15 Long-Term Liabilities Learning Objectives 15-1 Describe the major characteristics of bonds Explain how to account for bond transactions Explain how to account for long-term notes payable Discuss how long-term liabilities are reported and analyzed LEARNING OBJECTIVE Describe the major characteristics of bonds Long-term liabilities are obligations that are expected to be paid after one year Bonds are a form of interest-bearing notes payable 15-2 Sold in small denominations (usually $1,000 or multiples of $1,000) Attract many investors Corporation issuing bonds is borrowing money Person who buys the bonds (the bondholder) is investing in bonds LO Types of Bonds 15-3 LO Bonds Issuing Procedures State laws grant corporations the power to issue bonds Board of directors and stockholders must approve bond issues Board of directors must stipulate number of bonds to be authorized, total face value, and contractual interest rate Bond terms set forth in legal document known as a bond indenture Bond 15-4 certificate, typically a $1,000 face value LO Bonds Issuing Procedures Represents ►sum a promise to pay: of money at designated maturity date, plus ►periodic interest at a contractual (stated) rate on the maturity amount (face value) Interest Issued payments usually made semiannually to obtain large amounts of long-term capital Investment company sells the bonds for the issuing company 15-5 LO Illustration 15-1 Bond certificate 15-6 LO Determining the Market Value of a Bond Current market price (present value) is a function of the three factors: 1.dollar amounts to be received, 2.length of time until the amounts are received, and 3.market rate of interest The market interest rate is the rate investors demand for loaning funds 15-7 LO Determining the Market Value of a Bond Illustration: Assume that Acropolis Company on January 1, 2017, issues $100,000 of 9% bonds, due in five years, with interest payable annually at year-end The purchaser of the bonds would receive the following two types of cash payments: (1) principal of $100,000 to be paid at maturity, and (2) five $9,000 interest payments ($100,000 x 9%) over the term of the bonds 15-8 Illustration 15-2 Time diagram depicting cash flows LO Determining the Market Value of a Bond Illustration 15-2 The current market price of a bond is equal to the present value of all the future cash payments promised by the bond 15-9 Illustration 15-3 Computing the market price of bonds LO DO IT! Bond Terminology State whether each of the following statements is true or false True _ True _ False _ True _ False _ 15-10 Mortgage bonds and sinking fund bonds are both examples of secured bonds Unsecured bonds are also known as debenture bonds The stated rate is the rate investors demand for loaning funds The face value is the amount of principal the issuing company must pay at the maturity date The market price of a bond is equal to its maturity value LO Effective-Interest Method Amortizing Bond Discount Illustration: Candlestick, Inc issues $100,000 of 10%, five-year bonds on January 1, 2017, for $98,000, with interest payable each January This results in a discount of $2,000 Illustration 15B-2 Illustration 15B-2 Bond discount amortization schedule 15-63 LO Amortizing Bond Discount Illustration 15B-2 Bond discount amortization schedule Candlestick, Inc records the accrual of interest and amortization of bond discount on December 31 as follows Dec 31 Interest Expense 10,324 Interest Payable 10,000 15-64 324 Discount on Bonds Payable LO Amortizing Bond Discount Illustration 15B-2 Bond discount amortization schedule For the second interest period, at December 31, Candlestick makes the following adjusting entry Dec 31 Interest Expense 10,358 Interest Payable 10,000 15-65 358 Discount on Bonds Payable LO Amortizing Bond Premium Illustration: Candlestick, Inc issues $100,000 of 10%, five-year bonds on January 1, 2017, for $102,000, with interest payable January This results in a premium of $2,000 Illustration 15B-4 Bond premium amortization schedule 15-66 LO Amortizing Bond Premium Illustration 15B-4 Bond premium amortization schedule The entry Candlestick makes on December 31 is: Dec 31 Interest Expense 9,669 Premium on Bonds Payable Interest Payable 331 10,000 15-67 LO A Look at IFRS LEARNING OBJECTIVE Compare the accounting for long-term liabilities under GAAP and IFRS Key Points Similarities 15-68 IFRS requires that companies classify liabilities as current or noncurrent on the face of the statement of financial position (balance sheet), except in industries where a presentation based on liquidity would be considered to provide more useful information (such as financial institutions) When current liabilities (also called short-term liabilities) are presented, they are generally presented in order of liquidity LO A Look at IFRS Key Points 15-69 Under IFRS, liabilities are classified as current if they are expected to be paid within 12 months Similar to GAAP, items are normally reported in order of liquidity Companies sometimes show liabilities before assets Also, they will sometimes show long-term liabilities before current liabilities The basic calculation for bond valuation is the same under GAAP and IFRS In addition, the accounting for bond liability transactions is essentially the same between GAAP and IFRS LO A Look at IFRS Key Points IFRS requires use of the effective-interest method for amortization of bond discounts and premiums GAAP allows use of the straight-line method where the difference is not material Under IFRS, companies not use a premium or discount account but instead show the bond at its net amount For example, if a $100,000 bond was issued at 97, under IFRS a company would record: Cash Bonds Payable 15-70 97,000 97,000 LO A Look at IFRS Key Points Differences 15-71 The accounting for convertible bonds differs across IFRS and GAAP, Unlike GAAP, IFRS splits the proceeds from the convertible bond between an equity component and a debt component The equity conversion rights are reported in equity LO A Look at IFRS Key Points Differences 15-72 The IFRS leasing standard is IAS 17 Both Boards share the same objective of recording leases by lessees and lessors according to their economic substance—that is, according to the definitions of assets and liabilities However, GAAP for leases is much more “rules-based” with specific bright-line criteria (such as the “90% of fair value” test) to determine if a lease arrangement transfers the risks and rewards of ownership; IFRS is more conceptual in its provisions Rather than a 90% cut-off, it asks whether the agreement transfers substantially all of the risks and rewards associated with ownership LO A Look at IFRS Looking to the Future The FASB and IASB are currently involved in two projects, each of which has implications for the accounting for liabilities One project is investigating approaches to differentiate between debt and equity instruments The other project, the elements phase of the conceptual framework project, will evaluate the definitions of the fundamental building blocks of accounting In addition to these projects, the FASB and IASB have also identified leasing as one of the most problematic areas of accounting One of the first areas studied is, “What are the assets and liabilities to be recognized related to a lease contract?” Should the focus remain on the leased item or the right to use the leased item? This question is tied to the Boards’ joint project on the conceptual framework —defining an “asset” and a “liability.” 15-73 LO A Look at IFRS IFRS Self-Test Questions The accounting for bonds payable is: a) essentially the same under IFRS and GAAP b) differs in that GAAP requires use of the straight-line method for amortization of bond premium and discount c) the same except that market prices may be different because the present value calculations are different between IFRS and GAAP d) not covered by IFRS 15-74 LO A Look at IFRS IFRS Self-Test Questions The leasing standards employed by IFRS: a) rely more heavily on interpretation of the conceptual meaning of assets and liabilities than GAAP b) are more “rules based” than those of GAAP c) employ the same “bright-line test” as GAAP d) are identical to those of GAAP 15-75 LO A Look at IFRS IFRS Self-Test Questions The joint projects of the FASB and IASB could potentially: a) change the definition of liabilities b) change the definition of equity c) change the definition of assets d) All of the above 15-76 LO Copyright “Copyright © 2015 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.” 15-77 ... borrowing 15- 19 LO Issuing Bonds at a Discount Total Cost of Borrowing Illustration 15- 6 OR 15- 20 Illustration 15- 7 LO Issuing Bonds at a Discount Illustration 15- 8 Amortization of bond discount 15- 21... borrowing 15- 24 LO Issuing Bonds at a Premium Total Cost of Borrowing Illustration 15- 10 OR 15- 25 Illustration 15- 11 LO Issuing Bonds at a Premium Illustration 15- 12 Amortization of bond premium 15- 26... transaction 15- 11 LO Accounting for Bond Transactions Issue at Face Value, Discount, or Premium? Illustration 15- 4 Interest rates and bond prices Bond Contractual Interest Rate 10% 15- 12 Run slide