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CHAPTER 14

Long-Term Liabilities
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Questions

Brief
Exercises

Exercises

Problems

Concepts
for Analysis

1. Formal issuing
procedures; bond
concepts.

1, 3

1, 2

1, 5

2. Types of bonds.

11

10

2, 5

3. Valuing bonds at issue


date.

3, 4, 5, 6

2, 5

1, 2, 3, 4,
5

4. Bonds issued at premium


or discount; amortization
schedules; bond issue
costs.

5, 6, 7,
8, 9, 10

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, 3

5. Extinguishment of debt.

11, 12, 13

11

12, 13,
14, 15

2, 4, 5,
6, 7, 10

2, 3

6. Long-term notes payable;


Imputing interest.

14, 15, 16,


17, 18

12, 13,
14, 15

16, 17, 18

3, 8, 9

7. Fair value option.

19, 20

16

19

8. Off-balance sheet
financing.

22, 23, 24

9. 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, 2

*This material is discussed in the Appendix to the Chapter.

Copyright 2013 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 15/e Instructors Manual(For Instructor Use Only)

14-1

ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)


Learning Objectives

Brief
Exercises

Exercises

Problems

1, 2

1.

Describe the formal procedures associated


with issuing long-term debt.

2.

Identify various types of bond issues.

3.

Describe the accounting valuation


for bonds at date of issuance.

1, 2, 3, 4, 5,
6, 7, 8

3, 4, 5, 6, 7, 8,
9, 10, 11, 12,
13, 14, 15

1, 2, 3, 4, 5,
6, 7, 10

4.

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

5.

Describe the accounting for the


extinguishment of debt.

11

12, 13, 14, 15

2, 4, 5, 6,
7, 10

6.

Explain the accounting for long-term


notes payable.

12, 13, 14, 15

16, 17, 18

3, 8, 9

7.

Describe the accounting for the fair value


option.

16

19

8.

Explain the reporting of off-balance sheet


financing arrangements.

9.

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 Instructors 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 transactionsstraight-line.
Entries for bond transactionseffective-interest.
Amortization schedulestraight-line.
Amortization scheduleeffective-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 gaindebtors entries.
Term modification without gaincreditors entries.
Term modification with gaindebtors entries.
Term modification with gaincreditors 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

1520
1520
1520
1520
1520
1520
1520
1520
2030
1520
2030
1520
1520
1216
1015
1520
1520
1520
1015
1015
1520
2030
2530
2530
2030
1520
2025

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

1520
2530
2030
1520

Moderate
Moderate

5065
2025

Moderate
Simple
Moderate

2025
1525
2025

Moderate

2025

Moderate

4050

P14-5
P14-6
P14-7
P14-8
P14-9
P14-10
P14-11

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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

1525
3045
4050

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

2530

Moderate
Simple
Moderate
Moderate

1525
2025
2030
2330

CA14-2
CA14-3
CA14-4
CA14-5

14-4

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LEARNING OBJECTIVES
1.
2.
3.
4.
5.
6.
7.
8.
9.
*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 Instructors Manual(For Instructor Use Only)

14-5

CHAPTER REVIEW
*Note:All asterisked (*) items relate to material contained in the Appendix to the chapter.
1. 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
2. (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.
3. 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
4. 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.
5. 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.
6. 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

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Types of Bonds
7. (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
8. (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.
9. 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.

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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..........................................................

14-8

13,500
13,500

Copyright 2013 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 15/e Instructors Manual(For Instructor Use Only)

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.

Copyright 2013 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 15/e Instructors Manual(For Instructor Use Only)

14-9

Effective-Interest Amortization
14. The professions 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 statements 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 straight forward 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.

14-10

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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 bonds a 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.

Copyright 2013 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 15/e Instructors Manual(For Instructor Use Only)

14-11

Off-Balance Sheet Financing


27. (L.O. 8)A significant issue in accounting today is the question of off-balance-sheet financing .
Off-balance-sheet financing is an attempt to borrow monies in such a way that the
obligations are not recorded. Off-balance-sheet financing can take many different forms.
Some examples include (1) non-consolidated subsidiary, (2) a special purpose entity, and
(3) operating leases.
28. The FASBs response to off-balance-sheet financing arrangements has been increased
disclosure (note) requirements.
Presentation of Long-Term Debt
29. (L.O. 9)Companies that have large amounts and numerous issues of long-term debt
frequently report only one amount in the balance sheet and support this with comments
and schedules in the accompanying notes to the financial statements. These footnote
disclosures generally indicate the nature of the liabilities, maturity dates, interest rates,
call provisions, conversion privileges, restrictions imposed by the borrower, and assets
pledged as security. Long-term debt that matures within one year should be reported as
a current liability unless retirement is to be accomplished with other than current assets.
Analysis of Long-Term Debt
30. Long-term creditors and stockholders are interested in a companys long-run solvency
and the ability to pay interest when it is due. Two ratios that provide information about
debt-paying ability and long-run solvency are the debt to total assets ratio and the
times interest earned ratio.
Troubled Debt Restructurings
*31. (L.O. 10) A troubled debt restructuring occurs when a creditor for economic or legal
reasons related to the debtors financial difficulties grants a concession to the debtor that
it would not otherwise consider.
Settlement of Debt
*32. Creditor. When noncash assets (real estate, receivables, or other assets) or the issuance
of the debtors stock is used to settle a debt obligation in a troubled debt restructuring, the
noncash assets or equity interest given should be accounted for at their respective fair
values by the creditor. The creditor must determine the excess of the receivable over the
fair value of those same assets or equity interests transferred (loss).
*33. Debtor. The debtor is required to determine the excess of the carrying amount of the
payable over the fair value of the assets or equity interests transferred (gain). The debtor
recognizes a gain equal to the amount of the excess, and the creditor normally would
charge the excess (loss) against Allowance for Doubtful Accounts. In addition, the debtor
recognizes a gain or loss on disposition of assets to the extent that the fair value of those
assets differs from their carrying amount (book value).
14-12

Copyright 2013 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 15/e Instructors 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 debtors 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.

Copyright 2013 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 15/e Instructors Manual(For Instructor Use Only)

14-13

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 6. The appendix
provides a detailed discussion of troubled debt restructuring.
A. (L.O. 1)Long-term Debt.
1. Consists of present obligations not payable within the operating cycle of the company
or a year, whichever is longer.
2. 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.
1. 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 bonds stated interest rate and its market rate.
1.

A bonds 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.
TEACHING TIP

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.
2. Accounting for the issuance of bonds.

14-14

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.

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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.

3. (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.
TEACHING TIP

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.

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.

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14-15

4. 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.
TEACHING TIP
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.
1. 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


TEACHING TIP

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.
1. 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.
2. 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.

14-16

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(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.

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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.

3. 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.

4. Journal entries are similar to entries for bonds payable issued at a discount.
5. 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.


1. 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.
2. 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.
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1. 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
do not meet the criteria for balance sheet reporting.

2. 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.

3. FASBs response has been to require increased note disclosure.


H. (L.O. 9)Presentation and Analysis of Long-Term Debt.
1. 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.

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14-19

d.

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Future payments for sinking fund requirements and maturity amounts of long-term
debt during each of the next five years should be disclosed.

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2.

Analysis of long-term debt.


TEACHING TIP

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.
1.

2.

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.
TEACHING TIP

Illustration 14-6 summarizes the accounting procedures for troubled-debt restructurings.

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*J. IFRS Insights


1. IFRS and GAAP have similar definitions of liabilities.
2. 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 do 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.

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ILLUSTRATION 14-1
INTEREST RATES AND BOND PRICES

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14-23

ILLUSTRATION 14-1 (continued)

14-24

Copyright 2013 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 15/e Instructors Manual(For Instructor Use Only)

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

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ILLUSTRATION 14-3
ACCOUNTING FOR BONDS

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ILLUSTRATION 14-4
EXTINGUISHMENT OF DEBT

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14-27

ILLUSTRATION 14-5
DEBT TO TOTAL ASSETS AND
TIMES INTEREST EARNED RATIOS

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Copyright 2013 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 15/e Instructors Manual(For Instructor Use Only)

ILLUSTRATION 14-6
SUMMARY OF ACCOUNTING FOR TROUBLED-DEBT
RESTRUCTURING

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14-29

14-30

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