Chapter 15-1 CHAPTER CHAPTER 15 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition Chapter 15-2 Study Study Objectives Objectives Explain why bonds are issued Prepare the entries for the issuance of bonds and interest expense Describe the entries when bonds are redeemed or converted Describe the accounting for long-term notes payable Contrast the accounting for operating and capital leases Identify the methods for the presentation and analysis of long-term liabilities Chapter 15-3 Long-Term Long-Term Liabilities Liabilities Bonds Basics Types of bonds Issuing procedures Trading Market value Chapter 15-4 Accounting for Bond Issues Accounting for Bond Retirements Issuing bonds at face value Discount or premium Issuing bonds at a discount Issuing bonds at a premium Redeeming bonds at maturity Redeeming bonds before maturity Converting bonds into common stock Accounting for Other Long-Term Liabilities Long-term notes payable Lease liabilities Statement Presentation and Analysis Presentation Analysis Bond Bond Basics Basics Bonds are a form of interest-bearing notes payable Three advantages over common stock: Stockholder control is not affected Tax savings result Earnings per share may be higher Chapter 15-5 LO Explain why bonds are issued Bond Bond Basics Basics Effects on earnings per share—stocks vs bonds Illustration 15-2 Chapter 15-6 LO Explain why bonds are issued Bond Bond Basics Basics Question The major disadvantages resulting from the use of bonds are: Chapter 15-7 a that interest is not tax deductible and the principal must be repaid b that the principal is tax deductible and interest must be paid c that neither interest nor principal is tax deductible d that interest must be paid and principal repaid LO Explain why bonds are issued Bond Bond Basics Basics Types of Bonds Secured and Unsecured (debenture) bonds Term and Serial bonds Registered and Bearer (or coupon) bonds Convertible and Callable bonds Chapter 15-8 LO Explain why bonds are issued Bond Bond Basics Basics Issuing Procedures Bond contract known as a bond indenture Represents a promise to pay: (1) sum of money at designated maturity date, plus (2) periodic interest at a contractual (stated) rate on the maturity amount (face value) Paper certificate, typically a $1,000 face value Interest payments usually made semiannually Generally issued when the amount of capital needed is too large for one lender to supply Chapter 15-9 LO Explain why bonds are issued Bond Bond Basics Basics Issuer Issuer of of Bonds Bonds Illustration 15-3 Maturity Maturity Date Date Contractual Contractual Interest Interest Rate Rate Chapter 15-10 Face Face or or Par Par Value Value LO Explain why bonds are issued Accounting Accounting for for Other Other Long-Term Long-Term Liabilities Liabilities Exercise: (b) Prepare the journal entry to record the lease on January 1, 2008 Jan Leased asset - equipment Lease liability 36,144 36,144 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 Chapter 15-37 LO Contrast the accounting for operating and capital leases Accounting Accounting for for Other Other Long-Term Long-Term Liabilities Liabilities Question The lessee must record a lease as an asset if the lease: Chapter 15-38 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 LO Contrast the accounting for operating and capital leases Statement Statement Analysis Analysis and and Presentation Presentation Presentation Chapter 15-39 Illustration 15-14 LO Identify the methods for the presentation and analysis of long-term liabilities Statement Statement Analysis Analysis and and Presentation Presentation Analysis of Long-Term Debt Two ratios that provide information about debtpaying ability and long-run solvency are: 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 Chapter 15-40 LO Identify the methods for the presentation and analysis of long-term liabilities Statement Statement Analysis Analysis and and Presentation Presentation Analysis of Long-Term Debt Two ratios that provide information about debtpaying ability and long-run solvency are: 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 Chapter 15-41 LO Identify the methods for the presentation and analysis of long-term liabilities Present Present Value Value Concepts Concepts Related Related to to Bond Bond Pricing Pricing To illustrate present value concepts, assume that you are willing to invest a sum of money that will yield $1,000 at the end of one year, and you can earn 10% on your money What is the $1,000 worth today? To compute the answer, divide the future amount by plus the interest rate ($1,000/1.10 = $909.09 Illustration 15A-1 Chapter 15-42 LO Compute the market price of a bond Present Present Value Value Concepts Concepts Related Related to to Bond Bond Pricing Pricing To illustrate present value concepts, assume that you are willing to invest a sum of money that will yield $1,000 at the end of one year, and you can earn 10% on your money What is the $1,000 worth today? To compute the answer, divide the future amount by plus the interest rate ($1,000/1.10 = $909.09 or use a Present Value of table ($1,000 X 90909) = $909.09 (10% per period, one period from now) Illustration 15A-1 Chapter 15-43 LO Compute the market price of a bond Present Present Value Value Concepts Concepts Related Related to to Bond Bond Pricing Pricing The selling price of a bond is equal to the sum of two items: 1) The present value of the face value of the bond discounted at the investor’s required rate of return PLUS 2) The present value of the periodic interest payments discounted at the investor’s required rate of return Chapter 15-44 LO Compute the market price of a bond Present Present Value Value Concepts Concepts Related Related to to Bond Bond Pricing Pricing Assume 10%, 5-year bonds with a face value of $100,000 are sold and the investor’s required rate of return is 10% Interest payments are made semiannually Illustration 15A-8 Chapter 15-45 LO Compute the market price of a bond Present Present Value Value Concepts Concepts Related Related to to Bond Bond Pricing Pricing Assume 10%, 5-year bonds with a face value of $100,000 are sold and the investor’s required rate of return is 12% Interest is paid semiannually Illustration 15A-10 The 55839 factor is from the present value of table for 10 periods at 6% per period The 7.36009 factor is from the present value of an annuity table for 10 periods at 6% per period Chapter 15-46 LO Compute the market price of a bond Effective-Interest Effective-Interest Method Method of of Bond Bond Amortization Amortization Under the effective-interest method, the amortization of bond discount or bond premium results in period interest expense equal to a constant percentage of the carrying value of the bonds The follow steps are required under the effectiveinterest method Compute the bond interest expense Compute the bond interest paid or accrued Compute the amortization amount Chapter 15-47 LO Apply the effective-interest method of amortizing bond discount and bond premium Effective-Interest Effective-Interest Method Method of of Bond Bond Amortization Amortization Assume on January 1, 2008, 10%, year bonds with a face value of $100,000, are sold for $92,639, resulting in an effective interest rate of 12% Interest is paid semiannually This results in a discount of $7,361 The cash paid each period equals $100,000 X 5% = $5,000 Interest expense the first period = $92,639 X 6% = $5,558 This results in a discount amortization of $558 Illustration 15B-2 Chapter 15-48 LO Apply the effective-interest method of amortizing bond discount and bond premium Effective-Interest Effective-Interest Method Method of of Bond Bond Amortization Amortization Assume on January 1, 2008, 10%, year bonds with a face value of $100,000, are sold for $92,639, resulting in an effective interest rate of 12% Assume interest is paid semiannually This results in a discount of $7,361 The cash paid each period equals $100,000 X 5% = $5,000 Interest expense the first period = $92,639 X 6% = $5,558 This results in a discount amortization of $558 The journal entry on July 1, 2008, to record the interest payment and amortization of discount is as follows: July Chapter 15-49 Interest Expense 5,558 Cash Discount on Bonds Payable 5,000 558 LO Apply the effective-interest method of amortizing bond discount and bond premium Straight-line Straight-line Method Method of of Bond Bond Amortization Amortization Assume on January 1, 2008, 10%, year bonds with a face value of $100,000, are sold for $92,639, resulting in an effective interest rate of 12% Interest is paid semiannually This results in a discount of $7,361 The cash paid each period equals $100,000 X 5% = $5,000 The discount to be amortized each period is $7,361/10 periods = $736 per period Therefore Interest Expense each period will be $5,000 + $736 = $5,736 The journal entry on July 1, 2008, to record the interest payment and amortization of discount is as follows: July Chapter 15-50 Interest Expense 5,736 Cash Discount on Bonds Payable 5,000 736 LO Apply the straight-line method of amortizing bond discount and bond premium Copyright Copyright “Copyright © 2008 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” Chapter 15-51 .. .CHAPTER CHAPTER 15 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition Chapter 15- 2 Study Study Objectives Objectives Explain why... the market rate of the bond Chapter 15- 12 LO Explain why bonds are issued Accounting Accounting for for Bond Bond Issues Issues Assume Contractual Rate of 8% Chapter 15- 13 Market Interest Bonds... per share may be higher Chapter 15- 5 LO Explain why bonds are issued Bond Bond Basics Basics Effects on earnings per share—stocks vs bonds Illustration 15- 2 Chapter 15- 6 LO Explain why bonds