Intermediate Accounting, 10th Edition

Kieso, Weygandt, and Warfield

Chapter 14: Long Term Liabilities

Prepared by
Krishnan Ranganathan, Angelo State University,
San Angelo, Texas
Part 1:
Part 1: Bonds
Bonds Payable
Payable
 Long-Term Debt: General
 Long term debt consists of probable future
sacrifices.
 It has various covenants or restrictions for the
protection of both lenders and borrowers.
 The indenture or agreement incorporates the terms
of the issue and restrictions.

09/14/20 Intermediate Accounting, 10th Edi 3

tion, Chapter 14 (Kieso et al.)
 Issuing Bonds
 Bonds are the most common type of long term debt.
 They are usually issued in denominations of $1,000.
 A bond indenture is a promise (by the lender to the
borrower) to pay:
 a sum of money at the designated date, and
 periodic interest at a stipulated rate on the face value
 A bond issue may be sold:
 either through an investment banker, or
 by private placement

09/14/20 Intermediate Accounting, 10th Edi 4

tion, Chapter 14 (Kieso et al.)
 Select Types of Bonds
 Secured and unsecured bonds: bonds secured by
collateral (real estate, stocks)
 Serial bonds: mature in installments
 Callable bonds: give issuer to call and retire debt
prior to maturity
 Convertible bonds: can be converted into other
corporate securities for a specified time after
issue
 Bearer bonds: are freely transferable by current owner.

09/14/20 Intermediate Accounting, 10th Edi 5

tion, Chapter 14 (Kieso et al.)
 Bond Issues: Parties to the Contract

lend cash
Issuer of
Issuer of Bonds
Bonds Bondholders
Bondholders
1. Bond Certificate

2. Periodic interest

3. Redemption of Face Value

09/14/20 Intermediate Accounting, 10th Edi 6

tion, Chapter 14 (Kieso et al.)
 Valuation of Bonds:
Determining Bond Prices
 The price of a bond issue is determined by:
 the present value of the annuity of interest payments
(at the contractual rate of interest), and
 the present value of the redemption (face) value,
 both discounted at the market rate of interest at
issue date.
 Interest payments by borrower are calculated as:
 Face value of bond issue * contractual interest rate
(as specified in the bond indenture)

09/14/20 Intermediate Accounting, 10th Edi 7

tion, Chapter 14 (Kieso et al.)
 Valuation of Bonds: Determining Bond
Prices - Example
 Given:
 Face value of bond issue: $100,000
 Term of issue: 5 years
 Contractual interest rate: 9% per year, payable
annually end of the year
 Market rate of interest: 11%

 Determine the issue price of the bonds.

09/14/20 Intermediate Accounting, 10th Edi 8

tion, Chapter 14 (Kieso et al.)
 Valuation of Bonds: Determining Bond
Prices - Cash Flows

Year 1 Year 2 Year 3 Year 4 Year 5

interest $9,000 $9,000 $9,000 $9,000 $9,000

$100,000
Redemption at maturity ==>
face value

Interest = $100,000 * 9% per year contractual rate

09/14/20 Intermediate Accounting, 10th Edi 9
tion, Chapter 14 (Kieso et al.)
 Valuation of Bonds: Determining Bond
Prices - Present Value of Cash Flows

Year 1 Year 2 Year 3 Year 4 Year 5

interest $9,000 $9,000 $9,000 $9,000 $9,000

$ 33,262 Discount at market rate, 11%

$9,000 * 3.69590
plus
Discount at market rate, 11%
$100,000 * 0.59345 $100,000
$ 59,345
=$92,607 is the issue price
09/14/20 Intermediate Accounting, 10th Edi 10
tion, Chapter 14 (Kieso et al.)
 Bond Issue Pricing: Concept
Relationship Relationship Rationale
between between
contractual rate Issue Price
and market rate and Face Value
CR = Mkt Rate Issue Price = F.V Market rate is the
same as Bond rate

CR < Mkt Rate Issue Price < F.V. Issuer offers a

discount to b/holder
to compensate for
lower bond interest
CR > Mkt Rate Issue Price > F.V. Issuer gets a
premium for
higher bond interest
09/14/20 Intermediate Accounting, 10th Edi 11
tion, Chapter 14 (Kieso et al.)
 Discount on Bonds Payable: Concept

 The discount is amortized (spread over the bond

term) either by the straight line method or the
effective interest method.
 The amortized discount on bond issue is added to the
interest paid in cash during the interest period.
 Interest expense is recognized as follows:
 Cash paid for interest: $XXX
 Add: Discount amortized: $XXX
 Interest expense recognized: $XXX
09/14/20 Intermediate Accounting, 10th Edi 12
tion, Chapter 14 (Kieso et al.)
 Premium on Bonds Payable: Concept
 The premium is amortized (spread over the bond
term) either by the straight line method or the
effective interest method.
 The amortized premium on bond issue is subtracted
from the interest paid in cash during the interest
period.
 Interest expense is recognized as follows:
 Cash paid for interest: $XXX
 Less: Premium amortized: $XXX
 Interest expense recognized: $XXX

09/14/20 Intermediate Accounting, 10th Edi 13

tion, Chapter 14 (Kieso et al.)
 A Note on Amortization Methods
 The straight line method allocates the same
amount of discount (or premium) to each
interest period.
 The effective interest method allocates the
discount or premium in increasing amounts
over the bond term (see following examples)
 However, the total discount or premium
amortized is the same under both methods.

09/14/20 Intermediate Accounting, 10th Edi 14

tion, Chapter 14 (Kieso et al.)
 Bonds Payable: Face Value, Discount, and
Carrying Value - Concept
100
90
80
70
60 F.V.
50
Dis. UNam
40
C.V.
30
20
10
0
at Issue End: Yr 2 End: Yr 4

1. Face value remains the same throughout the bond term.

2. Unamortized discount gradually decreases over the bond term.
3. Carrying value gradually increases and is equal to face value at redemption.

09/14/20 Intermediate Accounting, 10th Edi 15

tion, Chapter 14 (Kieso et al.)
 Bonds Payable: Face Value, Premium, and
Carrying Value - Concept

140
120

100
80 F.V.
60 Prem.UN
C.V.
40

20
0
at Issue End: Yr 2 End: Yr 4

1. Face value remains the same throughout the bond term.

2. Premium unamortized gradually decreases over the bond term.
3. Carrying value gradually decreases and is equal to face value at redemption.

09/14/20 Intermediate Accounting, 10th Edi 16

tion, Chapter 14 (Kieso et al.)
 Bonds Issued at Par on Interest Date

 Given: (Fiscal year is calendar year)

 Face value of bonds issued: $100,000
 Issue Price: $100,000
 Market Rate: 10%
 Contractual Rate: 10%
 Date of issue: January 1, 2000
 Interest dates: July 1 and Jan 1
 Give the journal entries for issue and payment of
interest.
09/14/20 Intermediate Accounting, 10th Edi 17
tion, Chapter 14 (Kieso et al.)
 Bonds Issued at Par on Interest Date
 January 1, 2000 (Issue):
 Cash $100,000
 Bonds Payable $100,000
 July 1, 2000 (Interest Payment):
 Interest Expense $ 5,000
 Cash $ 5,000
 December 31, 2000 (Interest Accrual):
 Interest Expense $ 5,000
 Interest Payable $ 5,000

09/14/20 Intermediate Accounting, 10th Edi 18

tion, Chapter 14 (Kieso et al.)
 Bonds Issued at a Premium on Interest Date:
Straight Line Amortization
 Given: (Fiscal year is calendar year)
 Face value of bonds issued: $ 100,000
 Issue Price: (issue at 108.53) $ 108,530
 Market Rate: 6%
 Contractual Rate: 8%
 Date of issue: January 1, 2000
 Interest dates: July 1 and Jan 1
 Term of issue: 5 years
 Give the journal entries for issue and interest payment.
09/14/20 Intermediate Accounting, 10th Edi 19
tion, Chapter 14 (Kieso et al.)
 Bonds Issued at a Premium on Interest Date:
Straight Line Amortization
 January 1, 2000 (Issue):
 Cash $108,530
 Bonds Payable $100,000
 Premium on Bonds Payable $ 8,530
 July 1, 2000 (Interest Payment):
 Interest Expense $ 3,147
 Premium on Bonds Payable $ 853
 Cash $ 4,000
 Note: Premium amortized = $ 8,530 / 10 payments = $ 853

09/14/20 Intermediate Accounting, 10th Edi 20

tion, Chapter 14 (Kieso et al.)
 Bonds Issued at a Discount on Interest Date:
Straight Line Amortization
 Given: (Fiscal year is calendar year)
 Face value of bonds issued: $ 100,000
 Issue Price: $ 92,278
 Market Rate: 10%
 Contractual Rate: 8%
 Date of issue: January 1, 2000
 Interest dates: July 1 and Jan 1
 Term of issue: 5 years
 Give the journal entries for issue and interest payment.
09/14/20 Intermediate Accounting, 10th Edi 21
tion, Chapter 14 (Kieso et al.)
 Bonds Issued at a Discount on Interest Date:
Straight Line Amortization
 January 1, 2000 (Issue):
 Cash $ 92,278
 Discount on Bonds Payable $ 7,722
 Bonds Payable $100,000
 July 1, 2000 (Interest Payment):
 Interest Expense $ 4,772
 Discount on Bonds Payable $ 772
 Cash $ 4,000
 Note: Discount amortized = $ 7,722 / 10 payments = $ 772

09/14/20 Intermediate Accounting, 10th Edi 22

tion, Chapter 14 (Kieso et al.)
 Bond Issued between Interest Dates: Concept

 Bonds may be issued between interest dates.

 Interest, for the period between the issue date and
the last interest date, is collected with the issue price
of the bonds.
 At the specified interest date, interest is paid for the
entire interest period (semi annual or annual)
 Premium or discount is also amortized from the
date of sale of bonds to the end of the interest
period.

09/14/20 Intermediate Accounting, 10th Edi 23

tion, Chapter 14 (Kieso et al.)
 Bonds Issued at a Premium between Interest
Dates: Straight Line Amortization
 Given: (Fiscal year is calendar year)
 Face value of bonds issued: $ 100,000
 Issue Price: (issue at 108.53) $ 108,530
 Market Rate: 6%
 Contractual Rate: 8%
 Date of issue: March 1, 2000
 Interest dates: July 1 and Jan 1
 Term of issue: 5 years
 Give the journal entries for issue and interest payment.
09/14/20 Intermediate Accounting, 10th Edi 24
tion, Chapter 14 (Kieso et al.)
 Bonds Issued at a Premium between Interest
Dates: Straight Line Amortization
 March 1, 2000 (Issue):
 Cash $109,863
 Bonds Payable $100,000
 Premium on Bonds Payable $ 8,530
 Bond Interest Expense (2 months) $ 1,333
 July 1, 2000 (Interest Payment):
 Bond Interest Expense $ 3,431
 Premium on Bonds Payable $ 569
 Cash $ 4,000
 Note: Premium amortized = ($853 / 6) * 4 months
09/14/20 Intermediate Accounting, 10th Edi 25
tion, Chapter 14 (Kieso et al.)
 Bonds Issued at a Discount between Interest
Dates: Straight Line Amortization
 Given: (Fiscal year is calendar year)
 Face value of bonds issued: $ 100,000
 Issue Price: $ 92,278
 Market Rate: 10%
 Contractual Rate: 8%
 Date of issue: March 1, 2000
 Interest dates: July 1 and Jan 1
 Term of issue: 5 years
 Give the journal entries for issue and interest payment.
09/14/20 Intermediate Accounting, 10th Edi 26
tion, Chapter 14 (Kieso et al.)
 Bonds Issued at a Discount between Interest
Dates: Straight Line Amortization
 March 1, 2000 (Issue):
 Cash $ 93,611
 Discount on Bonds Payable $ 7,722
 Bonds Payable $100,000
 Bond Interest Expense (2 mo) $ 1,333
 July 1, 2000 (Interest Payment):
 Bond Interest Expense $ 4,515
 Discount on Bonds Payable $ 515
 Cash $ 4,000
 Note: Discount amortized = ($ 772 / 6) * 4 months = $ 515
09/14/20 Intermediate Accounting, 10th Edi 27
tion, Chapter 14 (Kieso et al.)
 Bonds Issued at a Discount on Interest Date:
Effective Interest Amortization
 Given: (Fiscal year is calendar year)
 Face value of bonds issued: $ 100,000
 Issue Price: $ 92,278
 Market Rate: 10%
 Contractual Rate: 8%
 Date of issue: January 1, 2000
 Interest dates: July 1 and Jan 1
 Term of issue: 5 years
 Give the journal entries for issue and interest payment.
09/14/20 Intermediate Accounting, 10th Edi 28
tion, Chapter 14 (Kieso et al.)
 Bonds Issued at a Discount on Interest Date:
Effective Interest Amortization
 Effective interest method: Amortization schedule
 Date Interest Cash Discount Carrying
Expense Paid Amortized Value (end)
 1.1.00 --- --- --- $ 92,278
 July 1 $4,614 $4,000 $614 $ 92,892
 1.1.01 $4,645 $4,000 $645 $ 93,537
 Interest expense = Carrying value * (1/2) Mkt rate
at Beginning
 Discount amortized = Interest expense less cash paid

09/14/20 Intermediate Accounting, 10th Edi 29

tion, Chapter 14 (Kieso et al.)
 Bonds Issued at a Discount on Interest Date:
Effective Interest Amortization
 January 1, 2000 (Issue):
 Cash $ 92,278
 Discount on Bonds Payable $ 7,722
 Bonds Payable $100,000
 July 1, 2000 (Interest Payment):
 Bond Interest Expense $ 4,614
 Discount on Bonds Payable $ 614
 Cash $ 4,000

 Note: Discount amortized = $4,614 less $4,000 = $614

09/14/20 Intermediate Accounting, 10th Edi 30
tion, Chapter 14 (Kieso et al.)
 Classification of Discount on Bonds Payable

 Discount on bonds payable is a contra

liability account and is shown as:
 Bonds Payable (face value) : $ XXX
 less: Unamortized Discount : ($ XX)
 Bonds Payable (carrying value): $ XXX

09/14/20 Intermediate Accounting, 10th Edi 31

tion, Chapter 14 (Kieso et al.)
 Classification of Premium on Bonds Payable

 Premium on bonds payable is an adjunct

account and is shown as:
 Bonds Payable (face value) : $ XXX
 Add: Unamortized Premium : $ XX
 Bonds Payable (carrying value): $ XXX

09/14/20 Intermediate Accounting, 10th Edi 32

tion, Chapter 14 (Kieso et al.)
 Accounting for the Costs of Issuing Bonds

 Costs of issue must be amortized over the life

of the bond issue.
 Even though both straight line and effective
interest methods are acceptable, the straight
line method is used in most cases.

09/14/20 Intermediate Accounting, 10th Edi 33

tion, Chapter 14 (Kieso et al.)
 Extinguishment of Debt

 When debt is extinguished (paid),

 any premium or discount on bond issue
must be amortized up to the date of
extinguishment, and
 any bond issue costs must be amortized up
to date of extinguishment.
 Any gain or loss from extinguishment of debt
is treated as an extraordinary item.
09/14/20 Intermediate Accounting, 10th Edi 34
tion, Chapter 14 (Kieso et al.)
 Extinguishment of Debt: Example
 Given:
 Existing debt: $800,000
 Called and canceled at $808,000
 Unamortized discount: $ 14,400
 Unamortized bond issue costs: $ 9,600

 Note: Both discount and bond issue costs have been

amortized up to the date of cancellation of debt.
 Give the journal entry for the extinguishment.
09/14/20 Intermediate Accounting, 10th Edi 35
tion, Chapter 14 (Kieso et al.)
 Extinguishment of Debt: Example

 Bonds Payable $800,000

 Loss on Extinguishment $ 32,000
 Discount on Bonds $ 14,400
 Unamortized Bond Issue
Costs $ 9,600
 Cash $ 808,000

 Note: The loss is a balancing figure and an extraordinary

item.

09/14/20 Intermediate Accounting, 10th Edi 36

tion, Chapter 14 (Kieso et al.)
Part 2:
Part 2: Long-Term
Long-Term Notes
Notes Payable
Payable
 LT Notes Payable and Bonds Payable:
A Comparison

 Notes payable and bonds payable are similar in

that:
 both have fixed maturity dates
 both have either stated or implicit rates
 Like a bond, a note payable is valued at the
present value of its future interest payments
and the principal (at maturity date.)

09/14/20 Intermediate Accounting, 10th Edi 38

tion, Chapter 14 (Kieso et al.)
 Note Issues
 A note may be issued at:
 face value
 or other than its face value
 When issued at other than its face value, a note may
have:
 no interest specified (zero interest), or
 an interest rate less than the market rate (discount results)
 A discount is amortized over the note term under the
effective interest method

09/14/20 Intermediate Accounting, 10th Edi 39

tion, Chapter 14 (Kieso et al.)
 Note Issued for Cash and Other Rights
 Sometimes, an issuer (borrower) of a note
payable with below-market interest gives the
recipient of the note (lender) additional buying
rights.
 Then, the borrower is also the seller; and the lender
is also the buyer.
 The borrower must record both:
 a discount on the note, and
 unearned revenue
 See next slide for example

09/14/20 Intermediate Accounting, 10th Edi 40

tion, Chapter 14 (Kieso et al.)
 Note Issued for Cash and Other Rights

 Given:
 Issuer gives a 5 year, $100,000 note payable to Recipient
company on 1.1.2000.
 The note is zero interest bearing.
 The market rate is 10%.
 Recipient company has special rights to buy $500,000 of
merchandise from Issuer company at below market
prices.
 Recipient company buys $ 50,000 of merchandise (market
price) on April 14, 2000.
 Journalize in Issuer’s books.
09/14/20 Intermediate Accounting, 10th Edi 41
tion, Chapter 14 (Kieso et al.)
 Note Issued for Cash and Other Rights
Issues a 5 yr, $100,000,
zero % interest note. Recipient of
Issuer of Note
Note
Market rate is 10%
Gives issuer cash, $100,000

Recipient (buyer) has special buying

rights at below market prices

Issuer records:
1. Discount on the note ( $37, 908), and
2. Unearned Revenue ($37,908) toward the special
buying rights of the recipient of note

09/14/20 Intermediate Accounting, 10th Edi 42

tion, Chapter 14 (Kieso et al.)
 Note Issued for Cash and Other Rights

 Books of the Issuer (1.1.2000):

 Cash $100,000
 Discount on Note Payable $ 37,908
 Note Payable $100,000
 Unearned Revenue $ 37,908

 The discount is amortized over the term of note.

 The (unearned) revenue is recognized as sales are
made.
09/14/20 Intermediate Accounting, 10th Edi 43
tion, Chapter 14 (Kieso et al.)
 Books of the Issuer of Note

 Note interest expense $ 3,105

 Discount on Note Payable $ 3,105
 ($100,000 - $ 37,908) * 10% * (1/2) = $3,105

 Cash (or A/Rec: Recipient) $ 46,209

 Unearned Revenue $ 3,791
 Sales Revenue $ 50,000
 (Revenue recognized = $ 37,908 * ( $50,000 / $500,000)

09/14/20 Intermediate Accounting, 10th Edi 44

tion, Chapter 14 (Kieso et al.)
 Off Balance Sheet Financing
 Off balance sheet financing represents borrowing
arrangements that are not recorded.
 The amount of debt reported in the balance sheet
does not include such financing arrangements.
 The objective is to improve certain financial ratios
(such as debt-equity ratio)
 In project financing arrangements, companies form
a new entity and borrow through that entity.
 The debt appears on the books of the new entity, and
not on those of the parent companies.
09/14/20 Intermediate Accounting, 10th Edi 45
tion, Chapter 14 (Kieso et al.)
 Chapter 14:
Chapter 14: Appendix
Appendix
Accounting for
Accounting for Troubled
Troubled Debt
Debt
 Accounting Issues

 In troubled debt cases, two important issues

emerge:
 When should a loss be recognized?
 What is the amount of loss to be recognized?
 See next slide for a summary of key terms.

09/14/20 Intermediate Accounting, 10th Edi 47

tion, Chapter 14 (Kieso et al.)
 Troubled Debt: Key Terms
Troubled debt

Impairment Restructuring

Creditor grants a
Probable loss: concession to
creditor, unable debtor due to
to collect principal debtor’s financial
and interest. difficulties.

09/14/20 Intermediate Accounting, 10th Edi 48

tion, Chapter 14 (Kieso et al.)
 Troubled Debt: Key Terms
Restructuring

Creditor grants a concession to debtor

due to debtor’s financial difficulties.

Settlement Modification of Terms

1. Reduction of principal
Debtor transfers equity 2. Reduction of interest rate
interest or non-cash 3. Extension of maturity date
assets to creditor 4. Reduction of accrued interest

09/14/20 Intermediate Accounting, 10th Edi 49

tion, Chapter 14 (Kieso et al.)
 Gain or Loss: Debtor and Creditor - Settlement
Debtor Creditor
 Gain = excess of carrying  Loss = excess of loan
amount of payable over receivable over fair
fair value of assets value of assets
transferred to creditor received from debtor
 The gain is extraordinary  The loss is ordinary
 Recognize loss or gain and is charged to
on disposition of non- Allowance for
cash assets transferred to Doubtful accounts
creditor

09/14/20 Intermediate Accounting, 10th Edi 50

tion, Chapter 14 (Kieso et al.)
 Modification of Terms: No Gain to
Debtor (1 of 2)
 Debtor recognizes loss as follows:
 Total (undiscounted) cash outflows after
restructuring
 less
 carrying value of debt before restructuring
 Note 1: The post-restructuring cash outflows may
be higher due to an extension of the
maturity date.
 Note 2: The cash flows are NOT discounted.
09/14/20 Intermediate Accounting, 10th Edi 51
tion, Chapter 14 (Kieso et al.)
 Modification of Terms: No Gain to
Debtor (2 of 2)
 Creditor recognizes loss as follows:
 Total (discounted) cash outflows after
restructuring
 less
 carrying value of debt before restructuring

 Note: The creditor must discount principal and

interest receipts at the historical (original)
effective rate of the loan.
09/14/20 Intermediate Accounting, 10th Edi 52
tion, Chapter 14 (Kieso et al.)
 Modification of Terms: Gain to Debtor

 Debtor recognizes gain as follows:

 Total (undiscounted) cash outflows after
restructuring
 less
 total carrying value of debt before restructuring

 Note: The gain is reported as an extraordinary item.

09/14/20 Intermediate Accounting, 10th Edi 53

tion, Chapter 14 (Kieso et al.)
 Modification of Terms: Gain to Debtor

 Creditor recognizes loss as follows:

 Total (discounted) cash outflows after
restructuring
 less
 total carrying value of debt before restructuring

 Note: The loss is reported as an ordinary loss (Bad

Debts Expense)

09/14/20 Intermediate Accounting, 10th Edi 54

tion, Chapter 14 (Kieso et al.)
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