After completing this chapter you should be able to: Explain the types and payment patterns of notes, compare bond financing with stock financing, assess debt features and their implications, compute the debt-to-equity ratio and explain its use.
Chapter 14 Long-Term Liabilities PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W Caldwell, D.B.A., CMA Jon A Booker, Ph.D., CPA, CIA Cynthia J Rooney, Ph.D., CPA Winston Kwok, Ph.D., CPA McGrawHill/Irwin Copyright © 2011 by The McGrawHill Companies, Inc. All rights reserved 14 2 A1 Bond Financing Advantages Disadvantages Bonds not affect owner control Bonds Bonds require require payment payment of of both both periodic periodic interest interest and and par par value value at at maturity maturity Interest on bonds is tax deductible Bonds can increase return on equity Bonds Bonds can can decrease decrease return return on on equity equity 14 3 A1 Bond Trading Bonds are securities that can be purchased or sold in the securities markets They have a market value which is expressed as a percent of their par value The closing price indicates that the IBM bond is being sold at 119.25% of face value 14 4 P1 Bond Issuances Transaction on the Bond Issue Date Investors Corporation Bond Selling Price Bond Certificate 14 5 P1 Bond Issuances Transactions during the bond life Bond Interest Payments Corporation Bond Issue Date Bond Interest Payments Investors Interest Payment = Bond Par Value × Stated Interest Rate x Time 14 6 P1 Bond Issuances Transaction on the Maturity Date Investors Corporation Bond Face Value 14 7 P1 Issuing Bonds at Par n Jan 1, 2011, a company issued the following bonds: ar Value: $800,000 tated Interest Rate: 9% nterest Dates: 6/30 and 12/31 aturity Date = Dec 31, 2030 (20 years) 14 8 P1 Issuing Bonds at Par On June 30, 2011, the issuer of the bond pays the first semiannual interest payment of $36,000 $800,000 × 9% × ½ year = $36,000 This entry is made every six months until the bonds mature 14 9 P1 Issuing Bonds at Par On December 31, 2030, the bonds mature and the issuer of the bond pays face value of $800,000 to the bondholders 14 10 P1 Bond Discount or Premium 14 21 P4 Bond Retirement Retirement Retirement of of the the Fila Fila bonds bonds at at maturity maturity for for $100,000 $100,000 cash cash Because any discount or premium will be fully amortized at maturity, the carrying amount of the bonds will be equal to par value 14 22 P4 Bond Retirement Retirement of Bonds before Maturity Carrying Amount > Retirement Price = Gain Carrying Amount < Retirement Price = Loss Assume that $100,000 of callable bonds will be retired on July 1, 2011, after the first interest payment The bond carrying amount is $104,500.The bonds have a call premium of $3,000 14 23 P4 Bond Retirement By Conversion On On January value bonds bonds of Converse, with January 1, 1, $100,000 $100,000 par par value of Converse, with aa carrying carrying amount amount of of $100,000, $100,000, are are converted converted to to 15,000 15,000 ordinary ordinary shares shares of par value of $2 $2 par value 15,000 15,000 shares shares ×× $2 $2 par par value value per per share share 14 24 C1 Long-Term Notes Payable Cash Company Note Note Payable Payable Lender When is the repayment of the principal and interest going to be made? Note Date Note Maturity Date 14 25 C1 Long-Term Notes Payable Single Payment of Principal plus Interest Company Lender Single Payment of Principal plus Interest Note Date Note Maturity Date 14 26 C1 Long-Term Notes Payable Regular Payments of Principal plus Interest Company Lender Regular Payments of Principal plus Interest Payments either can be equal Note Date principal payments plus interest Note Maturity Date or equal payments 14 27 C1 Installment Notes On On January January 1, 1, 2011, 2011, Foghog Foghog borrows borrows $60,000 $60,000 from from aa bank bank to to purchase purchase equipment equipment It It signs signs an an 8% 8% installment installment note note requiring requiring 66 annual annual payments payments of of principal principal plus plus interest interest Compute Compute the the periodic periodic payment payment by by dividing dividing the the face face amount amount of of the the note note by by the the present present value value factor factor Computation Principal divided by PV factor Table PV of Annuity of $1 (B.3) Table Value Present Value Payment 4.6229 60,000 12,979 14 28 C1 Installment Notes with Equal Payments 14 29 P5 Installment Notes with Equal Payments Let’s Let’s record record the the first first payment payment made made on on December December 31, 31, 2011 2011 by by Foghog Foghog to to the the bank bank Refer Refer back back to to the the amortization amortization schedule schedule to to make make the the December December 31, 31, 2012 2012 payment payment on on the the note note 14 30 C1 Mortgage Notes and Bonds A A legal legal agreement agreement that that helps helps protect protect the the lender lender if if the the borrower borrower fails fails to to make make the the required required payments payments Gives Gives the the lender lender the the right right to to be be paid paid out out of of the the cash cash proceeds proceeds from from the the sale sale of of the the borrower’s borrower’s assets assets specifically specifically identified identified in in the the mortgage mortgage contract contract 14 31 A2 Features of Bonds and Notes Secured Secured and and Unsecured Unsecured Term Term and and Serial Serial Convertible Convertible and and Callable Callable Registered Registered and and Bearer Bearer 14 32 A3 Debt-to-Equity Ratio Debt-toEquity Ratio = Total Liabilities Total Equity This This ratio ratio helps helps investors investors determine determine the the risk risk of of investing investing in in aa company company by by dividing dividing its its total total liabilities liabilities by by total total equity equity 14 33 C2 Appendix 14A: Present Values of Bonds and Notes Present Value of $1 Rate Periods 3% 4% 5% 0.9709 0.9615 0.9524 0.9426 0.9246 0.9070 0.9151 0.8890 0.8638 0.8885 0.8548 0.8227 0.8626 0.8219 0.7835 0.8375 0.7903 0.7462 0.8131 0.7599 0.7107 0.7894 Face amount = $100,000 Contract rate = 8% Market rate = 10% Interest paid semiannually First, we calculate the present value of the principal repayment in periods (2 years × payments per year, using 5% market rate (10% annual rate ÷ payments per year) 0.7307 0.6768× 0.8227 = $82,270 $100,000 14 34 C2 Appendix 14A: Present Values of Bonds and Notes Semiannual Interest Annuity $100,000 $100,000 ìì 8% 8% ìì ẵ ẵ == $4,000 $4,000 $4,000 × 3.5460 = $14,184 Amount Principal $ 100,000 Interest 8,000 Issue price of debt Present Value of Annuity of $1 Rate Periods 3% 4% 5% 0.9709 0.9615 0.9524 1.9135 1.8861 1.8594 2.8286 2.7751 2.7232 3.7171 3.6299 3.5460 4.5797 4.4518 Present 4.3295 PV Factor Value 5.4172 5.2421 0.8227 $ 82,270 3.5460 14,184 6.2303 6.0021 $ 96,454 7.0197 6.7327 5.0757 5.7864 6.4632 14 35 End of Chapter 14 ... 14 32 A3 Debt-to-Equity Ratio Debt-toEquity Ratio = Total Liabilities Total Equity This This ratio ratio helps helps investors investors determine determine the the risk risk of of investing... Single Payment of Principal plus Interest Company Lender Single Payment of Principal plus Interest Note Date Note Maturity Date 14 26 C1 Long-Term Notes Payable Regular Payments of Principal... C1 Long-Term Notes Payable Cash Company Note Note Payable Payable Lender When is the repayment of the principal and interest going to be made? Note Date Note Maturity Date 14 25 C1 Long-Term