CHAPTER
11
Long-Term
Debt Financing
Learning Objective 1
Use present
value concepts
to measure
long-term
liabilities.
Define Long-Term Liabilities
Accounting for
Long-Term Liabilities
Measurement and recording of long-term
liabilities are based on the time value of
money concept.
Present value of $1 is
the value today of $1 to
be received or paid in
the future, given a
specific interest rate.
If money can earn 10% per year, $100 to be received 1 year
from now is approximately equal to $90.91 received today.
Present and Future
Value Tables
Present Value Table
Future Value Table
Locate the number of
periods in the left column
and the interest rate in the
row at the top of the table.
This intersection is the
factor representing the
present value of $1.
Discounting—present value
amount is the amount that
could be paid today to
satisfy the obligation.
Locate the number of
periods in the left column
and the interest rate in the
row at the top of the table.
This intersection is the
factor representing the
future value of $1.
Compounding—the
frequency with which
interest is added to the
principal.
Present Value
Present value of $100 paid in 5 years
discounted at 10 percent.
Today 1
2
3
4 Future
Discount at 10%
PV = $62.09
$82.64 $90.90 $100
Future Value
Future value of $100 today
compounded for 5 years at 10 percent.
Today 1
2
3
4 Future
Compound at 10%
$100 $110 $121
FV = $161.05
Value Table — Future Value
Joan invested $2,000 for 3 years at 12 percent,
compounded annually. Using the table below,
what is the future value of the $2,000?
Periods
6%
3
1.1910
4
1.2625
5
1.3382
6
1.4185
8%
1.2597
1.3605
1.4693
1.5869
10%
1.3310
1.4641
1.6105
1.7716
12%
1.4049
1.5735
1.7623
1.9738
Value Table — Future Value
Joan invested $2,000 for 3 years at 12 percent,
compounded semiannually. Using the table
below, what is the future value of the $2,000?
Periods
6%
3
1.1910
4
1.2625
5
1.3382
6
1.4185
8%
1.2597
1.3605
1.4693
1.5869
10%
1.3310
1.4641
1.6105
1.7716
12%
1.4049
1.5735
1.7623
1.9738
Computing the Interest Rate
Provide the Appropriate Formula.
Interest rate per compounding period =
Number of interest periods =
Define Annuities
Annuity
Present Value of an Annuity
Value Tables — Annuity
Joan is paid $8,000 a year for 8 years at 10
percent interest per year. Using the table below,
what is the present value of the annuity?
Periods
6%
7
5.5824
8
6.2098
9
6.8017
10
7.3601
8%
5.2064
5.7466
6.2469
6.7101
10%
4.8684
5.3349
5.7590
6.1446
12%
4.5683
4.9676
5.3282
5.6502
Learning Objective 2
Account for longterm liabilities,
including notes
payable and
mortgages payable.
Time Line of
Business Issues
+
–
Bond
Note
Payable
Mortgage
Payable
Bond
Choose
Issue
Pay
Amortize
Bond
Retire
Example: InterestBearing Notes
On January 1, 2004, Silver Eagle Co. borrowed
$20,000 for 3 years at 12 percent interest. The
interest is payable on December 31 of each
year. What entries are necessary for 2004?
Example: InterestBearing Notes
What entry is needed when Silver Eagle Co.
repays the loan on December 31, 2005?
What is a Mortgage Payable?
Example: Mortgages Payable
On January 1, 2006, Blue Bird Corp. borrowed
$500,000 to acquire a new building. The building
was signed as collateral for the 30-year, 7 percent
loan. Payments of $3,326.51 are to be made
monthly. What are the January 2006 entries?
Mortgages Payable
A mortgage amortization schedule shows
the breakdown between interest and
principal for each payment over the life
of a mortgage.
Month
1
2
3
4
5
6
Monthly
Payment
3,326.51
3,326.51
3,326.51
3,326.51
3,326.51
3,326.51
Principal
Paid
409.84
412.23
414.64
417.06
419.49
421.94
Interest
Paid
2,916.67
2,914.28
2,911.87
2,909.45
2,907.02
2,904.57
Mortgage
Balance
499,590.16
499,177.93
498,763.29
498,346.23
497,926.74
497,504.80
Learning Objective 3
Account for capital
lease obligations
and understand the
significance of
operating leases
being excluded
from the balance
sheet.
Lease Obligations
Match the Following
Terms.
Lessor
Operating
Lease
Lease
Lessee
Capital
Lease
1. The party that is granted the right to use
property under the terms of a lease.
2. The owner of property that is rented
(leased) to another party.
3. A simple short-term rental agreement.
4. A leasing transaction that is recorded
as a purchase by the lessee.
5. A contract that specifies the terms
under which the owner of an asset
agrees to transfer the right to use the
asset to another party.
Classifying Leases
If the lease is cancelable or does not meet any of
the four requirements, is it an operating lease?
Transfer of Ownership?
Bargain Purchase
Option?
Term  75% of
Useful Life?
Capital
Lease
PV Payment 90%
of FMV?
Operating
Lease
Example: Lease Obligations
On January 1, 2006, The Cockatoo Company leased
a computer. The lease requires annual payments of
$5,000 for 8 years. The applicable interest rate is
12 percent. How is the lease recorded? What is the
December 31, 2006 entry for interest expense?
Learning Objective 4
Account for bonds,
including the original
issuance, the payment
of interest, and the
retirement of bonds.
Define These Types of Bonds
Bond
Unsecured Bonds (Debentures)
Secured Bonds
Coupon (Bearer) Bonds
Types of Bonds Matching
Serial Bonds
Convertible Bonds
Term Bonds
Callable Bonds
Registered Bonds
1. Bonds that mature in one lump
sum on a specified future date.
2. Bonds that mature in a series of
installments at specified future
dates.
3. Bonds for which the issuer
reserves the right to pay the
obligation before its maturity date.
4. Bonds that can be traded for, or
converted to, other securities after
a specified period of time.
5. The names and addresses of the
bondholders are kept on file by the
issuing company.
Discuss These Types of
Bonds
Zero-Coupon Bonds
Junk Bonds
Characteristics of Bonds
Match Correctly.
Principal (face value
or market value)
Bond Maturity Date
Bond Indenture
Acontract
contract between
between aa bond
bond
A
issuer
issuerand
anda abond
bondpurchaser
purchaser
that
thatspecifies
specifiesthe
theterms
termsofofa a
bond.
bond.
The amount that will be paid on a
The amount that will be paid
bond at the maturity date.
on a bond at the maturity date.
The date at which a bond
The
date ator
which
bond
principal
face aamount
principal
orpayable.
face amount
becomes
becomes payable.
How Do You Determine
Issuance Price?
Price should equal:
Market rate (effective rate or yield rate) of
interest
Stated rate of interest
Determining Issuance Price
Correctly Define Each Term
Face Value
Bond Discount
Bond Premium
Characteristics of Bonds
Complete the Chart
Market Rate
8%
Bond
Stated
Interest
Rate
10%
10%
12%
Bond Sold at
Example: Bond Issued at
Face Value
Falcon Company agreed to issue 5-year,
$500,000 bonds and pay 10 percent
interest, compounded semiannually.
Assume the effective and stated rates are
equal. Calculate the issue price.
1. Semiannual interest payments
Present value of interest annuity
2. Maturity value of bonds
Present value of bonds
3. Issuance price of bonds
Example: Bond Issued
at a Discount
Falcon Company agreed to issue 5-year,
$500,000 bonds and pay 10 percent
interest, compounded semiannually.
Assume the effective rate is 12 percent.
Calculate the issue price of the bonds.
1. Semiannual interest payments
Present value of interest annuity
2. Maturity value of bonds
Present value of bonds
3. Issuance price of bonds
Example: Bond Issued
at a Premium
Falcon Company agreed to issue 5-year,
$500,000 bonds and pay 10 percent
interest, compounded semiannually.
Assume the effective rate is 8 percent.
Calculate the issue price of the bonds.
1. Semiannual interest payments
Present value of interest annuity
2. Maturity value of bonds
Present value of bonds
3. Issuance price of bonds
Example: Accounting for
Bonds Payable
On January 1, 2006, Falcon Company
agreed to issue 5-year, $500,000 bonds
and pay 10 percent interest, compounded
semiannually. Assume the effective rate is
10 percent. What entry is needed to
record the liability?
Example: Accounting for
Bonds Payable
On January 1, 2006, Falcon Company
agreed to issue 5-year, $500,000 bonds and
pay 10 percent interest, compounded
semiannually. Assume the effective rate is
10 percent. What entry is needed to record
the first interest payment?
Example: Bond Retirements
at Maturity
On January 1, 2006, Falcon Company agreed
to issue 5-year, $500,000 bonds and pay 10
percent interest, compounded semiannually.
Assume the effective rate is 10 percent.
What entry is needed to record the
retirement of the bond on January 1, 2011?
Example: Bond Retirements
Before Maturity
The Great Owl Company issued $200,000, 14
percent bonds, which are now selling for 107
and are callable at 110. The bonds were
issued at face value. If the company decides
to call the bonds, what entry is needed?
Learning Objective 5
Use debt-related ratios to
determine the degree of a
company’s financial
leverage and its ability to
repay loans
Define Debt Ratio
Define Debt-to-Equity Ratio
Times Interest Earned Ratio
Expanded Material
Learning Objective 6
Amortize bond
discounts and bond
premiums using either
the straight-line
method or the
effective-interest
method.
Define the Two Bond
Premium/Discount Amortization
Methods
Straight-line Method
Effective-interest Method
Which
method is
preferred by
GAAP?
Example: Bond Issued
at a Discount
On January 1, 2006, The Ostrich Company
agreed to issue 10-year, $200,000 bonds
and pay 10 percent interest, compounded
semiannually. The company received
$196,000 for the bonds. Make the entry to
record the issuance of the bonds.
Example: Bond Issued
at a Discount
On January 1, 2006, The Ostrich Company
agreed to issue 10-year, $200,000 bonds
and pay 10 percent interest, compounded
semiannually. Using straight-line
amortization, what entry is made for the
interest payment on June 30, 2006?
Example: Bond Issued
at a Discount
On January 1, 2006, The Ostrich Company
agreed to issue 10-year, $200,000 bonds
and pay 10 percent interest, compounded
semiannually. Using straight-line
amortization, what adjusting entry is
needed on December 31, 2006?
Example: Bond Issued
at a Discount
On January 1, 2006, The Ostrich Company
agreed to issue 10-year, $200,000 bonds
and pay 10 percent interest, compounded
semiannually. What entry is necessary to
retire the debt after 10 years?
Example: Bond Issued
at a Premium
On January 1, 2006, The Parrot Company
agreed to issue 10-year, $200,000 bonds
and pay 10 percent interest, compounded
semiannually. The company received
$210,000 for the bonds. Make the entry to
record the issuance of the bonds.
Example: Bond Issued
at a Premium
On January 1, 2006, The Parrot Company
agreed to issue 10-year, $200,000 bonds
and pay 10 percent interest, compounded
semiannually. The company received
$210,000 for the bonds. Using straightline amortization, what entry is made for
the interest payment on June 30, 2006?
Example: Bond Issued
at a Premium
On January 1, 2006, The Parrot Company
agreed to issue 10-year, $200,000 bonds
and pay 10 percent interest, compounded
semiannually. The company received
$210,000 for the bonds. Using straight-line
amortization, what entry is needed on
December 31, 2006?
Example: Bond Issued
at a Premium
On January 1, 2006, The Parrot Company
agreed to issue 10-year, $200,000 bonds
and pay 10 percent interest, compounded
semiannually. The company received
$210,000 for the bonds. What entry is
necessary to retire the debt after 10 years?
Effective-Interest Method
The Woodpecker Company issued a $1,000, 8
percent bond. The market rate was 7 percent at
the time of issuance. Create an effectiveinterest table.
A
B
C
D
E
(
#
Premium Unamortized
Interest
Payment Expense Amortization Premium
Bond
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Chapter 11 Complete