1
Chapter 13
Long-Term
Liabilities and
Receivables
2
Objectives
1. Explain the reasons for issuing long-term
liabilities.
2. Understand the characteristics of bonds
payable.
3. Record the issuance of bonds.
4. Amortize discounts and premiums under
the straight-line method.
5. Compute the selling price of bonds.
3
Objectives
6. Amortize discounts and premiums under
the effective interest method.
7. Explain extinguishment of liabilities.
8. Understand bonds with equity
characteristics.
9. Account for long-term notes payable.
10. Understand the disclosure of long-term
liabilities.
4
Objectives
11. Account for long-term notes receivable,
including impairment of a loan.
12. Understand troubled debt restructurings.
(Appendix)
13. Account for serial bonds. (Appendix)
5
Characteristics of Bonds
•
•
•
•
•
•
•
•
Debenture bonds
Mortgage bonds
Registered bonds
Coupon bonds
Zero-coupon bonds
Callable bonds
Convertible bonds
Serial bonds
6
Steps a Company Must Follow
When It Issues Bonds
 It must receive approval from regulatory
authorities, such as the Securities and Exchange
Commission.
 The company must set the terms of the bond
issue, such as the contract rate and the maturity
date.
 It must make a public announcement of its intent
to sell the bonds on a particular date and print the
bond certificates.
7
Recording the Issuance of Bonds
Company J sells bonds with a face value of $400,000
on the authorization date at 102.
Cash ($400,000 x 1.02)
Bonds Payable
Premium on Bonds Payable
408,000
400,000
8,000
Company M sells bonds with a face value of
$400,000 on the authorization date at 97.
Cash ($400,000 x .97)
Discount on Bonds Payable
Bonds Payable
388,000
12,000
400,000
8
Recording the Issuance of Bonds
On March 1, 2001, Grimes Corporation issues
$800,000 of 10-year bonds dated January 1, 2001 at
par. The bonds have a contract (stated) interest rate of
12% and pay interest semiannually.
Cash
Interest Expense
Bonds Payable
816,000
16,000
800,000
$800,000 x 0.12 x 2/12
Continued
9
Recording the Issuance of Bonds
On July 1, 2001, Grimes Corporation records the
semiannual interest payment.
Interest Expense
Cash
Interest Expense
48,000
16,000
32,000
48,000
48,000
$800,000 x 0.12 x 6/12
The balance of $32,000 represents the
interest cost since the bonds were
issued.
10
Straight-Line
Method
11
Issuing Bonds at a Discount
Jet Company sells bonds for $92,976.39 on
January 1, 2001. The bonds have a face value
of $100,000 and a 12% stated annual interest
rate. Interest is paid semiannually and the
bonds mature on December 31, 2005.
Cash
Discount on Bonds Payable
Bonds Payable
Continued
92,976.39
7,023.61
100,000.00
12
Issuing Bonds at a Discount
Jet Company records the first interest
payment on June 30, 2001.
Interest Expense
Discount on Bonds Payable
Cash
6,702.36
702.36
6,000.00
$6,000 + $702.36
$100,000 $7,023.61
x 0.12 x 1/2
÷ 10
13
Issuing Bonds at a Discount
After this second entry, the long-term
liabilities section of Jet’s December 31, 2001
balance sheet would appear as follows:
Bonds payable
Less: Discount on Bonds Payable
$100,000.00
(5,618.89)
$ 94,381.11
$7,023.61 - $702.36 - $702.36
14
Issuing Bonds at a Premium
Jet Company sold bonds on January 1, 2001 for
$107,721.71. Interest is paid semiannually.
Cash
107,721.71
Bonds Payable
$7,721.71 ÷100,000.00
10
Premium on Bonds Payable
7,721.71
The first interest payment is made on June 30.
Interest Expense
5,227.83
Premium on Bonds Payable
772.17
Cash ($100,0000 x 0.12 x 1/2)
Continued
6,000.00
15
Issuing Bonds at a Premium
After this second entry, the long-term
liabilities section of Jet’s December 31, 2001
balance sheet would appear as follows:
Bonds payable
Add: Premium on Bonds Payable
$100,000.00
6,177.37
$106,177.37
$7,721.71 - $772.17 - $772.17
16
Effective
Interest
Method
17
Determining the Selling Price
Jet Company desires to sell $100,000 of 5-year bonds
paying semiannual interest with a stated rate of 12%.
The current effective interest rate is 14%.
Present value of principal
($100,000 x 0.508349)
Present value of interest
($6,000 x 7.023582)
Less face value
Discount
$ 50,834.90
42,141.49
$ 92,976.39
(100,000.00)
$ 7,023.61
18
Determining the Selling Price
Jet Company desires to sell $100,000 of 5-year bonds
paying semiannual interest with a stated rate of 12%.
The bonds are sold to yield 14% interest.
Present value of principal
($100,000 x 0.613913)
Present value of interest
($6,000 x 7.721735)
Less face value
Premium
$ 61,391.30
46,330.41
$107,721.71
(100,000.00)
$ 7,721.71
19
Issuing Bonds at a Discount
Jet Company sells bonds for $92,976.39 on
January 1, 2001. The bonds have a face value
of $100,000 and a 12% stated annual interest
rate. Interest is paid semiannually and the
bonds mature on December 31, 2005.
Cash
Discount on Bonds Payable
Bonds Payable
Continued
92,976.39
7,023.61
100,000.00
20
Issuing Bonds at a Discount
Jet Company records the first interest
payment on June 30, 2001.
Interest Expense
Discount on Bonds Payable
Cash
6,508.35
508.35
6,000.00
$92,976.39 x 0.14 x 1/2
$100,000
x 0.12
x 1/2
$6,508.35$6,000.00
21
Issuing Bonds at a Discount
Jet Company records the second interest
payment on December 31, 2001.
Interest Expense
Discount on Bonds Payable
Cash
6,543.93
543.93
6,000.00
($92,976.39 + $508.35) x 0.14 x 1/2
$100,000
x 0.12
x 1/2
$6,543.93
- 6,000.00
22
Issuing Bonds at a Premium
Jet Company sold bonds on January 1, 2001 for
$107,721.71. Interest is paid semiannually.
Cash
107,721.71
Bonds Payable
100,000.00
Premium on Bonds Payable
$107,721.71 x 0.10 x7,721.71
1/2
$6,000.00
- $5,386.09
The first interest payment
is made on
June 30.
Interest Expense
5,386.09
Premium on Bonds Payable
613.91
Cash
Continued
6,000.00
23
Issuing Bonds at a Premium
Jet Company records the second interest
payment on December 31, 2001.
Interest Expense
Premium on Bonds Payable
Cash
5,355.39
644.61
6,000.00
($107,721.71 - $613.91) x 0.10 x 1/2
$100,000
x 0.12 x 1/2
$6,000.00
- $5,355.39
24
Comparison of Book Values
Selling
Price
Effective Interest Method
Premium
Face Value Straight-Line Method
Discount
Selling
Price
Effective Interest Method
Issue Date
Maturity Date
25
Bond Issue Costs
On January 1, 2001 Bergen Company issues 10-year
bonds with a face value of $500,000 at 104. Expenditures
connected with the issue totaled $8,000.
Cash ($520,000 - $8,000)
Deferred Bond Issue Costs
Premium on Bonds Payable
Bonds Payable
512,000
8,000
20,000
500,000
0.04 x $500,000
26
Bond Issue Costs
Each year for the ten years
Deferred Bond Issue Costs is
amortized on a straight-line
basis by charging Bond
Interest Expense for $800.
27
Accruing Bond Interest
McAdams Company issues $200,000 of 10%, 5-year
bonds on October 1, 2001 for $185,279.87. Interest on
these bonds is payable each October 1 and April 1.
Cash
Discount on Bonds Payable
Bonds Payable
185,279.87
14,720.13
Continued
200,000.00
28
Accruing Bond Interest
At the end of the fiscal year, December 31, 2001, an
adjusting entry is required to record interest for three
months (assume straight-line amortization).
Interest Expense
Discount on Bonds Payable
Interest Payable
5,736.01
736.01
5,000.00
($14,720.13 ÷ 5) x 3/12
$200,000 x 0.10 x 3/12
29
Accruing Bond Interest
At the end of the fiscal year, December 31, 2001, an
adjusting entry is required to record interest for three
months (assume the effective-interest amortization).
Interest Expense
5,558.40
Discount on Bonds Payable
558.40
Interest Payable
5,000.00
$185,279 x 0.12 x 3/12
$5,558.40 - $5,000.00
30
Extinguishment of Liabilities
Under FASB Statement No. 125, a liability is considered
extinguished for financial reporting purposes if either of
the following occurs:
 The debtor pays the creditor and is relieved of its
obligation for the liability. For debt securities this
payment may take place at maturity, or prior to
maturity, by recall or by reacquisition.
 The debtor is released legally from being the
primary obligor under the liability, either by law
or by the creditor.
31
Bonds Retired Prior to Maturity
Conceptually, gains or losses
from refundings could be
recognized either--
• Over the remaining
life of the old issue.
• Over the life of the
new bond issue.
• In the current
period.
32
Bonds Retired Prior to Maturity
Whether bonds are recalled,
retired, or refunded prior to
maturity, any gain or loss is
considered extraordinary.
33
Bonds Retired Prior to Maturity
Channing Corporation originally issued $100,000 of
12% bonds at 97 on January 1, 1996. The bonds have
a 10-year life, pay interest on January 1 and July 1, and
are callable at 105 plus accrued interest. The company
amortizes the discount by the straight-line method.
On June 30, 2001 the company recalls the bonds.
Continued
34
Bonds Retired Prior to Maturity
First, Channing records the current interest expense
and liability, including the amortization of the discount
that expired since the last interest payment.
Interest Expense
Discount on Bonds Payable
Interest Payable
6,150
150
6,000
($3,000 ÷ 10) x 1/2
$100,000 x 0.12 x 1/2
35
Bonds Retired Prior to Maturity
Channing then records the reacquisition of the
bonds at 105 plus accrued interest of $6,000.
Bonds Payable
Interest Payable
Extraordinary Loss on Bond
Redemption
Discount on Bonds Payable
Cash
100,000
6,000
6,350
1,350
111,000
Original discount
$ 3,000
Less: Amortization
for 5 1/2 years
(1,650)
Unamortized discount $1,350
36
Bonds With Equity
Characteristics
By acquiring bonds with detachable stock
warrants or with a conversion feature, the
bondholder has- the right to receive interest on the bonds,
and…
 the right to acquire common stock and to
participate in the potential appreciation of
the market value of the company’s
common stock.
37
Bonds Issued with Detachable
Stock Warrants
Market Value of Bonds
Without Warrants
Amount
Assigned to =
x Issuance
Price
Market Value of Bonds + Market Value
Bonds
Without Warrants
of Warrants
Amount
Market Value of Warrants
Assigned to =
x Issuance
Price
Market Value of Bonds + Market Value
Warrants
Without Warrants
of Warrants
38
Bonds Issued with Detachable
Stock Warrants
Paul Company sold
$800,000 of 12% bonds at
101 ($808,000). Each bond
carried 10 warrants, and
each warrant allows the
holder to acquire one share
of $5 par common stock for
$25 per share. The warrants
are quoted at $3 each.
39
Bonds Issued with Detachable
Stock Warrants
Market Value of Bonds
Without Warrants
Amount
Assigned to =
x Issuance
Price
Market Value of Bonds + Market Value
Bonds
Without Warrants
of Warrants
Amount
$990 x 800
x $808,000
Assigned to =
($990 x 800) + ($3 x 800 x 10)
Bonds
Amount
Assigned to =
Bonds
$784,235.29
40
Bonds Issued with Detachable
Stock Warrants
Amount
Market Value of Warrants
Assigned to =
x Issuance
Price
Market Value of Bonds + Market Value
Warrants
Without Warrants
of Warrants
Amount
$3 x 800 x 10
x $808,000
Assigned to =
($990 x 800) + ($3 x 800 x 10)
Warrants
Amount
Assigned to =
Warrants
$23,764.71
41
Bonds Issued with Detachable
Stock Warrants
Cash
Discount on Bonds Payable
Bonds Payable
Common Stock Warrants
808,000.00
15,764.71
800,000.00
23,764.71
$800,000.00 - $784,235.29
From slide 40
42
Bonds Issued with Detachable
Stock Warrants
Later, 500 warrants are exercised at $25 each.
Cash
12,500.00
Common Stock Warrants
1,485.50
Common Stock
2,500.00
Additional Paid-in Capital
on Common Stock ($23,765.71 ÷ 8,000)11,485.50
x 500
The remaining warrants expire.
$23,764.71 - $1,485.50
Common Stock Warrants
22,279.21
Additional Paid-in Capital
from Expired Warrants
22,279.21
43
Convertible Bonds
 Avoid the downward price pressures on its stock
that placing a large new issue of common stock
on the market would cause.
Why
 Avoid the direct sale
of issue
common stock when it
believes its stockconvertible
currently is undervalued in the
market.
bonds?
 Penetrate that segment of the capital market that
is unwilling or unable to participate in a direct
common stock issue.
 Minimize the costs associated with selling
securities.
44
Notes Payable Issued for Cash
On January 1, 2001, Johnson Company issues a 3-year,
non-interest-bearing note with a face value of $8,000
and receives $5,694.24 in exchange.
Cash
Discount on Notes Payable
Notes Payable
Contra account
to Notes Payable
5,694.24
2,305.76
8,000.00
45
Notes Payable Issued for Cash
On December 31, 2001 Johnson Company
records the interest expense on the note.
Interest Expense
Discount on Notes Payable
Notes payable
Less: Unamortized discount
Carrying value at beginning of year
x Effective interest rate
Entry amount
683.31
683.31
$8,000.00
(2,305.76)
$5,694.24
0.12
$ 683.31
46
Notes Payable Exchanged for
Cash and Rights or Privileges
Verna Company borrows $100,000 by issuing a 3year, non-interest-bearing note to a customer. In
addition, Verna Company agrees to sell inventory to
the customer at a reduced price over a 5-year period.
The firm’s incremental borrowing rate is 12%.
$100,000 - ($100,000 x 0.711780)
Cash
Discount on Notes Payable
Notes Payable
Unearned Revenue
100,000.00
28,822.00
100,000.00
28,822.00
47
Notes Payable Exchanged for
Cash and Rights or Privileges
$71,178 x 0.12
End of First Year
Interest Expense
8,541.36
Discount on Notes Payable
8,541.36
Unearned Revenue
5,764.40
Sales Revenue
5,764.40
End of Second Year
$28,822 ÷ 5
Interest Expense
9,566.32
Discount on Notes Payable
9,566.32
($71,178 5,764.40
+ $8,541.36) x 0.12
Unearned Revenue
Sales Revenue
5,764.40
48
Notes Payable Exchanged for
Property, Goods, or Services
APB Opinion No. 21 states that the stipulated rate of
interest should be presumed fair. This presumption
can be overcome only if--
1. No interest is stated, or
2. The stated rate of interest is clearly
unreasonable, or
3. The face value of the note is materially different
from the cash sales price of the property, goods,
or services, or the fair value of the note at the
date of the transaction.
49
Long-Term Notes Receivable
On January 1, 2001, Joyce Company accepted a
$10,000 non-interest-bearing, 5-year note in exchange
for used equipment it sold to Marsden Company.
Notes Receivable
10,000.00
Accumulated Depreciation
3,000.00
Discount on Notes Receivable
4,325.73
Equipment
8,000.00
Gain on Sale of Equipment $10,000 - present value
674.27
of
equipment, $5,674.27
50
Long-Term Notes Receivable
December 31, 2001
Discount on Notes Receivable
Interest Revenue
December 31, 2002
680.91
680.91
($10,000 - $4,325.73) x 0.12
Discount on Notes Receivable
Interest Revenue
762.62
762.62
$10,000 - ($4,325.73 - $680.91) x 0.12
51
Impairment of a Loan
A loan is impaired if it is probable
that the creditor will not be able to
collect all amounts due according
to the contract terms.
52
Impairment of a Loan
Snook Company has a $100,000 note receivable from
the Ullman Company that it is carrying at face value.
The loan agreement called for Ullman to pay 8%
interest each December 31and the principal on
December 31, 2006. Ullman paid the December 31,
2001 interest, but informed Snook that it probably
would miss the next two year’s interest payments
because of financial difficulties. In addition, the
principal payment would be one year late.
53
Impairment of a Loan
Value
SnookofCompany
the impaired
computes
loan isthe
$85,733.93
present
($63,017.00
value of the impaired
+ $22,716.93)
loan.
Present value of the principal = $100,000 x present value of a
single sum for 6 years at 8%
= $100,000 x 0.630170
= $63,017.00
Present value of the interest = $8,000 x present value of an
annuity for 4 years at 8% deferred
2 years
= $8,000 x 3.312127 x 0.857339
= $22,716.93
54
Impairment of a Loan
December 31, 2001 (Snook Company)
Bad Debt Expense
14,266.07
Allowance for Doubtful Accts.
14,266.07
$100,000 - $85,733.93
December 31, 2002 (Snook Company)
Allowance for Doubtful Accounts 6,858.71
Interest Revenue
6,858.71
8% x $85,733.93
55
Troubled Debt Restructuring
Modification of Terms
 Reduction of the stated interest rate for the
remainder of the debt.
 Extension of the maturity date at a stated interest
rate lower than the current market rate for new
debt with similar risk.
 Reduction of the face amount or maturity amount
of the debt.
 Reduction of accrued interest.
Click button to skip Appendix material
56
Troubled Debt Restructuring
Modification of Terms
When a restructuring involves only a
modification of terms, the carrying value of the
liability is compared to the undiscounted future
cash payments specified by the terms. Then,
two different situations may arise:
Continued
57
Troubled Debt Restructuring
1. If the undiscounted total future
cash payments are greater than
(or equal to) the carrying value
of the liability, the debtor does
not recognize a gain, the
carrying value is not reduced,
and interest expense is
recognized in future periods
using an imputed interest rate.
Continued
58
Troubled Debt Restructuring
2. If the future cash payments are
less than the carrying value of
the liability, the debtor
recognizes a gain, the carrying
value of the liability is reduced,
and interest expense is not
recognized in future periods.
59
Troubled Debt Restructuring
Equity or Asset Exchange
When a debtor satisfies a liability by
exchanging an equity interest or an asset
of lesser value, it records the transfer on
the basis of the fair value of the equity
interest or asset transferred and
recognizes an extraordinary gain.
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Chapter 13