14
Long-Term Liabilities:
Bonds and Notes
Principles of Financial Accounting, 11e
Reeve • Warren • Duchac
14-1
11-1
2
Describe the
characteristics and
terminology of bonds
payable.
14-12
11-2
14-2
2
Bond Characteristics
and Terminology
The underlying contract between
the company issuing bonds and
the bondholders is called a bond
indenture or trust indenture.
14-3
11-3
2
Proceeds from Issuing Bonds
The market or effective rate of interest
is determined by transactions between
buyers and sellers of similar bonds. The
market rate of interest is affected by a
variety of factors, including investors’
expectations of current and future
economic conditions.
14-4
11-4
2
MARKET RATE = CONTRACT RATE
Selling price of bond = $1,000
If the contract rate equals the market rate of
interest, the bonds will sell at their face amount.
14-5
11-5
2
MARKET RATE > CONTRACT RATE
Selling price of bond < $1,000
Discount
If the market rate is higher than the contract rate,
the bonds will sell at a discount.
14-6
11-6
2
MARKET < CONTRACT RATE
Selling price of bond > $1,000
+
Premium
If the market rate is lower than the contract rate,
the bonds will sell at a premium.
14-7
11-7
3
Journalize entries for
bonds payable.
14-21
11-8
14-8
3
Bonds Issued at Face Amount
On January 1, 2009, Eastern Montana
Communications Inc. issued for cash
$100,000 of 12%, five-year bonds;
interest payable semiannually. The
market rate of interest is 12%.
14-9
11-9
3
Since the bond rate of interest and the market rate
of interest are the same, the bonds will sell at their
face amount.
14-10
11-10
3
Every six months (on June 30 and December 31)
after the bonds are issued, interest of $6,000
($100,000 × .12 × 6/12) is paid.
14-11
11-11
3
The bond matured on December 31, 2013. At this
time, the corporation paid the face amount to the
bondholder.
14-12
11-12
3
Bonds Issued at a Discount
On January 1, 2009, Western Wyoming
Distribution Inc. issued $100,000, 12%
(paid semiannually on June 30 and
December 31), five-year bonds when
the market rate was 13%.
14-13
11-13
3
On January 1, 2009, the firm issued $100,000
bonds for $96,406 (a discount of $3,594).
The discount may be viewed as the amount
required by investors to accept a bond rate
of interest below the market rate.
14-14
11-14
3
Example Exercise 14-2
Issuing Bonds at a Discount
On the first day of the fiscal year, a company issues a
$1,000,000, 6%, 5-year bond that pays semi-annual
interest of $30,000 ($1,000,000 × 6% × ½), receiving
cash of $936,420. Journalize the entry to record the
issuance of the bonds.
Follow My Example 14-2
Cash……………………………………………
Follow
My Example
6-1
Discount
on Bonds Payable……………….
Bonds Payable…………………………
936,420
63,580
1,000,000
For Practice: PE 14-2A, PE 14-2B
14-28
14-15
11-15
3
Amortizing a Bond Discount
The two methods of computing amortization
of a bond discount are as follows:
1. Straight-line method
2. Effective interest rate method,
sometimes called the interest method
Both methods amortize the same total amount
of discount over the life of the bonds.
14-16
11-16
3
Straight-Line Amortization
On June 30, 2009, six-months’ interest is paid and
the bond discount is amortized ($3,594 × 1/10)
on the five-year bond issued in Slide 27.
*
*$100,000 × 12% × 6/12
14-17
11-17
3
Example Exercise 14-3
Discount Amortization
Using the bond from Example Exercise 14-2 (Slide 28),
journalize the first interest payment and the
amortization of the related bond discount.
Follow My Example 14-3
Interest Expense…………………………….
Discount on Bonds Payable…………
Cash…………...…………………………
Paid interest and amortized the
bond discount ($63,580 ÷ 10).
36,358
6,358
30,000
For Practice: PE 14-3A, PE 14-3B
14-31
14-18
11-18
3
Bonds Issued at a Premium
On January 1, 2009, Northern Idaho Transportation
Inc. issued a $100,000, 12%, five-year bond for
$103,769. The market rate of interest was 11%.
14-19
11-19
3
Example Exercise 14-4
Issuance of Bonds at a Premium
A company issues a $2,000,000, 12%, five-year bond
that pays semiannual interest of $120,000 ($2,000,000 ×
12% × ½), receiving cash of $2,154,440. Journalize the
bond issuance.
Follow My Example 14-4
Cash…………………………………………… 2,154,440
Follow Premium
My Example
6-1 Payable...……….
on Bonds
154,440
Bonds Payable…………………………
2,000,000
For Practice: PE 14-4A, PE 14-4B
14-33
14-20
11-20
3
Amortizing a Bond Premium
The first entry to record the interest payment and
the amortization of the $100,000, 12%, five-year
bond issued on January 1, 2009 (Slide 32), is
made on June 30, 2009.
6,000.00
14-21
11-21
3
Example Exercise 14-5
Premium Amortization
Using the bond from Example Exercise 14-4 (Slide
journalize the first interest payment and the
amortization of the related bond premium.
33),
Follow My Example 14-5
Interest Expense………………..……………
Premium on Bonds Payable...……………..
Cash…………………………
104,556
15,444
120,000
For Practice: PE 14-5A, PE 14-5B
14-35
14-22
11-22
3
Bond Redemption
A corporation may call or redeem
bonds before they mature. Callable
bonds can be redeemed by the
issuing corporation within the
period of time and the price stated in
the bond indenture. Normally, the
call price is above the face value.
14-23
11-23
3
On June 30, a corporation has a bond issue of
$100,000 outstanding on which there is an
unamortized premium of $4,000. The corporation
purchases one-fourth of the bonds for $24,000.
Gains and losses on the redemption of bonds are
reported as Other Income (Loss).
14-24
11-24
3
The corporation calls the remaining $75,000 of
outstanding bonds, which are held by a private
investor, for $79,500 on July 1, 2009.
14-25
11-25
3
Example Exercise 14-6
Redemption of Bonds Payable
A $500,000 bond issue on which there is an unamortized
discount of $40,000 is redeemed for $475,000. Journalize
the redemption of the bonds.
Follow My Example 14-6
Bonds Payable...………………..………………. 500,000
Loss on Redemption of Bonds..……………... 15,000
Discount on Bonds Payable……………..
Cash………………………………………….
40,000
475,000
For Practice: PE 14-6A, PE 14-6B
14-39
14-26
11-26
4
Describe and illustrate
the accounting for
installment notes.
14-40
11-27
14-27
4
Installment Notes
An installment note is a debt that requires the
borrower to make equal periodic payments to
the lender for the term of the note. Unlike
bonds, a note payment consists of payment of
a portion of the amount initially borrowed (the
principal) and payment of interest on the
outstanding balance.
14-28
11-28
4
Issuing an Installment Note
Lewis Company issues a $24,000, 6%, five-year
note to City National Bank on January 1, 2008.
The annual payment is $5,698.
14-29
11-29
4
Exhibit 3
14-30
11-30
Amortization of Installment Notes
4
The entry to record the first payment on December
31, 2008, is as follows:
(Column C of Exhibit 3)
(Column D of Exhibit 3)
14-31
11-31
4
The entry to record the second payment on
December 31, 2009, is as follows:
(Column C of Exhibit 3)
(Column D of Exhibit 3)
14-32
11-32
4
The entry to record the final payment on
December 31, 2012, is as follows:
(Column C of Exhibit 3)
(Column D of Exhibit 3)
After the entry is posted, the balance in Notes
Payable related to this note is zero.
14-33
11-33
4
Example Exercise 14-7
Journalizing Installment Notes
On the first day of the fiscal year, a company
issue a $30,000, 10%, five-year installment
note that has annual payments of $7,914. The
first payment consists of $3,000 of interest and
$4,914 of principal repayment.
a. Journalize the entry to record the issuance
of the installment note.
b. Journalize the first annual note payment.
14-47
14-34
11-34
Example Exercise 14-7 (continued)
4
Follow My Example 14-7
a.
b.
14-48
14-35
11-35
For Practice: PE 14-7A, PE 14-7B