Long-Term Liabilities: Bonds and Notes Chapter 14 Student Version These Theseslides slidesshould shouldbe beviewed viewedusing usingthe thepresentation presentation mode mode(click (clickthe the icon icontotostart startpresentation) presentation) © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use Prepared by: C Douglas Cloud Professor Emeritus of Accounting Pepperdine University Learning Objective 1 Compute the potential impact of long-term borrowing on earnings per share © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Financing Corporations Corporations finance their operations using the following sources: Short-term debt, such as purchasing goods or services on account Long-term debt, such as issuing bonds or notes payable Equity, such as issuing common or preferred stock © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Financing Corporations A bond is a form of an interest-bearing note Like a note, a bond requires periodic interest payments, and the face amount must be repaid at the maturity date © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Financing Corporations Huckadee Corporation is considering the following plans to issue debt and equity: © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Financing Corporations In deciding among financing plans, the effect on earnings per share is often considered Earnings per share (EPS) measures the income earned by each share of common stock It is computed as follows: Net Income - Preferred Dividends Earnings per Share = Number of Common Shares Outstanding © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Financing Corporations Assume the following data for Huckadee Corporation: Earnings before interest and income taxes are $800,000 The tax rate is 40% All bonds or stocks are issued at their par or face amount © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use Learning Objective Compute the potential impact of long-term borrowing on earnings per share Describe the characteristics and terminology of bonds payable © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Bond Characteristics and Terminology The underlying contract between the company issuing bonds and the bondholders is called a bond indenture or trust indenture © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Bond Characteristics and Terminology Usually, the face amount of each bond, called the principal, is $1,000, or a multiple of $1,000 Interest on bonds may be payable annually, semiannually, or quarterly Most pay interest semiannually © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Bond Redemption On June 30, 2011, a corporation has a bond issue of $100,000 outstanding, on which there is an unamortized premium of $4,000 The corporation redeems one-fourth of the bonds for $24,000 Gains on the redemption of bonds are reported in the Other Income section of the income statement © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Bond Redemption The corporation calls the remaining $75,000 of outstanding bonds, which are held by a private investor, for $79,500 on July 1, 2011 Losses on the redemption of bonds are reported in the Other Loss section of the income statement © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use Learning Objective Compute the potential impact of long-term borrowing on earnings per share Describe the characteristics and terminology of bonds payable Journalize entries for bonds payable Describe and illustrate the accounting for installment notes © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO 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 includes the following: Payment of a portion of the amount initially borrowed, called the principal Payment of interest on the outstanding balance © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Installment Notes Installment notes are often used to purchase specific assets, such as equipment, and are often secured by the purchased asset When a note is secured by an asset, it is called a mortgage note If the borrower fails to pay a mortgage note, the lender has the right to take possession of the pledged asset © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Issuing an Installment Note Lewis Company issues a $24,000, 6%, five-year note to City National Bank on January 1, 2010 The annual payment is $5,698 © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Annual Payments The entry to record the first payment on December 31, 2010, is as follows: © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Annual Payments The entry to record the second payment on December 31, 2011, is as follows: © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Annual Payments The entry to record the final payment on December 31, 2014, is as follows: After the entry is posted, the balance in Notes Payable related to this note is zero © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use Learning Objective Compute the potential impact of long-term borrowing on earnings per share Describe the characteristics and terminology of bonds payable Journalize entries for bonds payable Describe and illustrate the accounting for installment notes Describe and illustrate the reporting of long-term liabilities including bonds and notes payable © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Reporting Long-Term Liabilities © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use Learning Objective Compute the potential impact of long-term borrowing on earnings per share Describe the characteristics and terminology of bonds payable Journalize entries for bonds payable Describe and illustrate the accounting for installment notes Describe and illustrate the reporting of long-term liabilities including bonds and notes payable Describe and illustrate how the number of times interest charges are earned is used to evaluate a company’s financial © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Number of Times Interest Charges are Earned Analysts assess the risk that bondholders will not receive their interest payments by computing the number of times interest charges are earned during the year as follows: Number of Times Interest Charges are = Earned Income Before Income Tax + Interest Expense Interest Expense © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Number of Times Interest Charges are Earned Under Armour, Inc.’s 2008 annual report stated that the firm had interest expense of $850,000 and income before income taxes of $69,900,000 The number of times interest charges are earned for Under Armour, Inc., is computed as follows: Number of $69,900,000 + $850,000 Times Interest Charges are = $850,000 Earned © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use = 83.24 Long-Term Liabilities: Bonds and Notes The End Student Version Prepared by: C Douglas Cloud Professor Emeritus of Accounting Pepperdine University © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use ... Amortizing a Bond Discount The effective interest rate method is required by generally accepted accounting principles However, the straight-line method may be used if the results not differ significantly