to the state at
regular intervals.
Current and Long-Term Liabilities
16
Example
Assume that the 12/22/x8 sales of
Macy’s in California totaled $2,000,000.
The state tax rate is 8.25%. The
business would record the day’s sales as
follows:
Cash
2,165,000
Sales Revenue
2,000,000
Sales Taxes Payable 165,000
Current and Long-Term Liabilities
17
Example
When forwarding the collected sales
taxes to the state, the following entry will
be recorded:
Sales Taxes Payable 165,000
Cash
165,000
Current and Long-Term Liabilities
18
d. Current Portion of Long-Term Debt:
Some bonds payable are paid in
installments. The current maturity
portion of a long-term debt should be
reported as a current liability.
Current and Long-Term Liabilities
19
e. Accrued Liabilities:
Expenses incurred but have not yet
been paid by the company.
If these liabilities are due within one
year or one operating cycle whichever
is longer, they should be reported as
current liabilities.
Current and Long-Term Liabilities
20
f. Payroll and Payroll Taxes Payable
Include salary payable to employees,
employee income taxes payable
(employee income taxes withholdings),
FICA taxes payable (employee’s FICA
taxes withholdings by the
employer),etc.
Current and Long-Term Liabilities
21
Example
Salaries Expense
50,000
Employee FICA Taxes Payable*
Federal I/T Payable
State I/T Payable
Employee Union Dues Payable
Salaries Payable`
3,825
12,500
4,000
250
29,425
For 2008, FICA (Federal Insurance Contributions Act) tax includes 6.2%
and 1.45% of Social Security and Medicare taxes, respectively, on the first
$102,000 gross income. This payroll tax is imposed by the federal
government on both employees and employers to fund Social security and
Medicare.
* 50,000 x (6.2% + 1.45%) = 3,825
22
g. Unearned Revenues:
Revenues collected in advance before
providing services.
Example: Assume that New Magazine
collects $300 subscription fee in advance
from a subscriber. The entry will be:
Cash
300
Unearned Subscription Revenue 300
Current and Long-Term Liabilities
23
Estimated Liabilities
Liabilities exist but the amount is
unknown (i.e., property taxes, warranty
obligations, coupon and premium
obligations …)
Current and Long-Term Liabilities
24
Estimated Liabilities (contd.)
a. Warranty Obligations (Product
Warranty)
b. Premium and Coupon Obligations
c. Estimated Vacation Pay Liability
Current and Long-Term Liabilities
25
a. Warranty Obligations
These obligations are associated with the
sales of the period and are recognized at the
end of the period.
Journal Entry:
Warranty Expenses
xxx
Estimated Warranty Liabilities
xxx
When warranty services are provided:
Estimated warranty liabilities
xxx
Cash (or Inventory)
xxx
Current and Long-Term Liabilities
26
b. Premium and Coupon Obligations
Liabilities of premiums and coupons
should be estimated and recognized in
the year when sales are made.
Journal Entry
Premium (or Coupon) Expenses xxx
Estimated Premium Claims
(or coupon) outstanding
xxx
Current and Long-Term Liabilities
27
b. Premium and Coupon Obligations
(contd.)
When premium (or coupon) are claimed:
Journal Entry
Estimated Premium Claims
(coupon) outstanding
xxx
Inventory
xxx
* If the actual redemption of coupons (or premiums)
is greater than the estimated liabilities, the
underestimated amount would be recognized as
the expense of the current year. (APB Opinion No.
20)
Current and Long-Term Liabilities
28
c. Estimated Vacation Pay Liability:
Example:
12/31/X1
Vacation Pay Expense
xxx
Estimated Vacation Pay Liability xxx
2/1/X2
Estimated Vacation Pay Liability xxx
Cash
xxx
Current and Long-Term Liabilities
29
II. Long-Term Liabilities
1. Present value concept
2. Annuity
3. Topics of long-term liabilities
Current and Long-Term Liabilities
30
1. Present Value Concept
Present value of $1 is the value today
of $1 to be received at some future
date, given a specific interest rate.
Current and Long-Term Liabilities
31
Example 1
What is the present value of $100 to be
received a year from now given the
annual market interest rate is 10%?
P.V. * (1 + 10%) = $100
P.V. = $100/1.1
= $100 x 0.9091
= $90.91
Current and Long-Term Liabilities
32
Example 2
What is the present value of $100 to be
received two years from now given the
annual interest rate is 10%?
P.V * (1-10%) * (1+10%) = $100
P.V * (1-10%)2 = $100
P.V. * 1.21= $100
P.V.
= $100 / 1.21
= $100 * 0.8264
= $82.64
Current and Long-Term Liabilities
33
2. Annuity
Receiving (or paying)a constant amount of
money at the end of each period (equal time
internal) for a given number of periods.
$100
$100
$100
$100
$100
1 year
Receiving $100 every year for the following 5
years. (period = 1 year) (starting a year from now)
Current and Long-Term Liabilities
34
2. Annuity (contd.)
Present Value (P.V.) of an annuity:
Using the example above given 10% Interest rate:
P.V. of the first $100 =
$100 * 0.9091 = $90.91
P.V. of the second $100 = $100 * 0.8264 = $82.64
P.V. of the third $100 =
$100 * 0.7513 = $75.13
P.V. of the fourth $100 = $100 * 0.6830 = $68.30
P.V. of the fifth $100 =
Total
$100 * 0.6209 = $62.09
3.7907 $379.07
Current and Long-Term Liabilities
35
2. Annuity (contd.)
The P.V. of $100 annuity receiving
every year for the following 5 years,
starting a year from now =>
$100  3.7907 = $379.07
Can be obtained from the annuity table
under 10%, 5 periods.
Current and Long-Term Liabilities
36
3. Topics of Long-Term Liabilities
A. Corporate bonds
B. Convertible bonds and notes
C. Other long-term liabilities
Current and Long-Term Liabilities
37
A. Corporate Bonds
Bonds are securities issued by a
corporation to borrow money from the
public.
The corporation will receive cash when
bonds are issued.
The face value (principal) of the bonds
must be repaid to the bondholders on the
maturity date.
the bond issuers will pay interests to the
bondholders periodically (i.e., semiannually .
38
Topics of Bonds
The procedures of bond issuance.
Units of bonds.
Types of bonds.
Determination of bond price.
Present value of bonds.
Issuance of bonds at face value, at a
discount or at a premium.
Accounting for bonds payable.
Bond retirement before maturity.
39
The Procedures of Bond Issuance
1. Receive the approval from the board of
directors and stockholders.
2. Draw a bond indenture* and print bond
certificates**.
3. Make a public announcement of its intent to
sell the bonds on a particular date.
*a written agreement between the issuer and bondholders (a
legal document) with terms such as stated interest rate, the
maturity date, the convertibility, the trustee, etc.
**provides information such as bond issuer, face value, stated
interest rate, the maturity date, etc. See Illustration 11-10 for
an example.
40
The Procedures of Bond Issuance
(contd..)
4. Negotiate the appropriate selling price with
the underwriters based on the terms of
bond issue (i.e., the stated interest rate),
the general bond market conditions, the
risk of the bonds and the expected state of
the economy.
5. The underwriter purchases the bonds from
the issuing company and resells them to
the clients or the underwriter may sell the
bonds for the company for a commission.
Current and Long-Term Liabilities
41
Units of Bonds
Bonds are usually issued at the unit of
$1,000 or a multiple of $1,000.
Price of bonds: stated at 100s
i.e., $1,000 issued at 98
issuing price = $1,000 * 0.98 = $980
Current and Long-Term Liabilities
42
Types of Bonds
On the basis whether the bonds are
secured:
Secured bonds (with assets pledged)
Unsecured bonds (Debentures)
On the basis of how the bonds mature:
Term Bonds
Serial Bonds
Current and Long-Term Liabilities
43
Determination of Bond Price
The obligations of bond issuers:
(1) to pay the principle (the face value)
when bonds mature on the maturity date.
(2) to pay stated (or contractual) interest
periodically (i.e., semiannually or
annually) over the life the bond.
Current and Long-Term Liabilities
44
Present Value of Bonds
Bond Price: equals the present value (PV) of
the bond.
PV of the bond equals the sum of
(1) the present value of the principal received
on the maturity date plus
(2) the present value of the periodic interests
(an annuity).
Current and Long-Term Liabilities
45
Present Value of Bonds

Discount rate = effective rate = market
interest rate

This rate depends on the riskiness of
the issuer and the economic condition.

In general, a higher risk will result in a
higher market interest rate.
Current and Long-Term Liabilities
46
Bonds Issued at Face Value
When the stated interest rate equals
the market interest rate, the bond price
will equal the face value of the bond.
Current and Long-Term Liabilities
47
Example 1
Page company issued a 5-year term bond
with face amount $100,000 and stated
annual interest rate 10%.
The interests are paid semiannually.
Assume that the annual market interest
(effective rate) demanded by investors for
bonds of this level of risk is also 10%.
What is the present value of the bond?
Current and Long-Term Liabilities
48
Example 1 (stated rate = market interest
rate)
 (1)P.V. of the principal ($100,000 mature
in 5 years, semiannual discount rate 5%,
10 periods):
$100,000 * 0.6139 = $61,390
 (2) P.V. of the stated interests received
semiannually for 10 periods (annuity,
semiannual discount rate = 5%, 10
periods)
5,000* x 7.7217 = 38,608.5
* The semiannual stated interest paid
= $100,000 x 10% x 1/2 = $5,000
49
Example 1 (contd.)
The P.V. of the bond = the sum of (1) and (2)
(1) + (2) = $61,390 + 38,608.5 = $100,000
Current and Long-Term Liabilities
50
Example 1 (contd.)
Therefore, when the stated rate equals the
effective rate (the market interest rate), the
bond price (the P.V. of bonds) equals the
face value. (state rate=5%, effective rate
=5%)
J.E. (when bonds are issued at face value)
Cash
100,000
Bonds payable
Current and Long-Term Liabilities
100,000
51
Bonds Issued at A Discount
When the stated interest rate is less
than the market interest rate, the
present value of a bond will be less
than its face value.
Current and Long-Term Liabilities
52
Example 2 (stated rate <effective rate)
Use the same information as in example 1
on p47, except that the annual market
interest rate is 12%.
What is the semiannual interest received
by bondholders?
$100,000 x 10% * 1/2 = $5,000
What is the discount rate used to
compute the P.V. of the bond?
6% (the semiannual effective rate)
Current and Long-Term Liabilities
53
Example 2 (contd.)
Compute the present value of the bond:
Since the interests are paid semiannually, the
discount rate will be 6% with 10 periods.
(1) P.V. of the principal = $100,000 x .5584 = $55,840
P.V. table, 6%, 10periods
(2) P.V. of the semiannual interests:
$5,000 x 7.3601 = 36,800.5
Annuity table, 6%, 10periods
Current and Long-Term Liabilities
54
Example 2 (contd.)
Annuity table, 6%, 10periods
P.V. of the bond = (1) + (2)
= $55,840 + 36,800.5
= $92,640.5
Current and Long-Term Liabilities
55
Example 2 (contd.)
$92,640.5 < $100,000 (Discount = $7359.5)
P.V. of bond < Face vale
 => when the stated rate is less than the
effective rate (i.e., 5% < 6%), the P.V. of
the bond will be less than the face value.
Current and Long-Term Liabilities
56
Example 2 (contd.)
J.E. (when bonds are issued at discount)
Cash
92,640.5
Discount on Bonds
7,359.5
Bonds Payable
100,000
(state rate =5%, effective rate =6%)
Current and Long-Term Liabilities
57
Bonds Issued at Premium
When the stated interest rate is higher
than the effective interest rate
demanded by the investors for the level
of the risk of the bonds, the present
value of the bonds would be greater
than its face value.
Current and Long-Term Liabilities
58
Example 3 (stated rate > effective rate)
Use the same information as in
example 1 on p47, except that the
market interest rate is 8%. (the stated
interest rate is still at 10%)
What is the semiannual interest
received by bondholder?
$100,000 x 10% x 1/2 = $5,000
Current and Long-Term Liabilities
59
Example 3 (contd.)
What is the discount rate used to
compute the P.V. of the bond?
4% (the semiannual effective rate
when interests are paid semiannually)
(10 periods)
Current and Long-Term Liabilities
60
Example 3 (contd.) (stated rate <
effective rate)
Compute the P.V. of the bond:
(1) P.V. of the principal:
$100,000 x 0.6756 = $67,560
(2) P.V. of the semiannual interest:
$5,000 x 8.1109 = $40,554.5
P.V. of the bond = (1) + (2)
= $67,560 + 40,554.5 = $108,114.5
Current and Long-Term Liabilities
61
Example 3 (contd.)
J.E. (When Bonds are issued at Premium)
Cash
108,114.50
Bonds Payable
100,000.00
Premium on Bonds Payable
8,114.50
(state rate=5%, effective rate =4%)
Current and Long-Term Liabilities
62
Accounting for Bonds Payable
A premium account: an adjunct account
to the Bonds Payable account and is
shown as an addition to the bonds
payable account.
A discount account: a contra account to
the bonds payable and is shown as a
deduction from the bonds payable
account.
Current and Long-Term Liabilities
63
Accounting for Bonds Payable
Book value (carrying value) of the bonds
issued =
the face value plus any unamortized
premiums or minus any unamortized
discounts.
Current and Long-Term Liabilities
64
Accounting for Bonds Payable
(contd..)
The information of example 1 is summarized
below with some additional information:
Issuing Company:
Stated Interest:
Effective Interest:
Date of Issuance:
Date of Maturity:
Interest Payment Dates:
Face Value:
P.V. of the Bond:
Page Company
10% (annual)
10% (annual)
2/1/x1(sold on 2/1/x1)
2/1/x6
2/1 and 8/1
$100,000
$100,000
Current and Long-Term Liabilities
65
Accounting for Bonds Payable
(contd.)
J.E.
2/1/x1 Cash
100,000
B/P
8/1/x1 Interest Expense
Cash
100,000
5,000
Current and Long-Term Liabilities
5,000
66
Accounting for Bonds Payable
(contd.)
12/31/x1 Adjusting entry for 5-month
interest expense occurred but not
paid. The interest payment dates
are 2/1 and 8/1).
Interest Expense 4,167
Interest payable
4,167
Current and Long-Term Liabilities
67
Accounting for Bonds Payable
(contd.)
2/1/x2
Interest Expense
833
Interest Payable
4,167
Cash
5,000
8/1/x2
Interest Expense
5,000
Cash
5,000
12/31/x2 Adjusting entry for the 5-month unrecorded
interest expense.
Interest Expense
4,167
Interest payable
4,167
Current and Long-Term Liabilities
68
Accounting for Bonds Payable
(contd.)
2/1/x3
(Interest payment)
8/1/x3
(Interest payment)
12/31/x3 (Adjusting)
..
.
12/31/x5 (Adjusting)
2/1/x6
Interest Expense
833
Interest payable
4,167
Cash
5,000
Bonds Payable
100,000
cash
100,000
(Bond Retired at Maturity)
Current and Long-Term Liabilities
69
Accounting for B/P When Bonds Are
Issued at A Discount
The information of example 2 on p52 is
summarized below with some additional
information:
Stated Interest = 10% (annual)
Effective Interest = 12% (annual)
Date of Issuance = 1/1/x1 (sold on 1/1/x1)
Date of Maturity = 1/1/x6
Interest Payment Dates = 6/30 and 12/31
Face Value = $100,000
P.V. of the Bond = 92,640.50
70
Accounting for B/P When Bonds Are
Issued at A Discount (contd.)
Discount = $100,000 - 92,640.5 = 7,359.50
Current and Long-Term Liabilities
71
Amortization of Bond Discount
Amortization methods:
1. Straight-Line Method: the Discount would be
amortized equally over the life of the bond(i.e.,
Amortization over 10 periods).
$7359.50/10 = $735.95
Therefore, the interest expense for every period is
$5,000 + 735.95 = $5,735.95
Semiannual
Interest Payment
the amortized Discount
2. Effective - Interest Method:
Interest Expense = P.V. of Bond x effective rate
72
1.Amortization of Bond Discount –
Straight-Line Method
J.E
(Bonds are issued at discount and use the
Straight-Line method to amortize the discount)
1/1/x1 Cash
92640.50
Discount on Bonds payable 735.95
B/P
100,000
6/30/x1 Interest Expense
5,735.95
Cash
5000 *
Discount on Bonds Payable
735.95 **
12/31/x1 Interest Expense
5,735.95 ***
Cash
5,000
Discount on Bonds Payable
735.95
73
Amortization of Bond Discount –
Straight-Line Method (contd..)
* Interest Payment = semiannual interest = $100,000 x 10% x 1/2
** Amortization of Discount over 10 periods (7359.50/10)
*** Interest Expense = Interest Payment + Amortized Discount.
6/30/x2
12/31/x2
6/30/x3
12/31/x3
6/30/x4
12/31/x4
6/30/x5
Same J.E. as recorded on 6/30/x1
Same J.E. as recorded on 6/30/x1
Same J.E. as recorded on 6/30/x1
Same J.E. as recorded on 6/30/x1
Same J.E. as recorded on 6/30/x1
Same J.E. as recorded on 6/30/x1
Same J.E. as recorded on 6/30/x1
Current and Long-Term Liabilities
74
Amortization of Bond Discount –
Straight-Line Method (contd..)
12/31/x5 Interest Expense
5,735.95
Cash
5,000.00
Discount on Bonds Payable
1/1/x6
B/P
735.95
100,000
Cash
100,000
Current and Long-Term Liabilities
75
Amortization of Bond Discount –
Straight-Line Method (contd..)
Discount on Bonds
1/1/x1 7,359.50 735.95 6/30/x1
735.95 12/31/x1
735.95 6/30/x2
.
...
735.95 12/31/x5
Interest Expense from 1/1/x1 to 12/31/x5
= $ 5,735.95 * 10
= $5,7,359.50
= $50,000 + 7,359.5
Interest payments
Discount on Bonds
Current and Long-Term Liabilities
76
2.The Effective Interest Method to
Amortize Bond Discount
Use the example on p69 and use the effective
interest method to amortize the discount.
Interest Payment = $100,000 * 5%= $5,000
Interest Expense = P.V. of Bond at the
Beginning of the period  the Effective Rate
Amortized Discount = Interest Expense Interest payment
Long-Term Liabilities
77
Effective Interest Amortization Tablebond are issued at a discount
1
Period
P.V at Beg.
Of Period
0
1
2
3
4
5
6
7
8
9
10
92,641
93,199
93,791
94,418
95,083
95,787
96,534
97,326
98,166
99,056
Total
2
Interest
Expense
(1) * 6%
$5,558
5,592
5,627
5,665
5,704
5,704
5,792
5,840
5,890
5,944
3
4
Cash
Amortized
(Interst)
Discount
payments (2) - (3)
$5,000
$558
$5,000
592
$5,000
627
$5,000
665
$5,000
704
$5,000
747
$5,000
792
$5,000
840
$5,000
890
$5,000
944
$57,359
$50,000
5
Unamortized
Discount
(5)-(4)
$7,359
$6,801
6,209
5,582
4,917
4,213
3,466
2,674
1,834
944
-
6
B.V. at end of
Period
$100,000 - (5)
$92,641
93,199
93,791
94,418
95,083
95,787
96,514
97,326
98,166
99,056
100,000
7,359
Long-Term Liabilities
78
The Effective Interest Method to Amortize
Bond Discount (Contd.)
Journal Entries :
1/1/x1 Cash
Discount on B/P
B/P
6/30/x1 Interest Expense
(period 1)
Cash
Discount on B/P
12/31/x1 Interest Expense
(period 2)
Cash
Discount on B/P
92,641
7,359
100,000
5,558
5,000
558
5,592
5,000
592
Long-Term Liabilities
79
Accounting for Bonds Payable - Bonds
Are Issued at A Discount (Contd.)
6/30/x2 Interest Expense
Cash
Discount on B/ P
:
:
6/30/x5 Interest Expense
Cash
Discount on B/P
12/31/x5 Interest Expense
Cash
Discount on B/P
1/1/x6 B/P
Cash
Long-Term Liabilities
5,672
5,000
672
5,890
5,000
890
5,944
5,000
944
100,000
100,000
80
Accounting for Bonds Payable - Bonds
Are Issued at A Discount (Contd.)
Discount on Bonds Payable Interest Expense over 10
1/1/x2 7,359
558…6/30/x1
periods =>
Period 1 $5,558
592…12/31/x1 Period 2 $5,592
672…6/30/x2 period 3 $5,627
890…6/30/x5
Period 9 $ 5,890
Period 10 $ 5,944
944…12/31/x5
0
$57,359
$57360= $50,000 + 7,359
Long-Term Liabilities
81
Accounting for Bonds Payable (Contd.)
APB Opinion 21 requires the use of the
effective interest method to amortize
premium or discount when two amortization
methods generate significant different
results.
Expenditures connected with a bond issue
(legal fees, printing costs, etc.) should be deferred
and amortized as expense over the life of the
bond using the straight-line method.
82
Accounting for B/P When Bonds Are
Issued at A Premium
Information of example 3 is summarized
below with some additional information:
Stated Interest Rate (annual) = 10%
Effective Interest Rate (annual) = 8%
Date of Issuance = 1/1/x1 (sold on 1/1/x1)
Date of Maturity = 1/1/x5
Interest Payment Dates = 6/30 and 12/31
Face Value = $100,000
P.V. of the Bond = $108,115
Current and Long-Term Liabilities
83
Accounting for B/P When Bonds Are
Issued at A Premium (contd.)
Premium = $108,114.5 - 100,000 =
$8,114.5
 The premium would decrease the
interest expense and should be
amortized over 10 periods.
 Using the straight-lint method to amortize
the premium, $811.45 would be
amortized every period.
Current and Long-Term Liabilities
84
Accounting for B/P When Bonds Are
Issued at A Premium (contd.)
J.E (Amort. = Straight-Line method)
1/1/x1 Cash 108,114.5
B/P
100,000
Prem. on B/P
8,114.5
6/30/x1 Prem.on B/P
811.45
Int. Exp.
4,188.55
Cash
5,000
Current and Long-Term Liabilities
85
Accounting for B/P When Bonds Are
Issued at A Premium (contd.)
12/31/x1 Premium on Bonds Payable 811.45
Interest Expense
4,188.55
Cash
5,000
6/30/x5 Premium. on Bonds Payable 811.45
..
Interest Expense
4,188.55
.
Cash
5,000
Current and Long-Term Liabilities
86
Accounting for B/P When Bonds Are
Issued at A Premium (contd.)
12/31/x5 Premium on Bonds Payable
Interest Expense
811.45
4,188.55
Cash
1/1/x5
B/P
5,000
100,000
Cash
100,000
Current and Long-Term Liabilities
87
Accounting for B/P When Bonds Are
Issued at A Premium (contd.)
Premium on Bonds
Interest Expense for 10
6/30/x1 811.45 8114.5---1/1/x1
periods = $4188.55 x 10 =
12/31/x1 811.45
41,885.5
41,885.5 = 50,000 - 8,114.5
6/30/x5 811.45
12/31/x5 811.45
0
Total Interest
(cash) payment
Current and Long-Term Liabilities
Premium on
Discount
88
Bond Retirements Before Maturity
(i.e., Callable Bonds)
Use example 2 (issued at a Discount; using
straight-line amortization)
Bond Retired at the end of period 3 for $98,000.
Discount on Bonds
7,359
736…Period 1
736…Period 2
736…Period 3
5,151
round to the dollar from $735.9
Unamortized discount at then end of period 3
PV of the Bond = 100,000 - 5,151 = 94,849
89
Bond Retirements Before Maturity
(contd.)
B/P
100,000
Loss
on Retirement of Bonds*
3,151
Discount on Bonds Payable
Cash
5,151
98,000
*or Loss on bond redemption
Current and Long-Term Liabilities
90
Convertible Bonds –Converting
Bonds into Common Stock
At conversion, the carrying amount (the
book value) of the bonds is transferred
from a liability to stockholders’ equity.
Current and Long-Term Liabilities
91
Example (Converting Bonds into
Common Stock)
MI Corp. has convertible bonds
outstanding with a carrying amount (book
value) of $10.5 million.
The maturity value (face amount) of the
bonds is $12 million.
The bondholders convert the bonds into
250,000 shares of the company’s $2 par
common stock on 3/8/x7
Current and Long-Term Liabilities
92
Example (contd.)
3/8/x7 ( $ in millions)
Bonds Payable
Discount on Bonds Payable
Common Stock
Paid-in Capital in excess of
Par-Common
12
1.5
0.5
10
Book value of bonds = $12-1.5= $10.5 (million)
Current and Long-Term Liabilities
93
Corporate Bond Listing*
 Corporate bond listings usually include
the coupon (i.e., the stated interest),
maturity date, last price traded, the
current yield and the volume traded.
 Examples of Corporate bond listings:
Bonds
Cur. Yld. Vol Close
Net Chg.
BosCelts 6s38
9.2
22 65 3/8
+ 1/4
PacBell 6 5/8 34 6.7
5 99 1/8
- 1/8
* Source:
http://www.investinginbonds.com/learnmore.asp?catid=3&id=45
Current and Long-Term Liabilities
94
Bond Current Yield and Yield-toMaturity*
Current Yield = Annual Stated Interest/Close Price
BosCelts 60/653.75
= 9.2%
PacBell 66.25/991.25= 6.7%
Yield- to-Maturity: The discount rate ( r )to equate all
future cash flows (i.e., stated interest and the par value)
of the bond with the present value of the bond.
BosCelts: 653.5 = 60(1+r)-1 +60 (1+r) -2 +….+
60(1+r)-28 +1,000x(1+r)-28
2038-2010 = 28
YTM is a better measure of bond returns than the current yield.
•
* Source: http://www.moneychimp.com/articles/finworks/fmbondytm.htm
Current and Long-Term Liabilities
95
Accounting for Long-Term Notes
Payable
 Companies often borrow money from banks
by issuing a long-term note with specific
assets as security for the loan.
 This note payable is referred to as mortgage
notes payable.
 The interest of the note could be either fixed
or adjustable.
 The terms of the note typically require the
borrow to make installment payments over
the term of the loan.
96
Long-Term Notes Payable (contd.)
 Each payment will include:1)the interest on
the unpaid balance of the loan, and 2) a
reduction of loan principal.
 Since the stated interest rate on the note is
the market interest rate, the borrower will
receive cash equals the face value of the
note (no discount or premium).
97
Long-Term Notes Payable –An Example
Example: (Source: Financial Accounting by
Weygandt, Kimmel and Kieso, p493 )
Porter Tech. Inc. issues a $500,000, 12%,
20-year mortgage note on 12/31/2008 to
obtain needed finance for a new research
lab. The terms require a semiannual
installment payments of $33,231. The
installment payment schedule for the first
two years is as follows:
98
Long-Term Notes Payable (contd.)
Semiannual
annual int.
period
Cash
payment
Interest
Expense
Reduction of
Principal
12/31/08
Principal
Balance
$500,000
6/30/09
$33,231
$30,000
$3.321
496,769
12/31/09
$33,231
29,806
3,425
493,344
06/30/10
$33,231
29,601
3,630
489,714
12/31/10
$33,231
29,383
3,848
485,866
99
Long-Term Notes Payable (contd.)
Journal entries:
12/31/08 Cash
500,000
Mortgage N/P
500,000
6/30/09
Interest exp.*
30,000
Mortgage N/P
3,231
Cash
33,231
*Interest exp. = $500,000x 6% = $30,000
100
Presentation of Long-Term
Liabilities on Balance Sheet
Balance Sheet (partial)
Long term liabilities
Bonds payable, 8%, due 2015 $2,000,000
Less: Discount on bonds payable
Mortgages note payable, 9% due
in 2023, secured by plant assets
Lease liability
Total long-term liabilities
90,000
$1,910,000
700,000
800,000
$3,410,000
101
Advantages of Financing Operations
with Bonds Versus Stock
Issuing Note or
Issuing Stock
Bonds Payable
Creates no liability or
Does not dilute ownership.
interest expense. Does Results in higher earnings
not increase debt /equity per share.
ratio.
Current and Long-Term Liabilities
102
Ratios

Debt to total assets ratio
= total debt/total assets
 Times interest earned ratio*
= income before income taxes and interest
expense/interest expense
*Measured the company’s ability to meet
interest payments when they are due.
103
Other Long-Term Liabilities
a. Lease
b. Post-retirement benefits liabilities
Current and Long-Term Liabilities
104
a. Lease
A lease is a contractual agreement in
which the lessee agrees to make
periodic payments to lessor in
exchange for the usage of the assets
(i.e., building, airplane, copiers,
automobiles…).
Current and Long-Term Liabilities
105
a. Lease
Operating Lease: treated as a rental
agreements.
Capital Lease: treated as a purchase.
(Thus, recognized leased assets as an
assets and the lease obligation as a
liability on the B/S.)
Current and Long-Term Liabilities
106
a. Lease (contd.)
Off-balance-sheet financing: an
acquisition of assets or services with
debt that is not reported on the balance
sheet (neither the assets nor the debt is
reported).
Current and Long-Term Liabilities
107
b. Post-retirement Benefits Liabilities
Based on SFAS No. 106, companies
need to report the post retirement benefits
(i.e., medical insurance provided to
retirees) on an accrual basis starting
1993.
Therefore, companies started to report
the liabilities for post retirement benefits
(other than pensions) in 1993 on their
B/S.
Current and Long-Term Liabilities
108
b. Post-retirement Benefits Liabilities
For example, IBM reported 6,074
million post retirement benefits liabilities
on 1993, about 25% of its stockholders’
equity.
Current and Long-Term Liabilities
109