Accounting principles, 13th edition ch15

Accounting Principles Thirteenth Edition Weygandt Kimmel Kieso Chapter 15 Long-Term Liabilities Prepared by Coby Harmon University of California, Santa Barbara Westmont College Chapter Outline Learning Objectives LO Describe the major characteristics of bonds LO Explain how to account for bond transactions LO Explain how to account for long-term notes payable LO Discuss how long-term liabilities are reported and Copyright ©2018 John Wiley & Son, Inc analyzed 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 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 Copyright ©2018 John Wiley & Son, Inc Major Characteristics of Bonds Types of Bonds Secured bonds have specific assets of issuer pledged as collateral for bonds Unsecured bonds, also called debenture bonds, are issued against general credit of borrower Convertible bonds can be converted into common stock at bondholder’s option Callable bonds, issuing company can redeem (buy back) at a stated dollar amount prior to maturity LO Copyright ©2018 John Wiley & Son, Inc Major Characteristics of Bonds Issuing Procedures State laws grant corporations 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 bond indenture Bond certificate, typically a $1,000 face value LO Copyright ©2018 John Wiley & Son, Inc Major Characteristics of Bonds Issuing Procedures Represents a promise to pay:  sum of money at designated maturity date, plus  periodic interest at a contractual (stated) rate on maturity amount (face value) Interest payments usually made semiannually Issued to obtain large amounts of long-term capital Investment company sells bonds for issuing company LO Copyright ©2018 John Wiley & Son, Inc ILLUSTRATION 15.1 Bond certificate LO Copyright ©2018 John Wiley & Son, Inc Major Characteristics of Bonds Bond Trading Bondholders can convert their holdings into cash by selling the bonds at the current market price on national securities exchanges Prices are quoted as a percentage of the face value Issuer Bonds Maturity Close Yield Time Warner Cable 6.75 June 15, 2039 116.4 5.49 ILLUSTRATION 15.2 Market information for bonds LO Copyright ©2018 John Wiley & Son, Inc Major Characteristics of Bonds Determining the Market Price of a Bond Current market price (present value) is a function of three factors: dollar amounts to be received length of time until the amounts are received market rate of interest Market interest rate is the rate investors demand for loaning funds LO Copyright ©2018 John Wiley & Son, Inc Determining the Market Price of a Bond Illustration: Assume that Acropolis Company on January 1, 2020, 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 $100,000 Principal $9,000 ILLUSTRATION 15.3 $9,000 $9,000 $9,000 $9,000 Interest Years Time diagram depicting LO cash flows Copyright ©2018 John Wiley & Son, Inc 10 Amortizing Bond Premium Illustration: Candlestick Inc., sold $100,000, five-year, 10% bonds on January 1, 2020, for $102,000 Interest is payable on January ILLUSTRATION 15A.4 Premium Interest Interest to Interest Amortization Unamortized Carrying Period Be Paid Expense ($2,000 ÷ 5) Premium Value Issue date LO Bond $2,000 $ 102,000 $10,000 $9,600 $ 400 1,600 101,600 10,000 9,600 400 1,200 101,200 10,000 9,600 400 800 100,800 10,000 9,600 400 400 100,400 10,000 9,600 400 100,000 $50,000 $48,000 $2,000 Copyright ©2018 John Wiley & Son, Inc 50 Amortizing Bond Premium Premium Bond Interest Interest to Interest Amortization Unamortized Carrying Period Be Paid Expense ($2,000 ÷ 5) Premium Value Issue date $2,000 $ 102,000 $10,000 $9,600 $ 400 1,600 101,600 10,000 9,600 400 1,200 101,200 Interest is payable on January Prepare the journal entry to record the first accrual of bond interest and the amortization of bond discount on December 31 Interest Expense 9,600 Premium on Bonds Payable 400 Interest Payable LO 10,000 Copyright ©2018 John Wiley & Son, Inc 51 Appendix 15B Effective-Interest 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 Required steps: LO Compute the bond interest expense Compute the bond interest paid or accrued Compute the amortization amount Copyright ©2018 John Wiley & Son, Inc 52 Effective-Interest Amortization Required steps: Compute the bond interest expense Compute the bond interest paid or accrued Compute the amortization amount (1) (2) Bond Interest Expense Bond Interest Paid Carrying Value of Bonds at Beginning of Period LO ILLUSTRATION 15B.1 Effectivex Interest Rate Face - Amount (3) Contractual x of Bond Copyright ©2018 John Wiley & Son, Inc Interest Rate = Amortization Amount 53 Amortizing Bond Discount Illustration: Candlestick Inc., sold $100,000, five-year, 10% bonds on January 1, 2020, for $98,000 Interest is payable each January ILLUSTRATION 15B.2 Bond Discount Amortization Schedule Interest Interest Period Paid Interest Expense (10.5348% x Preceding Carrying Value) Discount Unamortized Carrying Amort Discount Value LO $2,000 $98,000 $10,000 $10,324 (10.5348% × $98,000) $324 1,676 98,324 10,000 $10,358 (10.5348% × $98,324) $358 1,318 98,682 10,000 $10,396 (10.5348% × $98,682) $396 922 99,078 10,000 $10,438 (10.5348% × $99,078) $438 484 99,516 10,000 $10,484 (10.5348% × $99,516) $484 100,000 $50,000 $52,000 Copyright ©2018 John Wiley & Son, Inc $2,000 54 Amortizing Bond Discount ILLUSTRATION 15B.2 Bond Discount Amortization Schedule Interest Interest Period Paid Interest Expense (10.5348% x Preceding Carrying Value) Discount Unamortized Carrying Amort Discount Value $2,000 $98,000 $10,000 $10,324 (10.5348% × $98,000) $324 1,676 98,324 10,000 $10,358 (10.5348% × $98,324) $358 1,318 98,682 Candlestick Inc records the accrual of interest and amortization of bond discount on December 31 as follows Interest Expense 10,324 Discount on Bonds Payable Interest Payable LO 324 10,000 Copyright ©2018 John Wiley & Son, Inc 55 Amortizing Bond Discount ILLUSTRATION 15B.2 Bond Discount Amortization Schedule Interest Interest Period Paid Interest Expense (10.5348% x Preceding Carrying Value) Discount Unamortized Carrying Amort Discount Value $2,000 $98,000 $10,000 $10,324 (10.5348% × $98,000) $324 1,676 98,324 10,000 $10,358 (10.5348% × $98,324) $358 1,318 98,682 For the second interest period, at December 31, Candlestick makes the following adjusting entry Interest Expense 10,358 Discount on Bonds Payable Interest Payable LO 358 10,000 Copyright ©2018 John Wiley & Son, Inc 56 Amortizing Bond Premium Illustration: Candlestick Inc., sold $100,000, five-year, 10% bonds on January 1, 2020, for $102,000 Interest is payable each January ILLUSTRATION 15B.4 Bond Premium Amortization Schedule Interest Interest Period Paid Interest Expense (9.4794% x Preceding Carrying Value) Premium Unamortized Carrying Amort Premium Value LO $2,000 $102,000 $10,000 $9,669 (9.4794% × $102,000) $331 1,669 101,669 10,000 9,638 (9.4794% × $101,669) 362 1,307 101,307 10,000 9,603 (9.4794% × $101,307) 397 910 100,910 10,000 9,566 (9.4794% × $100,910) 434 476 100,476 10,000 9,524 (9.4794% × $100,476) 476 100,000 $50,000 $48,000 Copyright ©2018 John Wiley & Son, Inc $2,000 57 Amortizing Bond Premium ILLUSTRATION 15B.4 Bond Premium Amortization Schedule Interest Interest Period Paid Interest Expense (9.4794% x Preceding Carrying Value) Premium Unamortized Carrying Amort Premium Value $2,000 $102,000 $10,000 $9,669 (9.4794% × $102,000) $331 1,669 101,669 10,000 9,638 (9.4794% × $101,669) 362 1,307 101,307 Candlestick Inc records the accrual of interest and amortization of bond premium on December 31 as follows Interest Expense 9,669 Premium on Bonds Payable 331 Interest Payable LO 10,000 Copyright ©2018 John Wiley & Son, Inc 58 A Look at IFRS Key Points Similarities As indicated in Chapter 11, in general GAAP and IFRS define liabilities similarly 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 Copyright ©2018 John Wiley & Son, Inc 59 A Look at IFRS Key Points Similarities 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 Copyright ©2018 John Wiley & Son, Inc 60 A Look at IFRS Key Points Similarities 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 97,000 Bonds Payable LO 97,000 Copyright ©2018 John Wiley & Son, Inc 61 A Look at IFRS Key Points Differences 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 criteria to determine if a lease arrangement is a finance or operating lease IFRS is more conceptual in its provisions Leases classified as operating leases under GAAP are accounted for differently under IFRS Also, IFRS allows alternative measurement bases for right-of-use assets (e.g., the revaluation model) LO Copyright ©2018 John Wiley & Son, Inc 62 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 The results of these projects could change the classification of many debt and equity securities LO Copyright ©2018 John Wiley & Son, Inc 63 Copyright Copyright © 2018 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States 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 Copyright ©2018 John Wiley & Son, Inc 64 ... price of a bond is equal to its maturity value False LO Copyright ©2018 John Wiley & Son, Inc 12 Accounting for Bond Transactions Corporation records bond transactions when it issues (sells) bonds... does the issuing company journalize the transaction LO Copyright ©2018 John Wiley & Son, Inc 13 Accounting for Bond Transactions Issuing at Face Value, Discount, or Premium Bond Contractual Interest... 10% ILLUSTRATION 15.5 Interest rates and bond prices LO Copyright ©2018 John Wiley & Son, Inc 14 Accounting for Bond Transactions The market interest rate: a is the contractual interest rate used