ACC101- PRINCIPLE OF ACCOUNTING

Session 25
CHAPTER 14: LONG-TERM LIABILITIES

1
 OBJECTIVES

BOND BASICS
A1 Compare bond financing with stock financing.
BOND ISSUANCES
P1 Prepare entries to record bond issuance and interest expense.
P2 Compute and record amortization of bond discount using straight-line method.
P3 Compute and record amortization of bond premium using straight-line method.
BOND RETIREMENT
P4 Record the retirement of bonds.
LONG-TERM NOTES
C1 Explain the types of notes and prepare entries to account for notes.
A1 Compare bond financing with stock financing.
A2 Assess debt features and their implications
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 1. Bond Basics
A1 1.1. Bond Financing
Advantages Disadvantages

Bonds do not affect stockholder

control. Requires payment of both periodic
interest and par value at maturity.

ROE  when the Interest on bonds is tax deductible.

expected rate of return Can decrease return on equity
from the new assets > when the company pays more in
interest rate on the debt Bonds can increase return on interest than it earns on the
financing equity. borrowed funds.
 1. Bond Basics
A2 1.2. Bond Trading

Bond Rate Maturity Yield Volume Close Change

IBM 7% 25 5.9% 130 119.25 +1.25

Bond market values are

expressed as a percent of
their par value.
 1. Bond Basics
A2 1.3. Bond-Issuing Procedures

. . .an investment firm

A company sells the called an underwriter.
bonds to. . . The underwriter sells the
bonds to. . .

A trustee
monitors the
bond issue.
. . . investors
 1. Bond Basics
A1 1.3. Bond-Issuing Procedures

▪ Bond indenture: the legal contract between the issuer and the bondholders (and specifies
how often interest is paid).
▪ Bond certificate: includes specifics such as the issuer’s name, the par value, the contract
interest rate, and the maturity date.

Corporation Investors
Bond Selling Price

Bond Certificate
at Par Value
 1. Bond Basics
A1 1.3. Bond-Issuing Procedures

Bond Interest Payments

Corporation Investors
Bond Interest Payments

Bond Issue Interest Payment =

Date
Bond Par Value × Stated Interest Rate
 2. Bond Issuances
P1 2.1. Issuing Bonds at Par

A company is authorized to issue the following bonds on January 1, 2009:

▪ Par Value = $800,000
▪ Stated Interest Rate = 9%
▪ Interest Dates = 6/30 and 12/31
▪ Bond Date = Jan. 1, 2009
▪ Maturity Date = Dec. 31, 2028 (20 years)
 2. Bond Issuances
P1 2.1. Issuing Bonds at Par
On June 30, 2009, to record the first semiannual interest payment is . . .

$800,000 × 9% × ½ year = $36,000

This entry is made every six months until the bonds mature.

When they mature, the issuer records its payment of principal as follows.
 2. Bond Issuances
P2 2.2. Bond Discount or Premium
▪ Contract rate paid in cash ≠ bond interest expense actually incurred by the issuer.

Bond Sets Market Sets

Contract Market Contract rate > Market rate →Bonds sell at Premium
Rate (*) Rate
(*) coupon rate, stated rate, or nominal rate.
Contract rate = Market rate →Bonds sell at Par

Contract rate < Market rate →Bonds sell at Discount

 2. Bond Issuances
P2 2.3. Issuing Bonds at a Discount

Fila announces an offer to issue bonds with the following provisions:

▪ Par Value = $100,000

▪ Issue Price = 96.454% of par value

▪ Stated Interest Rate = 8%

▪ Market Interest Rate = 10%

} Bond will sell at a discount.

▪ Interest Dates = 6/30 and 12/31

▪ Bond Date = Jan. 1, 2009

▪ Maturity Date = Dec. 31, 2010 (2 years)

 2. Bond Issuances
P2
2.3. Issuing Bonds at a Discount

On Jan. 1, 2009, Fila will record the bond issue as:

Par value $ 100,000

Cash proceeds 96,454 *
Discount $ 3,546
*$100,000 x 96.454%

DR CR
Jan 1 Cash 96,454
Discount on Bonds Payable 3,546
Bonds Payable 100,000
Sold bonds at a discount on issue date

Contra-Liability
Account
 2. Bond Issuances
P2 2.3. Issuing Bonds at a Discount
Partial Balance Sheet as of Jan. 1, 2009
Long-term Liabilities:
Bonds Payable 100,000
Less: Discount on Bonds Payable 3,546 96,454

Maturity Value

Carrying Value

Amortizing a Bond Discount

Using the straight-line method, the discount amortization will be
$887(rounded) every six months.
$3,546 ÷ 4 periods = $887(rounded)
 2. Bond Issuances
P2
2.3. Issuing Bonds at a Discount

Amortizing a Bond Discount

Fila will make the following entry every six months to record the cash
interest payment and the amortization of the discount.
DR CR
Jun 30 Bond Interest Expense 4,887
Discount on Bonds Payable 887
Cash 4,000
To record interest payment and amortization

$3,546 ÷ 4 periods = $887 (rounded)

$100,000 × 8% × ½ = $4,000
 2. Bond Issuances
P2 2.3. Issuing Bonds at a Discount

Amortizing a Bond Discount

Straight-Line Amortization Table
Interest Interest Discount Unamortized Carrying
Date Payment Expense Amortization* Discount Value
1/1/2009 $ 3,546 $ 96,454
6/30/2009 $ 4,000 $ 4,887 $ 887 2,659 97,341
12/31/2009 4,000 4,887 887 1,772 98,228
6/30/2010 4,000 4,887 887 885 99,115
12/31/2010 4,000 4,885 885 - 100,000
$ 16,000 $ 19,546 $ 3,546
* Rounded.
 2. Bond Issuances
P3 2.4. Issuing Bonds at a Premium

Adidas issues bonds with the following features on January 1, 2009:

▪ Par Value = $100,000

▪ Issue Price = 103.546% of par value

▪ Stated Interest Rate = 12%

▪
}
Market Interest Rate = 10%
Bond will sell at a premium.

▪ Interest Dates = 6/30 and 12/31

▪ Bond Date = Jan. 1, 2009

▪ Maturity Date = Dec. 31, 2010 (2 years)

 2. Bond Issuances
P3 2.4. Issuing Bonds at a Premium

On Jan. 1, 2009, Adidas will record the bond issue as:

Par value $ 100,000

Cash proceeds 103,546 *
Premium $ 3,546
*$100,000 x 103.546%
DR CR
Jan 1 Cash 103,546
Premium on Bonds Payable 3,546
Bonds Payable 100,000
Sold bonds at a premium on issue date

Adjunct-Liability
Account
 2. Bond Issuances
P3 2.4. Issuing Bonds at a Premium

Partial Balance Sheet as of Jan. 1, 2009

Long-term Liabilities:
Bonds Payable 100,000
Plus: Premum on Bonds Payable 3,546 103,546

Maturity Value
Carrying Value

Amortizing a Bond Discount

Using the straight-line method, the premium amortization will be
$887(rounded) every six months.
$3,546 ÷ 4 periods = $887(rounded)
 2. Bond Issuances
P3 2.4. Issuing Bonds at a Premium

Amortizing a Bond Premium

Fila will make the following entry every six months to record the cash
interest payment and the amortization of the premium.
DR CR
Jun 30 Bond Interest Expense 5,113
Premium on Bonds Payable 887
Cash 6,000
To record interest payment and amortization

$3,546 ÷ 4 periods = $887 (rounded)

$100,000 × 12% × ½ = $6,000
 2. Bond Issuances
P3 2.4. Issuing Bonds at a Premium

Amortizing a Bond Premium

Straight-Line Amortization Table
Interest Interest Premium Unamortized Carrying
Date Payment Expense Amortization* Premium Value
1/1/2009 $ 3,546 $ 103,546
6/30/2009 $ 6,000 $ 5,113 $ 887 2,659 102,659
12/31/2009 6,000 5,113 887 1,772 101,772
6/30/2010 6,000 5,113 887 885 100,885
12/31/2010 6,000 5,115 885 - 100,000
$ 24,000 $ 20,454 $ 3,546
* Rounded.
 2. Bond Issuances
C2 2.5. Bond Pricing
Present Value of a Discount Bond

Here are the Fila bonds we worked with earlier:

▪ Par Value = $100,000

▪ Issue Price = ?

▪ Stated Interest Rate = 8%

▪ Market Interest Rate = 10%

▪ Interest Dates = 6/30 and 12/31

▪ Bond Date = Jan. 1, 2009

▪ Maturity Date = Dec. 31, 2010 (2 years)

 2. Bond Issuances
C2 2.5. Bond Pricing
Present Value of a Discount Bond
Present
Present
Cash Flow Table Value Amount
Value
Factor
Par value of the bond PV of $1 (B.1) 0.8227 $ 100,000 $ 82,270

Interest (annuity) PV of Annuity of

$1 (B.3) 3.5460 4,000 14,184
Price of bond $ 96,454

1. Semiannual rate = 5% (Market rate 10% ÷ 2)

2. Semiannual periods = 4 (Bond life 2 years × 2)

$100,000 × 8% × ½ = $4,000
 2. Bond Issuances
C2 2.5. Bond Pricing
Present Value of a Premium Bond
Present
Present
Cash Flow Table Value Amount
Value
Factor
Par value of the bond PV of $1 (B.1) 0.8227 $ 100,000 $ 82,270

Interest (annuity) PV of Annuity of

$1 (B.3) 3.5460 6,000 21,276
Price of bond $ 103,546

1. Semiannual rate = 5% (Market rate 10% ÷ 2)

2. Semiannual periods = 4 (Bond life 2 years × 2)

$100,000 × 12% × ½ = $6,000

 3. Bond Retirement
P4 3.1. Bond Retirement at Maturity

Let’s retire the Fila bonds at maturity for $100,000 cash.

DR CR
Dec 31 Bonds Payable 100,000
Cash 100,000
Retirement of bonds at maturity

Because any discount or premium will be fully amortized at

maturity, the carrying value of the bonds will be equal to
par value.
 3. Bond Retirement
P4 3.2. Bond Retirement before Maturity

• Carrying Value > Retirement Price = Gain

• Carrying Value < Retirement Price = Loss
Let’s retire the Adidas bonds on June 30, 2009, after the first interest
payment. The bond carrying value is $102,659, and the unamortized
bond premium is $2,659. Because the bonds are retired early, a call
premium of $3,000 must be paid to the bondholders.

DR CR
Jun 30 Bonds Payable 100,000
Premium on Bonds Payable 2,659
Loss on Bond Retirement 341
Cash 103,000
To record bond retirement before maturity
 3. Bond Retirement
P4 3.3. Bond Retirement by Conversion

On January 1, $100,000 par value bonds of Converse, with a

carrying value of $100,000, are converted to 15,000 shares
of $2 par value common stock.
DR CR
Jan 1 Bonds Payable 100,000
Common Stock 30,000
Paid-in Capital in Excess of Par 70,000
To record conversion of bonds into common stock

15,000 shares × $2 par value per share

 4. Long-Term Notes Payable
C1

Cash

Company Note Payable Lender

When is the repayment of the principal and

interest going to be made?

Note Date Note Maturity

Date
 4. Long-Term Notes Payable
C1

Single Payment of Principal

plus Interest

Company Lender
Single Payment of
Principal plus Interest

Note Date Note Maturity

Date
 4. Long-Term Notes Payable
C1

Regular Payments of
Principal plus Interest

Company Lender
Regular Payments of Principal plus Interest

Payments can either be equal

Note Date principal payments plus interest or Note Maturity
equal payments. Date
 4. Long-Term Notes Payable
C1 4.1. Installment Notes with Equal Payments
On January 1, 2009, Foghog borrows $60,000 from a bank to
purchase equipment. It signs an 8% installment note requiring 6
annual payments of principal plus interest.
DR CR
Jan 1 Cash 60,000
Notes Payable 60,000
Borrowed $60,000 b y signing an 8% note

Compute the periodic payment by dividing the face

amount of the note by the present value factor.
Table Present
Computation Table
PV of Value Value Payment
Principal divided Annuity of
by PV factor $1 (B.3) 4.6229 60,000 12,979
 4. Long-Term Notes Payable
P5 4.1. Installment Notes with Equal Payments

Amortization Schedule
(A = 8% * D) (B = C - A) C (D = Previous -B)
Interest Note Note
Date Expense Amortization* Payment Balance
Beginning Balance $ 60,000
12/31/2009 $ 4,800 $ 8,179 $ 12,979 51,821
12/31/2010 4,146 8,833 12,979 42,988
12/31/2011 3,439 9,540 12,979 33,448
12/31/2012 2,676 10,303 12,979 23,145
12/13/2013 1,852 11,127 12,979 12,017
12/31/2014 961 12,017 12,979 0
$ 17,873 $ 60,000 $ 77,874
* Rounded.
 4. Long-Term Notes Payable
P5 4.1. Installment Notes with Equal Payments

Let’s record the first payment made on December 31, 2009

by Foghog to the bank.

DR CR
Dec 31 Notes Payable 8,179
Interest Expense 4,800
Cash 12,979
To record payment on note payab le

Refer back to the amortization schedule and see if you can

make the entry for the second payment on the note.
DR CR
Dec 31 Notes Payable 8,833
Interest Expense 4,146
Cash 12,979
To record payment on note payable
 4. Long-Term Notes Payable
C1 4.2. Mortgage Notes and Bonds

A legal agreement that helps protect the lender if the borrower

fails to make the required payments.

Gives the lender the right to be paid out of the cash proceeds
from the sale of the borrower’s assets specifically identified in
the mortgage contract.
 4. Long-Term Notes Payable
A2 4.3. Features of Bonds and Notes

Secured and Convertible and

Unsecured Callable

Term and Serial Registered and

Bearer
 Debt-to-Equity Ratio
A3

Debt-to- Total Liabilities

=
Equity Ratio Total Equity

This ratio helps investors determine the risk of investing in a

company by dividing its total liabilities by total equity.

Six Flags Debt-to-Equity Ratio

$ in million 2006 2005 2004 2003
Total liabilities $ 2,811 $ 2,799 $ 2,816 $ 3,321
Total equity 376 694 826 1,362
Debt-to-equity 7.5 4.0 3.4 2.4
Industry debt-to equity 1.2 1.0 0.9 0.8
 14A – Present Values of Bonds and
Notes
C2 Present Value of $1
Rate
Periods 3% 4% 5% Let’s calculate the present value of a
1 0.9709 0.9615 0.9524 debt instrument that has a face amount
2 0.9426 0.9246 0.9070
3 0.9151 0.8890 0.8638
of $100,000, contract rate of 8%, market
4 0.8885 0.8548 0.8227 rate of 10% with interest paid
5 0.8626 0.8219 0.7835 semiannually. First, we calculate the
6 0.8375 0.7903 0.7462
present value of the principal repayment
7 0.8131 0.7599 0.7107
8 0.7894 0.7307 0.6768 in 4 periods (2 years × 2 payments per
9 0.7664 0.7026 0.6446 year, using 5% market rate (10% annual
10 0.7441 0.6756 0.6139 rate ÷ 2 payments per year).

$100,000 × 0.8227 = $82,270

C2
14A – Present Values of Bonds and
Notes
Present Value of Annuity of $1
Rate
Periods 3% 4% 5%
1 0.9709 0.9615 0.9524
2 1.9135 1.8861 1.8594
Interest Annuity
3 2.8286 2.7751 2.7232
$100,000 × 8% × ½ = $4,000 4 3.7171 3.6299 3.5460
5 4.5797 4.4518 4.3295
6 5.4172 5.2421 5.0757
7 6.2303 6.0021 5.7864
$4,000 × 3.5460 = $14,184 8 7.0197 6.7327 6.4632
9 7.7861 7.4353 7.1078
10 8.5302 8.1109 7.7217

Present
Amount PV Factor Value
Principal $ 100,000 0.8227 $ 82,270
Interest 8,000 3.5460 14,184
Issue price of debt $ 96,454
 14B – Effective Interest Amortization

Effective Interest Amortization Schedule

Interest Interest Discount Unamortized Carrying
Date Payment Expense Amortization* Discount Value
1/1/2009 $ 3,546 $ 96,454
6/30/2009 $ 4,000 $ 4,823 $ 823 2,723 97,277
12/31/2009 4,000 4,864 864 1,859 98,141
6/30/2010 4,000 4,907 907 952 99,048
12/31/2010 4,000 4,952 952 0 100,000
$ 16,000 $ 19,546 $ 3,546
* Rounded.

$96,454 × 5% = $4,823 $100,000 - $2,723 = $97,277

 14C - Issuing Bonds Between Interest Dates
C3

Avia sells $100,000 of its 9% bonds at par on March 1, 2009, 60 days

after the stated issue date. The interest on Avia bonds is payable
semiannual on each June 30 and December 31.
Stated Issue First Interest
date 1/1 Date of sale 3/1 date 6/30
$1,500 accrued $3,000 earned
Bondholder pays Issuer pays $4,500 to
$1,500 to issuer bondholder
DR CR
Mar 1 Cash 101,500
Interest Payable 1,500
Bonds Payable 100,000
To record sale of bonds on 3/1
DR CR
Jun 30 Bond Interest Expense 3,000
Interest Payable 1,500
Cash 4,500
To record first interest payment
 14D - Leases and Pensions
C4

A lease is a contractual agreement between the lessor (asset owner) and

the lessee (asset renter or tenant) that grants the lessee the right to use
the asset for a period of time in return for cash (rent) payments.

Operating Leases
Operating leases are short-term (or cancelable) leases in which the
lessor retains the risks and rewards of ownership. Examples include
most car and apartment rental agreements.

Capital Leases
Capital leases are long-term (or non-cancelable) leases by which the
lessor transfers substantially all risks and rewards of ownership to the
lessee. Examples include leases of airplanes and department store
buildings.
C4
14D - Leases and Pensions

A pension is a contractual agreement between an

employer and its employees for the employer to provide
benefits (payments) to employees after they retire.

Defined Benefit Plans

The employer’s contributions vary, depending on
assumptions about future pension assets and liabilities.
A pension liability is reported when the accumulated
benefit obligation is more than the plan assets, a so-
called underfunded plan.
Homework

HOMEWORK:
MCQs for review list

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