Chapter 14: Long-Term Liabilities

1. Bonds Payable:
• Understand the basics of bonds payable and how they represent long-term debt.
• Learn the accounting for the issuance of bonds at par, at a premium, and at a
discount.
• Explore the calculation of the carrying value of bonds.
2. Bond Amortization:
• Study the amortization of bond discounts and premiums over the life of the bond.
• Understand how to use the effective interest rate method for bond amortization.
• Learn how to calculate interest expense and interest payment.
3. Retirement of Bonds:
• Explore the accounting for the retirement of bonds before maturity.
• Understand the different methods used for retiring bonds, including the book value
and fair value methods.
• Learn about gain or loss on retirement and its impact on the financial statements.
4. Convertible Bonds:
• Understand the accounting for convertible bonds and the conversion process.
• Learn how to calculate the conversion ratio and the potential impact on diluted
earnings per share.
• Explore the financial reporting for convertible bonds.
5. Other Long-Term Liabilities:
• Study various other types of long-term liabilities, such as long-term notes payable
and mortgage payable.
• Understand how to account for the issuance, amortization, and retirement of these
liabilities.
6. Issuing Bonds Between Interest Dates:
• Learn how to account for bonds issued between interest payment dates.
• Understand the allocation of interest expense and the calculation of accrued interest
at issuance.
7. Presentation and Disclosure:
• Explore the presentation of long-term liabilities on the balance sheet.
• Understand the disclosure requirements for long-term liabilities in the financial
statements.
8. Effective Interest Rate Method:
• Understand the concept of the effective interest rate method and its application to
bond accounting.
• Learn how to calculate interest expense and the carrying amount using this method.
9. Installment Notes:
• Study the accounting for installment notes payable.
• Understand how to calculate interest and principal payments over the life of the
installment note.
10. Debt Covenants:
 • Explore the concept of debt covenants and their importance in long-term debt
agreements.
• Understand how debt covenants may impact financial reporting and disclosure.
11. Callable and Refundable Bonds:
• Learn about callable and refundable bonds and their impact on the issuer.
• Understand the accounting implications when bonds are called or refunded.

Example 1: Issuing Bonds at a Premium: Suppose a company issues $1,000,000 in bonds

with a face value of $1,000 each, a stated interest rate of 8%, and a maturity period of 5 years. The
market interest rate is 6%, resulting in the bonds being issued at a premium.

Solution:

1. Determine the Selling Price:

• Calculate the present value of future cash flows using the market interest rate.
• Pv=fv*(1-(1+r)-n)/r
• =$1,000,000×(1−(1+0.06)−5)0.06≈$1,150,273PV=0.06$1,000,000×(1−(1+0.06)−5)
≈$1,150,273
2. Determine the Premium:
• Premium = Selling Price - Face Value
• =$1,150,273−$1,000,000=$150,273Premium=$1,150,273−$1,000,000=$150,
273
3. Journal Entries:
• Record the issuance:
• Debit Cash: $1,150,273
• Credit Bonds Payable: $1,000,000
• Credit Premium on Bonds Payable: $150,273

Example 2: Amortization of Bond Premium

Continuing from Example 1, let's amortize the bond premium using the effective interest rate
method for the first interest payment.

Solution:

1. Calculate Interest Expense:

• Interest Expense=BeginningCarryingValue×MarketInterestRate
• =$1,150,273×0.06≈$69,017
2. Amortize Bond Premium:
• Amortization=InterestExpense−StatedInterest
• Amortization=$69,017−($1,000,000×0.08)=$69,017−$80,000=−$10,983
(negative because it's a premium)
3. Update Carrying Value:
• CarryingValue=PreviousCarryingValue+Amortization
 • CarryingValue=$1,150,273−$10,983=$1,139,290
4. Journal Entry for First Interest Payment:
• Debit Interest Expense: $69,017
• Debit Premium on Bonds Payable: $10,983
• Credit Cash: $80,000
 Intermediate Accounting 2 Chapter 14
Study online at https://quizlet.com/_2iolzh
Long Term Debt
Long Term liabilities
Indenture or agreement includes
Bond Indenture
Typical face value of a bond
Secured Bonds
Debenture Bond
Term bonds
Serial Bonds
Callable bonds
Convertible bonds
Commodity Backed Bonds
Deep Discount Bonds
Registered Bonds
Bearer or Coupon Bonds
Income Bonds
Revenue Bonds
Steps for issuance and marketing of bonds
Selling price of bonds
Present value of its expected future cash flows
Stated, Coupon, or Nominal rate
1/4
Consists of probable future sacrifices of economic benefits arising
fro present obligtions that are not payable within a year or the
operating cycle of hte company, whichever is longer
Bonds payable, long-term notes payable, mortgages payable,
pension liabilities, and lease liabilities
The amount authorized to be issued, interest rate, due date(s), call
provisions, property pledged as security, sinking funds require-
ments, working capital and dividend restrictions, and limitations
concerning the assumption of additional debt.
A promise to pay (1) a sum of money at a designated maturity
date, plus (2) periodic interest at a specified rate on the maturity
amount (face value).
$1,000
Backed by a pledge of some sort of collateral. Mortgage bonds
are secured by a claim on real estate. Collateral trust bonds are
secured by stock and bonds of other corporations.
An unsecured bond. A "junk bond" is unsecured and also very
risky, and therefore pays a high interest rate. Companies often use
theses bonds to finance leveraged buyouts
Bond issues that mature on a single date
Issues that mature in installments. Serially maturing bonds are
frequently used by school or sanitary districts, municipalities, or
other local taxing bodies that receive money through a special levy.
give the issuer the right to call and redeem the bonds prior to
maturity
If bonds are convertible into other securities of the corporations for
a specified time after insuance
Developed in an attempt to attract capital in a tight money market
- also called "asset linked bonds" are redeemable in measures of
a commodity, such as barrels of oil, tons of coal, or ounces of rare
metal.
Also called "zero interest debenture bonds" are sold at a discount
that provides the buyer's total interest payoff at maturity
Bonds issued in the name of the owner - and require surrender
of the certificate and insurance of a new certificate to complete a
sale.
Not recorded in the name of the owner and maybe transferred form
one owner to another by mere delivery
Pay not interest unless the issuing company is profitable
The interest on them is paid from specific revenue sources, most
frequently issued by airports, school districts, counties, toll road
authorities, and governmental bodies
(1) issuing company must arrange for underwriters that will help
market and sell the bonds (2) must obtain the Securities and
Exchange Commission's approval of the bond issue, undergo
audits, and issue a prospectus. (3) company must generally have
the bond certificates printed.
Is set by the supply and demand of buyers and sellers, relative
risk, market conditions, and the state of the economy
Consists of (1) interest (2) principal
The interest rate written in the terms of the bond indenture (and
often printed on the bond certificate) - the issuer of the bond sets
this rate
 Intermediate Accounting 2 Chapter 14
Study online at https://quizlet.com/_2iolzh
Par Value, Principal amount, maturity value
Discount or premium
Discount bonds
Premium Bonds
Effective Yield or Market Rate
If bonds sell at a discount
If bonds sell at a premium
There is an inverse realtionship
When bonds sell at less than face value
When a company issues bonds on an interest payment date at par
(face value)
Straight line method
Because of its relation to interest
Amortization of a discount
Amortization of a premium
Whether callable or not
When companies issue bonds on other than the interest payment Buyers of the bonds will pay the seller the interest accrued from
dates
The purchasers of the bonds
on the next semiannual interest payment date,
Because the bonds are issued between interest dates
Effective Interest Method
Steps for Effective Interest Method
The effective interest method produces
Both the effective interest and straight line methods result
Generally Accepted Accounting Principles
Discount on bonds payable
Contra Account
Adjunct Account
Companies report bond discounts and bond premiums
The issuance of bonds involves
The stated rate is expressed as a percentage of the face value of
the bonds
The difference between the face value of and the present value
of the bonds determines the actual price that buyers pay for the
bonds
If the bonds sells for less than face value
If the bonds sell for more than face value
The rate of interest actually earned by the bondholders
The effective yield exceeds the state rate
the effective yield is lower than the state rate
Between the market interest rate and the price of the bond
It means that investors demand a rate of interest height than the
state rate
It accrues no interest - no premium or discount exists
Amortized a constant amount each interest period
Companies amortize the discount and charge it to interest ex-
pense over the period of time that the bonds are outstanding
Increases interest expenses
Decreases interest expense
A company must amortize any premium or discount over the
bond's life to maturity because early redemption is not a certainty
the last interest payment date to the date of issuance
Pay the bond issuer in advance for that portion of the full six
months interest payments to which they are not entities because
they have not held the bonds for that period
Purchasers will receive the full six months' interest payment
It records the bond issuance at "par plus accrued interest"
The preferred procedure for amortization of a discount or premium
- also called Present Value Amortization
(1) Compute bond interest expense by first multiplying the carrying
value (book value) of the bonds at the beginning of the period
by the effective interest rate (2) Determine the bond discount or
premium amortization by comparing the bond interest expense
with the interest (cash) to be paid
A periodic interest expense equal to a constant percentage of the
carrying value of the bonds
In the same total amount of interest expense over the term of the
bonds
Require use of the effective interest method - when the annual
amounts are materially different
Is not an asset
Discount on bonds payable - a liability valuation account
Premium on bonds payable is a liability valuation account. It adds
to the face or maturity amount of the related liablity
As a direct deduction from or addition to the face amount of the
bond
Engraving and printing costs, legal and accounting fees, commis-
sions, promotion costs, and other similar charges
2/4
 Intermediate Accounting 2 Chapter 14
Study online at https://quizlet.com/_2iolzh
Companies are required to charge these costs to an asset account
Unamortized Bond Issue Costs (usually long-term) - companies then allocated the unamortized
bond issue costs to expense of the life of the debt
Reduces the proceeds of the bonds issued and increases the
The cost of issuing bonds
effective interest rate
Are treated as a deferred charge and amortized over the life of the
Unamortized bond issue costs
debt
Extinguishment of debt Recording the payment of debt
If the company holds the bonds to maturity The company does not compute any gains or losses
Reacquisition Price Any call premium and expense of reaquisation
Gain from extinguishment Any excess of the net carrying amount over the reacquisition price
Loss from extinguishment The excess of the reacquisition price over the net carrying amount
The unamortized premium or discount, and any costs of issue
At the time of reacquisition applicable to the bonds must be amortized up to the reaquisition
date
Long term debt that matures within one year, unless using no
Reported as a current liability
current assets to accomplish redemption
If the company plans to refinance debt, convert it into stock, or
No current Debt
retire it from a bond retirement fund
Measures the percentage of the total assets provided by creditors
Debt to asset ratio
- Total liabilities/Total assets
Indicates the company's ability to meet interest payments as they
Times interest earned ratio come due - Income before income taxes and interest expense/In-
terest expense
The greater the risk that the company may be unable to meet its
The higher the percentage of total liabilities to total assets
maturing obligations
In curing long-term debt is often a formal procedure. THe bylaws of
corporations usually require approval by the board of directs and
the stockholders before the corporation can issue bonds or can
Describe the formal procedures associate with issuing long-term
make other long-term debt arrangements. Generally, long-term
debt
debt has various covenants or restrictions. The covenants and
other terms of the agreement between the borrower and the lender
are stated in the bond indenture or note agreement.
Generally indicate the nature of the liabilities, maturity dates,
interest rates, call provisions, conversion privileges, restrictions
Note Disclosures
imposed by the creditors, and assets designated or pledged as
security
The covenants and other terms of the agreement between the
Bond Indenture
issuer of bonds and the lender are set forth in the
The interest rate written in the terms of the bond indenture is
Coupon rate, nominal rate, or stated rate
known as the
A bond for which the issuer has the right to call and retire the bonds
Callable Bond
prior to maturity
Registered bond A bond issued in the name of the owner is a
When the effective rate of a bond is lower than the stated, the bond
False
sells at a discount
Greater than the stated rate If a bond sold at 97, the market rate was
On January 1, Gasperson Inc issued $100,000,000, 7% bonds
A credit to Premium on bonds payable for $2,000,000 at 102. The journal entry to record the issuance of the bond will
include

Bellingham Inc sold bonds with a face value of $100,000,000

False
and stated interest rate of 8% for $92,280,000 to yield 10%. IF

3/4
 Intermediate Accounting 2 Chapter 14
Study online at https://quizlet.com/_2iolzh
the company uses the effective interest method is amortization,
interest expense for the first 6 months would be $4,000,000.
The effective interest method calculates bond interest expense by
False multiplying the carrying value of the bonds at the beginning of the
period by the stated rate of interest
Exceed what it would have been had the effective interest method If bonds are initially sold at a discount and the straight line method
of amortization been used of amortization is used, interest expense in the earlier years will
Ferrone Company issues $10,000,000, 7.8%, 20-year bonds to
yield 8% on January 1, 2014. Interest is paid on June 30 and
$392,082 December 31. The proceeds from the bonds are $9,802,072. Fer-
rite uses effective interest amortization. What amount of interest
expense will Ferrone record for the June 30 payment?
Gains and losses on early extinguishment of debt are reported as
True
other gains and losses on the income statement
On June 30, 2014, Baker Co. Had outstanding 8%, $6,000,000
face amount, 15-year bonds maturing on June 30, 2024. Interest if
payable on June 30 and Dec 31. The unamortized balances in the
$5,730,000 bond discount and deferred bond issue costs accounts on June
($6,000,000-$210,000-$60,000) 30, 2014 were $210,000 and $60,000 respectively. On June 30,
2014, Baker acquired all off tees bonds at 94 and retired them.
What net carrying amount should be used in computing gain or
loss on this early extinguishment of debt?
On January 1, 2014, Trinity Company loaned $901,560 to Litton
Industries in exchange for a 3 year, zero interest bearing note with
A credit to Discount on Notes Payable for $90,156 a face amount, $1,200,000. The prevailing rate of interest for a loan
of this type is 10%. The adjusting journal entry made by Litton at
December 31, 2014 with regard to the note will include
If a company elects the fair value option for its long-term liabilities,
False a decrease in the fair value of a bond payable will result in an
unrealized holding loss
Restrictions imposed by the creditor, assets pledged as security,
Note disclosures for long term debt generally include
and call provisions and conversion privileges
The loss recorded by the creditor in a troubled debt restructuring
True is based on the expected future cash flows discounted at the
historical effective interest rate

4/4