CHAPTER 14 Long-Term Liabilities ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Questions Brief Exercises Exercises Problems Concepts for Analysis Formal issuing procedures; bond concepts 1, 1, 1, Types of bonds 11 10 2, Valuing bonds at issue date 3, 4, 5, 2, 1, 2, 3, 4, Bonds issued at premium 5, 6, 7, or discount; amortization 8, 9, 10 schedules; bond issue costs 1, 3, 4, 6, 7, 8, 10 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15 1, 2, 3, 4, 5, 6, 7, 10, 11 1, 2, Extinguishment of debt 11, 12, 13 11 12, 13, 14, 15 2, 4, 5, 6, 7, 10 2, Long-term notes payable; Imputing interest 14, 15, 16, 17, 18 12, 13, 14, 15 16, 17, 18 3, 8, Fair value option 19, 20 16 19 Off-balance sheet financing 22, 23, 24 Presentation of long-term debt 21 1, 2, 20 4, 10 21, 22, 23, 24, 25, 26, 27 12, 13, 14 Topics *10 Troubled debt restructuring 25, 26, 27, 28, 29, 30 1, *This material is discussed in the Appendix to the Chapter Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 14-1 ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE) Learning Objectives Brief Exercises Exercises Problems 1, Describe the formal procedures associated with issuing long-term debt Identify various types of bond issues Describe the accounting valuation for bonds at date of issuance 1, 2, 3, 4, 5, 6, 7, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15 1, 2, 3, 4, 5, 6, 7, 10 Apply the methods of bond discount and premium amortization 2, 3, 4, 5, 6, 7, 8, 10 3, 4, 5, 6, 7, 8, 9, 10, 12, 13, 14, 15 1, 2, 3, 4, 5, 6, 7, 10, 11 Describe the accounting for the extinguishment of debt 11 12, 13, 14, 15 2, 4, 5, 6, 7, 10 Explain the accounting for long-term notes payable 12, 13, 14, 15 16, 17, 18 3, 8, Describe the accounting for the fair value option 16 19 Explain the reporting of off-balance sheet financing arrangements Indicate how to present and analyze long-term debt 20 4, 10 21, 22, 23, 24, 25 26, 27 12, 13, 14 *10 14-2 Describe the accounting for a debt restructuring Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ASSIGNMENT CHARACTERISTICS TABLE It e m Description Level of Difficu lty Time (minut es) E14-1 E14-2 E14-3 E14-4 E14-5 E14-6 E14-7 E14-8 E14-9 E14-10 E14-11 E14-12 E14-13 E14-14 E14-15 E14-16 E14-17 E14-18 E14-19 E14-20 *E14-21 *E14-22 *E14-23 *E14-24 *E14-25 *E14-26 *E14-27 Classification of liabilities Classification Entries for bond transactions Entries for bond transactions—straight-line Entries for bond transactions—effective-interest Amortization schedule—straight-line Amortization schedule—effective-interest Determine proper amounts in account balances Entries and questions for bond transactions Entries for bond transactions Information related to various bond issues Entry for retirement of bond; bond issue costs Entries for retirement and issuance of bonds Entries for retirement and issuance of bonds Entries for retirement and issuance of bonds Entries for zero-interest-bearing notes Imputation of interest Imputation of interest with right Fair value option Long-term debt disclosure Settlement of debt Term modification without gain—debtor’s entries Term modification without gain—creditor’s entries Term modification with gain—debtor’s entries Term modification with gain—creditor’s entries Debtor/creditor entries for settlement of troubled debt Debtor/creditor entries for modification of troubled debt Simple Simple Simple Simple Simple Simple Simple Moderate Moderate Moderate Simple Simple Simple Simple Simple Simple Simple Moderate Simple Simple Moderate Moderate Moderate Moderate Moderate Simple Moderate 15–20 15–20 15–20 15–20 15–20 15–20 15–20 15–20 20–30 15–20 20–30 15–20 15–20 12–16 10–15 15–20 15–20 15–20 10–15 10–15 15–20 20–30 25–30 25–30 20–30 15–20 20–25 P14-1 P14-2 P14-3 P14-4 Analysis of amortization schedule and interest entries Issuance and retirement of bonds Negative amortization Issuance and retirement of bonds; income statement presentation Comprehensive bond problem Issuance of bonds between interest dates, straight-line, retirement Entries for life cycle of bonds Entries for zero-interest-bearing note Entries for zero-interest-bearing note; payable in installments Comprehensive problem; issuance, classification, reporting Effective-interest method Simple Moderate Moderate Simple 15–20 25–30 20–30 15–20 Moderate Moderate 50–65 20–25 Moderate Simple Moderate 20–25 15–25 20–25 Moderate 20–25 Moderate 40–50 P14-5 P14-6 P14-7 P14-8 P14-9 P14-10 P14-11 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 14-3 ASSIGNMENT CHARACTERISTICS TABLE (Continued) Item Description Level of Difficu lty Time (minut es) *P14-12 *P14-13 *P14-14 Debtor/creditor entries for continuation of troubled debt Restructure of note under different circumstances Debtor/creditor entries for continuation of troubled debt with new effective-interest Moderate Moderate Complex 15–25 30–45 40–50 CA14-1 Bond theory: balance sheet presentations, interest rate, premium Bond theory: price, presentation, and retirement Bond theory: amortization and gain or loss recognition Off-balance-sheet financing Bond issue, ethics Moderate 25–30 Moderate Simple Moderate Moderate 15–25 20–25 20–30 23–30 CA14-2 CA14-3 CA14-4 CA14-5 14-4 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) LEARNING OBJECTIVES *10 *11 Describe the formal procedures associated with issuing long-term debt Identify various types of bond issues Describe the accounting valuation for bonds at date of issuance Apply the methods of bond discount and premium amortization Describe the accounting for the extinguishment of debt Explain the accounting for long-term notes payable Describe the accounting for the fair value option Explain the reporting of off-balance-sheet financing arrangements Indicate how to present and analyze long-term debt Describe the accounting for a debt restructuring Compare the accounting procedures for long-term liabilities under GAAP and IFRS *This material is covered in an Appendix to the chapter Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 14-5 CHAPTER REVIEW *Note: All asterisked (*) items relate to material contained in the Appendix to the chapter Chapter 14 presents a discussion of the issues related to long-term liabilities Long-term debt consists of probable future sacrifices of economic benefits These sacrifices are payable in the future, normally beyond one year or the operating cycle, whichever is longer Coverage in this chapter includes bonds payable, long-term notes payable, mortgages payable, and issues related to extinguishment of debt The accounting and disclosure issues related to long-term liabilities include a great deal of detail due to the potentially complicated nature of debt instruments Long-Term Debt (L.O 1) Long-term debt consists of obligations that are not payable within the operating cycle or one year, whichever is longer These obligations normally require a formal agreement between the parties involved that often includes certain covenants and restrictions for the protection of both lenders and borrowers These covenants and restrictions are found in the bond indenture or note agreement, and include information related to amounts authorized to be issued, interest rates, due dates, call provisions, security for the debt, sinking fund requirements, etc The important issues related to the long-term debt should always be disclosed in the financial statements or the notes thereto Long-term liabilities include bonds payable, mortgage notes payable, long-term notes payable, lease obligations, and pension obligations Pension and lease obligations are discussed in later chapters Issuing Bonds Bonds payable represent an obligation of the issuing corporation to pay a sum of money at a designated maturity date plus periodic interest at a specified rate on the face value The main purpose of issuing bonds is to borrow for the long term when the amount of capital needed is too large for one lender to supply Bond interest payments are usually made semiannually Bonds are debt instruments of the issuing corporation used by that corporation to borrow funds from the general public or institutional investors The use of bonds provides the issuer an opportunity to divide a large amount of long-term indebtedness among many small investing units Bonds may be sold through an underwriter who either (a) guarantees a certain sum to the corporation and assumes the risk of sale or (b) agrees to sell the bond issue on the basis of a commission Alternatively, a corporation may sell the bonds directly to a large financial institution without the aid of an underwriter 14-6 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) Types of Bonds (L.O 2) There are various types of bonds that can be issued, to include: term bonds, serial bonds, callable bonds, secured and unsecured bonds, convertible bonds, commodity-backed bonds, deep discount bonds, registered and coupon bonds, and income and revenue bonds Valuation of Bonds Payable (L.O 3) Bonds are issued with a stated rate of interest expressed as a percentage of the face value of the bonds When bonds are sold for more than face value (at a premium) or less than face value (at a discount), the interest rate actually earned by the bondholder is different from the stated rate The issue price is based on the effective yield or market rate of interest and is set by economic conditions in the investment market The effective rate exceeds the stated rate when the bonds sell at a discount, and the effective rate is less than the stated rate when the bonds sell at a premium To compute the issue price of bonds, the present value of future cash flows from interest and principal must be computed Bonds Issued at a Discount or Premium 10 (L.O 4) Discounts and premiums resulting from a bond issue are recorded at the time the bonds are sold The amounts recorded as discounts or premiums are amortized each time bond interest is paid The time period over which discounts and premiums are amortized is equal to the period of time the bonds are outstanding (date of sale to maturity date) 11 To illustrate the recording of bonds sold at a discount or premium, the following examples are presented If Aretha Company issued $100,000 of bonds dated January 1, 2014 at 98, on January 1, 2014, the entry would be as follows: Cash ($100,000 × 98) Discount on Bonds Payable Bonds Payable 98,000 2,000 100,000 If the same bonds noted above were sold for 102, the entry to record the issuance would be as follows: Cash ($100,000 × 1.02) Premium on Bonds Payable Bonds Payable 102,000 2,000 100,000 It should be noted that whenever bonds are issued, the Bonds Payable account is always credited for the face amount of the bonds issued Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 14-7 Straight-Line Amortization of Discount and Premium 12 To illustrate the amortization of the bond discount or premium, assume the bonds sold in the example above are five-year bonds, and they pay interest annually Since the bonds are sold on the issue date (January 1, 2014) they will be outstanding for the full five years Thus, the discount or premium would be amortized over the entire life of the bonds The entry to amortize the bond discount at the end of 2014 is: Interest Expense Discount on Bonds Payable ($2,000 ÷ 5) 400 400 The entry to amortize the premium is: Premium on Bonds Payable Interest Expense 400 400 Note that the amortization of the discount increases the interest expense for the period and the amortization of the premium reduces interest expense for the period Bonds Issued Between Interest Dates 13 When bonds are issued between interest dates, the purchase price is increased by an amount equal to the interest earned on the bonds since the last interest payment date On the next interest payment date, the bondholder receives the entire semiannual interest payment As a result, the amount of interest expense to the issuing corporation is the difference between the semiannual interest payment and the amount of interest prepaid by the purchaser For example, assume a 10-year bond issue in the amount of $300,000, bearing 9% interest payable semiannually on June 30 and December 31, dated January 1, 2014 If the entire bond issue is sold at par on March 1, 2014, the following journal entry will be made by the seller: Cash Bonds Payable Interest Expense *($300,000 × 09 × 2/12) 304,500 300,000 4,500* The entry for the semiannual interest payment on July 1, 2014 would be as follows: Interest Expense Cash 13,500 13,500 The total bond interest expense for the six month period is $9,000 ($13,500 – $4,500), which represents the correct interest expense corresponding to the four-month period the bonds were outstanding 14-8 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) Effective-Interest Amortization 14 The profession’s preferred procedure to amortize discounts and premiums is the effective-interest method This method computes the bond interest using the effective rate at which the bonds are issued More specifically, interest cost for each period is the effective interest rate multiplied by the carrying value (book value) of the bonds at the start of the period The effective-interest method is best accomplished by preparing a Schedule of Bond Interest Amortization This schedule provides the information necessary for each semiannual entry for interest and discount or premium amortization The chapter includes an illustration of a Schedule of Bond Interest Amortization for both a discount and premium situation Classification of Discounts and Premiums 15 Unamortized premiums and discounts are reported with the Bonds Payable account in the liability section of the balance sheet Premiums and discounts are not liability accounts; they are merely liability valuation accounts Premiums are added to the Bonds Payable account and discounts are deducted from the Bonds Payable account in the liability section of the balance sheet Accruing Interest on Bonds 16 If the interest payment date does not coincide with the financial statement’s date, the amortized premium or discount should be prorated by the appropriate number of months to arrive at the proper interest expense Interest payable is reported as a current liability Costs of Issuing Bonds 17 Some of the costs associated with issuing bonds include engraving and printing costs, legal and accounting fees, commissions, and promotion expenses GAAP indicates that these costs should be debited to a deferred charge account entitled, Unamortized Bond Issue Costs These costs are then amortized over the life of the issue in a manner similar to that used for discount on bonds Extinguishment of Debt 18 (L.O 5) The extinguishment, or payment, of long-term liabilities can be a relatively straightforward process which involves a debit to the liability account and a credit to cash The process can also be a complicated one when the debt is extinguished prior to maturity 19 The reacquisition of debt can occur either by payment to the creditor or by reacquisition in the open market At the time of reacquisition, any unamortized premium or discount, and any costs of issue related to the bonds must be amortized up to the reacquisition date to avoid misstatement of any resulting gain or loss on the extinguishment The difference between the reacquisition price and the net carrying amount of the debt is a gain (reacquisition price lower) or loss (reacquisition price greater) from extinguishment Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 14-9 Notes Payable 20 (L.O 6) The difference between current notes payable and long-term notes payable is the maturity date Accounting for notes and bonds is quite similar 21 Interest-bearing notes are treated the same as bondsa discount or premium is recognized if the stated rate is different than the effective rate Zero-interest-bearing notes have a present value that is less than the fair value, resulting in a discount on the note The discount is amortized using the effective-interest method 22 When a debt instrument is exchanged for noncash consideration in a bargained transaction, the stated rate of interest is presumed fair unless: (a) no interest rate is stated, (b) the stated interest rate is unreasonable, or (c) the stated face amount of the debt instrument is materially different from the current cash sales price for the same or similar items or from the current fair value of the debt instrument If the stated rate is determined to be inappropriate, an imputed interest rate must be used to establish the present value of the debt instrument 23 When an imputed interest rate is used for valuation purposes, it will normally be at least equal to the rate at which the debtor can obtain financing of a similar nature from other sources at the date of the transaction The object is to approximate the rate that would have resulted if an independent borrower and an independent lender had negotiated a similar transaction under comparable terms and conditions 24 Mortgage notes are a common means of financing the acquisition of property, plant, and equipment in a proprietorship or partnership form of business organization Normally, the title to specific property is pledged as security for a mortgage note Points assessed by the lender raise the effective interest rate above the stated rate If a mortgage note is paid on an installment basis, the current installment should be classified as a current liability 25 Because of unusually high, unstable interest rates and a tight money supply, the traditional fixed-rate mortgage has been partially supplanted with alternative mortgage arrangements Variable-rate mortgages feature interest rates tied to changes in the fluctuating market rate of interest Generally, variable-rate lenders adjust the interest rate at either one or three-year intervals Fair Value Option 26 (L.O 7) Companies may opt to record fair value in their accounts for most financial assets and liabilities including bonds and notes The FASB believes the fair value measurement provides more relevant and understandable information than amortized cost If companies choose this option, noncurrent liabilities are recorded at fair value, with unrealized holding gains or losses reported as part of net income 14-10 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) Modification of Terms *34 When the terms of a loan agreement are modified in a troubled debt restructuring (e.g reduction in interest rate), the creditor will incur a loss based upon cash flows discounted at the historical effective rate of the loan Since the debtor’s gain will continue to be calculated based upon undiscounted amounts, the gain recorded by the debtor will not equal the loss recorded by the creditor 14-12 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) LECTURE OUTLINE This chapter can be covered in three class sessions Students are generally familiar with the accounting for bonds payable from elementary accounting Some students may be unfamiliar with the effective-interest method of amortization of bond discount and premium This chapter provides an opportunity to apply present value concepts covered in chapter The appendix provides a detailed discussion of troubled debt restructuring A (L.O 1) Long-term Debt Consists of present obligations not payable within the operating cycle of the company or a year, whichever is longer Covenants or restrictions, for the protection of both lenders and borrowers, are stated in the bond indenture or note agreement B (L.O 2) Types of Bonds. The various types of bonds attract capital from different investors and risk takers and satisfy the cash flow needs of issuers Discuss the different types of bonds, including term bonds, serial bonds, callable bonds, secured and unsecured bonds, convertible bonds, commodity-backed bonds, deep discount bonds, registered and coupon bonds, and income and revenue bonds C (L.O 3) Valuation of Bonds Payable The price of a bond is determined by the interaction between the bond’s stated interest rate and its market rate A bond’s price is equal to the sum of the present value of the principal and the present value of the periodic interest a If the stated rate = the market rate, the bond will sell at par (face value) b If the stated rate < the market rate, the bond will sell at a discount c If the stated rate > the market rate, the bond will sell at a premium T EACHING T IP Illustration 14-1 can be used to demonstrate how bond prices are affected by the stated rate of interest and the market rate of interest A numerical example is given that calculates the selling price of bonds issued at a premium, at par, and at a discount Accounting for the issuance of bonds a The face value of the bond is always reflected in the Bonds Payable account b When a bond sells at a discount, the difference between the sales price and the face value is debited to Discount on Bonds Payable, a contra liability account Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 14-13 c When a bond sells at a premium, the difference between the sales price and the face value is credited to Premium on Bonds Payable, and adjunct account to Bonds Payable d Bonds sold between interest dates (1) The issue price includes the interest accrued since the last interest payment date (2) The accrued interest is credited to Interest Expense (L.O 4) Amortization of bond discounts and premiums a The amortization period for premiums or discounts is the period of time that the bonds are expected to be outstanding b Interest expense is increased by amortization of a discount and decreased by amortization of a premium c The straight-line method amortizes a constant amount each interest period d The effective-interest method is the preferred procedure used to calculate periodic interest expense The carrying value of the bonds at the beginning of the period is multiplied by the effective-interest rate to determine the interest expense The following relationships should be emphasized (1) Carrying value of bonds = Face value plus premium (or less discount) (2) Interest payable = Stated Interest rate × Face value of bonds (3) Interest expense = Effective-interest rate × Carrying value of bonds T EACHING T IP Illustration 14-2 compares the calculation of bond discount or premium amortization under the straight-line and effective-interest methods Interest Expense XX (4) If a premium exists: Premium on Bonds Payable Interest Payable (5) If a discount exists: e 14-14 Interest Expense Discount on Bonds Payable Interest Payable XX XX XX XX XX The straight-line method of amortization may be used if the results are not materially different from those produced by the effective-interest method Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) Bond issue costs are debited to a deferred charge account Unamortized Bond Issue Costs and amortized over the life of the issue, usually using the straight-line method T EACHING T IP Illustration 14-3 provides a review problem of accounting for bonds The numerical example requires calculating the bond issue price and related discount, recording the issuance of bonds, preparing an effective interest method amortization schedule, and preparing journal entries to record interest expense, amortization of bond discount and bond issue costs D (L.O 5) Extinguishment of Debt The difference between the bonds’ net carrying amount and the reacquisition price is a gain or loss from extinguishment a Reacquisition price = Price + call premium + reacquisition expenses b Carrying amount = Face value ± unamortized premium/discount – unamortized issuance costs c Gain on redemption of bonds: Carrying amount > reacquisition price d Loss on redemption of bonds: Carrying amount < reacquisition price T EACHING T IP Illustration 14-4 is a continuation of the numerical example of Illustration 14-3 Debt is extinguished two years after issuance and a loss is recognized E (L.O 6) Long-Term Notes Payable Accounting procedures for notes and bonds are quite similar Whenever the face value of a note does not represent the present value of the consideration in the exchange, the company must determine the implicit interest rate to properly record the exchange and the subsequent interest Notes not issued at face value a Zero-Interest-Bearing Notes (1) The implicit interest rate is the rate that equates the cash received (present value) with the amounts to be paid in the future (2) The difference between the face amount and the present value of the note is the discount and it is amortized to interest expense over the life of the note Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 14-15 b Interest-Bearing Notes (1) If a stated interest rate is unreasonable, an imputed interest rate must be used to determine the present value of the note (2) Any discount or premium must be recognized and amortized over the life of the note Notes Issued for Property, Goods, or Services a The present value of the debt is measured by the fair value of the property, goods, or services, or by an amount that reasonably approximates the fair value of the note If no interest rate is stated, the amount of interest is the difference between the face amount of the note and the fair value of the property b Imputing an interest rate The rate that would have resulted if an independent borrower and lender had negotiated a similar transaction must be approximated Journal entries are similar to entries for bonds payable issued at a discount Mortgage Notes Payable a A promissory note secured by property b The borrower usually receives cash equal to face value of the note c If a lender assesses points, the borrower receives less than the face value of the note (1) A point is 1% of the notes’ face value (2) The existence of points raises the effective interest rate and is treated as a discount on the mortgage d Fixed-rate vs variable-rate mortgages F (L.O 7) Fair Value Option Companies may opt to record fair value in their accounts for most financial assets and liabilities including bonds and notes The FASB believes the fair value measurement provides more relevant and understandable information than amortized cost If companies choose the fair value option, noncurrent liabilities are recorded at fair value, with unrealized holding gains or losses reported as part of net income G (L.O 8) Off-balance-sheet financing. An attempt to borrow monies in such a way to prevent recording the obligations 14-16 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) There are three forms: a Non-consolidated subsidiary (1) Because GAAP does not require a subsidiary that is less than 50% owned to be included in the consolidated financial statements, companies may omit liabilities held by these subsidiaries b Special-purpose entity (SPE) An entity created by a company to perform a special project (1) Often called project financing arrangements (2) The SPE finances and builds the project while the company that created the SPE benefits from the asset/project it created The SPE reports any liabilities on its books c Operating leases (1) Companies often lease assets instead of buying them to avoid incurring debt to finance the purchase The lease contracts can be structured so that they not meet the criteria for balance sheet reporting Rationale for off-balance-sheet financing a To attempt to “enhance the quality” of the balance sheet b To conform to loan covenants c To “balance” understatement of assets FASB’s response has been to require increased note disclosure H (L.O 9) Presentation and Analysis of Long-Term Debt. Presentation a Long-term obligations are often reported as one amount in the balance sheet and supported with comments and schedules in the notes b If the debt matures within one year, report it as a current liability, unless retirement is accomplished using noncurrent assets c Note disclosures generally indicate the nature of the liabilities, maturity dates, interest rates, call provisions, conversion privileges, restrictions imposed by creditors, and assets pledged as security d Future payments for sinking fund requirements and maturity amounts of long-term debt during each of the next five years should be disclosed Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 14-17 Analysis of long-term debt T EACHING T IP Use Illustration 14-5 to demonstrate the application of these ratios a Solvency Ability to pay interest and principal on long-term debt as it comes due b Debt to total assets ratio = Total debt Total assets (1) The higher the percentage, the greater the risk that the company may be unable to pay its maturing debt c Times interest earned ratio = Income before income taxes and interest expense Interest expense (1) The ability to meet interest payments as they come due I (L.O 10) Troubled-Debt Restructurings Settlement of debt at less than its carrying amount a Debtor (creditor) records gain (loss) equal to the excess of the carrying amount of the payable (receivable) over the fair value of the assets transferred b Debtor also recognizes gain or loss equal to the difference between the fair value of the assets transferred and their book value Continuation of debt with a modification of terms a Debtor records no gain when the total future cash flows exceed the prerestructuring carrying amount of the debt b Debtor records a gain when the pre-restructuring carrying amount of the debt exceeds the future cash flows T EACHING T IP Illustration 14-6 summarizes the accounting procedures for troubled-debt restructurings 14-18 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) *J IFRS Insights IFRS and GAAP have similar definitions of liabilities Relevant facts a Similarities (1) As indicated in our earlier discussions, GAAP and IFRS have similar liability definitions, and liabilities are classified as current and non-current (2) Much of the accounting for bonds and long-term notes is the same for GAAP and IFRS b Differences (1) Under GAAP, companies are permitted to use the straight-line method of amortization for bond discount or premium, provided that the amount recorded is not materially different than that resulting from effective-interest amortization However, the effective-interest method is preferred and is generally used Under IFRS, companies must use the effective-interest method (2) Under IFRS, companies not use premium or discount accounts 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 $97,000 as an increase to Cash and an increase to Bonds Payable (3) Under GAAP, bond issue costs are recorded as an asset Under IFRS, bond issue costs are netted against the carrying amount of the bonds (4) GAAP uses the term troubled-debt restructurings and has developed specific guidelines related to that category of loans IFRS generally assumes that all restructurings will be accounted for as extinguishments of debt (5) IFRS requires a liability and related expense or cost be recognized when a contract is onerous Under GAAP, losses on onerous contracts are generally not recognized under GAAP unless addressed by an industry- or transactionspecific requirements Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 14-19 ILLUSTRATION 14-1 INTEREST RATES AND BOND PRICES 14-20 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ILLUSTRATION 14-1 (continued) Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 14-21 Ca g ry in V alu e o f B on s d B eg g inn oin f P eri d o Ef ec t iv e I n t ere t s Ra t e ILLUSTRATION 14-2 BOND AMORTIZATION METHODS 14-22 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ILLUSTRATION 14-3 ACCOUNTING FOR BONDS Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 14-23 ILLUSTRATION 14-4 EXTINGUISHMENT OF DEBT 14-24 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ILLUSTRATION 14-5 DEBT TO TOTAL ASSETS AND TIMES INTEREST EARNED RATIOS Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) 14-25 ILLUSTRATION 14-6 SUMMARY OF ACCOUNTING FOR TROUBLED-DEBT RESTRUCTURING 14-26 Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ... Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ILLUSTRATION 14-3 ACCOUNTING FOR BONDS Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, ... Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) ILLUSTRATION 14-1 (continued) Copyright © 2013 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For... Inc. Kieso, Intermediate Accounting, 15/e Instructor’s Manual (For Instructor Use Only) LECTURE OUTLINE This chapter can be covered in three class sessions Students are generally familiar with the accounting