Reporting and Analyzing Long-Term Liabilities: Uaa - Acct 201 Principles of Financial Accounting Dr. Fred Barbee

ACCT 201
Reporting and
10
Chapter
Analyzing Long-Term
Liabilities
ACCT 201
UAA – ACCT 201

ACCT 201
Principles of Financial Accounting

Dr. Fred Barbee
1
Chapter 10 - Day 1 - Agenda
Topic LO Read HW
422-
Basics of Bonds A1, C1 QS1
425
E1,2,3,
P1, 425-
Bond Issuances 4,5,6;
P2, P3 436
P1
Present Value of 445-
C3, C4 None
Bonds and Notes 448
No Homework Due Today!

4
Basics of Bonds
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Basics of Bonds
Bond Selling Price
Bond Certificate
Company at Par Value Investors
Bond Issue
Date
Basics of Bonds
Bond Interest
Payments
Company Investors
Bond Interest Payments
Interest Payment =
Bond Issue Bond Par Value x
Date Stated Interest Rate
Basics of Bonds
Bond Par Value

at maturity date
Company Investors
Bond
Bond Issue
Maturity
Date
Date
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Advantages of Bonds
Bonds do not Interest on

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affect owner bonds is tax

control. deductible.
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Bonds can
increase
ROE.
8
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Disadvantages of Bonds
Bonds require Bonds require

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periodic payment payment of principal

of interest. at maturity.
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Bonds can
decrease ROE.
9
Convertible
and Callable
Secured Types
Registered
and of and Bearer
Unsecured Bonds
Term and
Serial
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Bond Trading
Bond market values
are expressed as a
percent of their par
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value.
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12
Bond Issuances
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
. . . investors
issue.
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Interest Rates and

the Issue Price
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14
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The Market Rate . . .

The rate of interest currently being
demanded in the market, i.e., the rate
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that investors expect to earn on their

investment.
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15
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The market rate is often referred to
by other terms . . .
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The Effective Rate

The Yield
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16
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The rate used to compute the
present values of the two components
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of the price of a bond:

The Present Value of the interest
payments; and
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The Present Value of the face value at

maturity.
17
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The Contract Rate . . .

The interest rate specified on the
face of the bond and in the bond
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indenture.
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18
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The contract rate is often referred
to by other names:
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The Stated Rate

The Nominal Rate
The Coupon Rate
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19
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The contract rate is used only to
calculate the amount of interest to
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be paid to the bondholders at each

interest period.
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20
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Interest Rates and

the Issue Price
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What Determines
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the Market Rate?

21
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In most cases the market price of
bonds is influenced by . . .
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The riskiness of the bonds; and

The interest rate at which the bonds are
issued.
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22
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Riskiness of the Bonds

The risk factor is a combination of:
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The general economic conditions; and
The financial status of the company

selling the bonds,
Moody’s, or
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Standard and Poors
23
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Interest Rate on the Bonds
The interest rate on the bonds is

primarily determined by the riskiness
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of the bonds . . .
The higher the risk,
The higher the interest rate.
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24
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Issuing Bonds
Payable
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What Determines
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the Issue Price?

25
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Issuing Bonds Payable
When issuing bonds payable, there

are three possibilities. Bonds may be
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issued . . .
At face value (par);
At a discount (less than par); or
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At a premium (greater than par).
26
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Bonds Issued at Face Value
If the market rate is equal

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to the contract rate, the

bonds will sell at face value
(i.e., at par).
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27
Market Rate = Contract Rate
Effective Coupon
Market Contract
Yield Nominal
Bonds will sell at

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Bonds Issued at a Discount
If the market rate is

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higher than the contract

rate, the bonds will sell at
a discount (less than face
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value).
29
Market Rate > Contract Rate
Effective Coupon
Market Contract
Yield Nominal
Bonds will sell at a

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Bonds Issued at a Premium
If the market rate is lower

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than the contract rate, the

bonds will sell at a premium
(more than face value)
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31
Market Rate < Contract Rate
Effective Coupon
Market Contract
Yield Nominal
Bonds will sell at

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Example #1
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Bonds Issued At
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Par Value
33
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Issuing Bonds at Par
Par Value = $1,000,000

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Stated Interest Rate = 10%

Market Interest Rate = 10%
Interest Dates = 6/30 & 12/31
Bond Date = Jan. 1, 2002
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Maturity Date = Dec. 31, 2021

(20 years)
34
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Bonds Issued at Face Value
If the market rate is equal

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to the contract rate, the

bonds will sell at face value
(i.e., at par).
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35
GENERAL JOURNAL Page 34

Date Description PR Debit Credit
Jan. 1 Cash 1,000,000
Bonds Payable 1,000,000
The journal entry to record the issuance of

bonds at par.


Jun. 30 Bond Interest Expense 50,000
Cash 50,000
$1,000,000  10% 1/2
The journal entry to record the six-month

interest payment on June 30.
This entry will be made every six months
until the bonds mature.

On Dec. 31, 202, when the bonds mature,

the following entry would be made.

Dec. 31 Bonds Payable 1,000,000
Cash 1,000,000

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Example #2
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Bonds Issued at
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A Discount
39
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Issuing Bonds at a Discount
Par Value = $1,000,000, 5 Years

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Issue Price = 92.6405% of par value

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Maturity Date = Dec. 31, 2006
40
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Bonds Issued at a Discount
If the market rate is

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higher than the contract

rate, the bonds will sell at
a discount (less than face
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value).
41
Cash
Par Value Proceeds Discount
$1,000,000 - $ 926,405 = $ 73,595
$1,000,000 92.6405%
Amortizing the discount increases

Interest Expense over the
outstanding life of the bond.

On Jan. 1, 2002, the bond issue would
be recorded as follows.

Jan. 1 Cash 926,405
Discount on Bonds Payable 73,595
Contra-Liability
Account

Partial Balance Sheet as of Jan. 1, 2002
Long-term Liabilities:
Bonds Payable $ 1,000,000
Less: Discount on Bonds Payable 73,595 $ 926,405
Maturity Value
Carrying Value

Less: Discount on Bonds Payable 73,595 $ 926,405
Using the straight-line method, the discount

amortization will be $7,360 every six months.
$73,595 ÷ 10 periods = $7,360 (rounded)

This entry will be made every six months to
record the interest payment and the
amortization of the discount.

Jun. 30 Interest Expense 57,360
Discount on Bonds Payable 7,360
Cash 50,000
$73,595 ÷ 10 periods = $7,360 (rounded)
$1,000,000 × 10% × ½ = $50,000

Straight-Line Amortization Table
A B C D E
Interest Interest Discount Unamortized Carrying
Date Payment Expense Amortization* Discount Value
1/1/2002 $ 73,595 $ 926,405
6/30/2002 $ 50,000 $ 57,360 $ 7,360 66,235 933,765
12/31/2002 50,000 57,360 7,360 58,875 941,125
$1,000,000 $73,595/10
x 10% x 1/2 = $7,360
(rounded)
$50,000 + $66,235 -
$7,360 $7,360
$1,000,000 -
$58,875
A B C D E
Interest Interest Discount Unamortized Carrying
Date Payment Expense Amortization* Discount Value
1/1/2002 $ 73,595 $ 926,405
6/30/2002 $ 50,000 $ 57,360 $ 7,360 66,235 933,765
12/31/2002 50,000 57,360 7,360 58,875 941,125
6/30/2003 50,000 57,360 7,360 51,515 948,485
12/31/2003 50,000 57,360 7,360 44,155 955,845
6/30/2004 50,000 57,360 7,360 36,795 963,205
12/31/2004 50,000 57,360 7,360 29,435 970,565
6/30/2005 50,000 57,360 7,360 22,075 977,925
12/31/2005 50,000 57,360 7,360 14,715 985,285
6/30/2006 50,000 57,360 7,360 7,355 992,645
12/31/2006 50,000 57,355 7,355 0 1,000,000
$ 500,000 $ 573,595 $ 73,595
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What if the company
used the effective
interest method to
amortize the
discount?
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Effective Interest Method
The effective interest method

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allocates bond interest expense

over the life of the bonds in a
way that yields a constant rate
of interest.
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50
Effective Interest Amortization Table
A B C D E
Interest Interest Discount Unamortized Present
Date Payment Expense* Amortization* Discount Value
1/1/2002 $ 73,595 $ 926,405
6/30/2002 $ 50,000 $ 55,584 $ 5,584 68,011 931,989
12/31/2002 50,000 55,919 5,919 62,092 937,908
$1,000,000 $55,919 -
x 10% x 1/2 $50,000
$931,989 x
$68,011 -
12% x 1/2
$5,919
$1,000,000 - $62,092; or
$931,989 + $5,919
Effective Interest Amortization Table
A B C D E
Interest Interest Discount Unamortized Present
Date Payment Expense* Amortization* Discount Value
1/1/2002 $ 73,595 $ 926,405
6/30/2002 $ 50,000 $ 55,584 $ 5,584 68,011 931,989
12/31/2002 50,000 55,919 5,919 62,092 937,908
6/30/2003 50,000 56,274 6,274 55,818 944,182
12/31/2003 50,000 56,651 6,651 49,167 950,833
6/30/2004 50,000 57,050 7,050 42,117 957,883
12/31/2004 50,000 57,473 7,473 34,644 965,356
6/30/2005 50,000 57,921 7,921 26,723 973,277
12/31/2005 50,000 58,396 8,397 18,326 981,674
6/30/2006 50,000 59,426 8,900 9,426 990,574
12/31/2006 50,000 59,430 9,426 0 1,000,000
$ 500,000 $ 573,595 $ 73,595
* Rounded.
Comparing Straight-Line and
Effective Interest Methods
Both methods report the same amount of
interest expense over the life of the bond.
Annual Interest Expense
$60,000
$59,000
$58,000
$57,000 Straight-Line Method
$56,000 Effective Interest
$55,000 Method
$54,000
$53,000
6/30/02
6/30/03
6/30/04
6/30/05
6/30/06
12/31/02
12/31/03
12/31/04
12/31/05
12/31/06
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Example #3
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Bonds Issued at
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A Premium
54
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Issuing Bonds at a Premium
Par Value = $1,000,000

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Issue Price = 108.1145% of par value

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Maturity Date = Dec. 31, 2006 (5 years)
55
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Bonds Issued at a Premium
If the market rate is lower

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than the contract rate, the

bonds will sell at a premium
(more than face value)
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56
Cash
Proceeds Par Value Premium
$1,081,145 - $ 1,000,000 = $ 81,145
$1,000,000 108.1145%
Amortizing the premium decreases

Interest Expense over the
outstanding life of the bond.

On Jan. 1, 2002, the company would
record the bond issue as follows.

Jan. 1 Cash 1,081,145
Premium on Bonds Payable 81,145
Adjunct-Liability
Account

Add: Premium on Bonds Payable 81,145 $ 1,081,145
Using the straight-line method, the premium

amortization will be $8,115 every six months.
$81,145 ÷ 10 periods = $8,115 (rounded)

The semiannual interest payment over the life

of the bonds.

Jun. 30 Interest Expense 41,885
Premium on Bonds Payable 8,115
Cash 50,000
$81,145 ÷ 10 periods = $8,115 (rounded)
$1,000,000 × 10% × ½ = $50,000

A B C D E
Interest Interest Premium Unamortized Carrying
Date Payment Expense Amortization* Premium Value
01/01/2002 $ 81,145 $ 1,081,145
06/30/2002 $ 50,000 $ 41,885 $ 8,115 73,030 1,073,030
12/31/2002 50,000 41,885 8,115 64,915 1,064,915
06/30/2003 50,000 41,885 8,115 56,800 1,056,800
12/31/2003 50,000 41,885 8,115 48,685 1,048,685
06/30/2004 50,000 41,885 8,115 40,570 1,040,570
12/31/2004 50,000 41,885 8,115 32,455 1,032,455
06/30/2005 50,000 41,885 8,115 24,340 1,024,340
12/31/2005 50,000 41,885 8,115 16,225 1,016,225
06/30/2006 50,000 41,885 8,115 8,110 1,008,110
12/31/2006 50,000 41,890 8,110 0 1,000,000
$ 500,000 $ 418,855 $ 81,145
* Rounded.
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Let’s look at the
effective interest
method
amortization table
for this bond.
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Effective Interest Method Amortization Table
A B C D E
Interest Interest Premium Unamortized Present
Date Payment Expense* Amortization* Premium Value
01/01/2002 $ 81,145 $ 1,081,145
06/30/2002 $ 50,000 $ 43,246 $ 6,754 74,391 1,074,391
12/31/2002 50,000 42,976 7,024 67,367 1,067,367
06/30/2003 50,000 42,695 7,305 60,062 1,060,062
12/31/2003 50,000 42,402 7,598 52,464 1,052,464
06/30/2004 50,000 42,099 7,901 44,563 1,044,563
12/31/2004 50,000 41,783 8,217 36,346 1,036,346
06/30/2005 50,000 41,454 8,546 27,800 1,027,800
12/31/2005 50,000 41,112 8,888 18,912 1,018,912
06/30/2006 50,000 40,756 9,244 9,668 1,009,668
12/31/2006 50,000 40,332 9,668 0 1,000,000
$ 500,000 $ 418,855 $ 81,145
* Rounded.
Issuing Bonds Between Interest Dates
Apr. 1, 2002 June 30, 2002

Jan. 1, 2002 Bond First
Bond Issue Interest
Date Date Payment
Accrued interest Earned interest
Investor pays Investor

bond purchase receives 6
price plus months’
accrued interest.
interest.
Issuing Bonds Between
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Interest Dates
Par Value = $1,000,000
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Maturity Date = Dec. 31, 2006 (5

years)
65
How much cash will the company receive for

the entire issue of the bonds?
Issue Price of Bonds $ 1,000,000
Accrued Interest
$1,000,000 × 10% × 3/12 = 25,000
Total Cash Received $ 1,025,000

What does the $25,000 in accrued interest

represent for the company?
Prepare the
journal entry to
record the
bond issue on
April 1, 2002.
Here is the journal entry to record the bond

issue on April 1, 2002.

Apr. 1 Cash 1,025,000
Interest Payable 25,000
Now, prepare the entry for June 30, 2002.

Here is the entry to record the interest
payment on June 30, 2002.

Jun. 30 Interest Payable 25,000
Interest Expense 25,000
Cash 50,000
$1,000,000 × 10% × ½ = $50,000

Accruing Bond Interest Expense
End of
accounting
Interest Payment Dates period
Jan. 1 Apr. 1 Oct. 1 Dec. 31
3 months’
accrued interest
At year-end, an adjusting entry is

necessary to recognize bond interest
expense accrued since the most recent
interest payment.

Reporting and Analyzing Long-Term Liabilities: Uaa - Acct 201 Principles of Financial Accounting Dr. Fred Barbee

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ACCT 201

UAA – ACCT 201

Principles of Financial Accounting

No Homework Due Today!

Bond Par Value

Bonds do not Interest on

affect owner bonds is tax

Bonds require Bonds require

periodic payment payment of principal

Interest Rates and

The Market Rate . . .

that investors expect to earn on their

The Market Rate . . .

The Effective Rate

The Market Rate . . .

of the price of a bond:

The Present Value of the face value at

The Contract Rate . . .

The Contract Rate . . .

The Stated Rate

The Contract Rate . . .

be paid to the bondholders at each

Interest Rates and

the Market Rate?

The Market Rate . . .

The riskiness of the bonds; and

Riskiness of the Bonds

The general economic conditions; and

The financial status of the company

Standard and Poors

The interest rate on the bonds is

the Issue Price?

When issuing bonds payable, there

At a premium (greater than par).

If the market rate is equal

to the contract rate, the

Market Rate = Contract Rate

Bonds will sell at

ACCT 201 ACCT 201 ACCT 201

If the market rate is

higher than the contract

Bonds will sell at a

ACCT 201 ACCT 201 ACCT 201

If the market rate is lower

than the contract rate, the

Market Rate < Contract Rate

Bonds will sell at

ACCT 201 ACCT 201 ACCT 201

Par Value = $1,000,000

Stated Interest Rate = 10%

Maturity Date = Dec. 31, 2021

If the market rate is equal

to the contract rate, the

GENERAL JOURNAL Page 34

The journal entry to record the issuance of

ACCT 201 ACCT 201 ACCT 201

GENERAL JOURNAL Page 39

The journal entry to record the six-month

ACCT 201 ACCT 201 ACCT 201

On Dec. 31, 202, when the bonds mature,

GENERAL JOURNAL Page 88

ACCT 201 ACCT 201 ACCT 201

Par Value = $1,000,000, 5 Years