Intermediate: Accounting

Intermediate Accounting
Seventeenth Edition
Kieso; Weygandt; Warfield
Lecture 5
Long-Term Liabilities
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Learning Objectives
After studying this lecture, you should be able to:
1.Describe the nature of bonds and indicate the
accounting for bond issuances.
2.Describe the accounting for the extinguishment of debt.
3.Explain the accounting for long-term notes payable.
4.Indicate how to present and analyze long-term debt.
Copyright ©2019 John Wiley & Sons, Inc. 2

Learning Objective 1
Describe the Nature of Bonds and Indicate
the Accounting for Bond Issuances

Bonds Payable
No explicit definition of a noncurrent (long-term) liability
is provided in current GAAP.
Many therefore use the following approach:
“if does not meet the definition of a current liability, it
must be long-term.”
LO 1 Copyright ©2019 John Wiley & Sons, Inc. 4

Bonds Payable
Issuing Bonds
• Bond contract known as a bond indenture.
• Represents a promise to pay a sum of money at
designated maturity date, plus periodic interest at a
specified rate on the maturity amount (face value).
• Paper certificate, typically a $1,000 face value.
• Interest payments usually made semiannually.
• Used when amount of capital needed is too large for
one lender to supply.

Types of Bonds
Corporate bond listing. What do the numbers mean?

Valuation and Accounting for Bonds
Payable
Issuance and Marketing of Bonds to the public
• Usually takes weeks or months.
• Issuing company must
• Arrange for underwriters.
• Obtain Securities and Exchange Commission before Sec
(SEC) approval of bond issue, undergo audits, and issue
a prospectus.
• Have bond certificates printed.

Payable
Selling Price of a Bond Issue set by the
• supply and demand of buyers and sellers,
• relative risk,
• market conditions, and
• state of the economy.
Investment community values a bond at the present
value of its expected future cash flows, which consist of
(1) interest and (2) principal.
Payable
Interest Rate
• Stated, coupon, or nominal rate = Rate written in the
terms of the bond indenture.
• Bond issuer sets this rate.
• Stated as a percentage of bond face value (par).
• Market rate or effective yield = Rate that provides an
acceptable return commensurate with issuer’s risk.
• Rate of interest actually earned by bondholders.

How do you calculate the amount of interest that is
actually paid to the bondholder each period?
(Stated Rate × Face Value of the Bond)
How do you calculate the amount of interest that is

actually recorded as interest expense by the issuer of
the bonds?
(Market Rate × Carrying Value of the Bond)

Assume Stated Rate of 8%

Illustration
ServiceMaster Company issues $100,000 in bonds, due in five
years with 9 percent interest payable annually at year-end. At
the time of issue, the market rate for such bonds is 11
percent.

Time Diagram for Bond Cash Flows
Present value of the principal: $100,000 × .59345 (Table 6.2) $59,345.00

Present value of the interest payments: $9,000 × 3.69590 (Table 6.4) 33,263.10
Present value (selling price) of the bonds $92,608.10

Bonds Issued at Par on Interest Date
Illustration: Buchanan Company issues at par 10-year term
bonds with a par value of $800,000, dated January 1, 2020,
and bearing interest at an annual rate of 10 percent payable
semiannually on January 1 and July 1, it records the following
entry.
Journal entry on date of issue, Jan. 1, 2020.
Cash 800,000
Bonds Payable 800,000

Bonds Issued at Par on Interest Date
Interest
Journal entry to record first semiannual interest payment on
July 1, 2020.
Interest Expense 40,000

Cash 40,000
Journal entry to accrue interest expense at Dec. 31, 2020.

Interest Payable 40,000

Bonds Issued at Discount on Interest
Date (1 of 2)
Illustration: If Buchanan Company issues $800,000 of 10-
year bonds on January 1, 2020, at 97, and bearing interest
at an annual rate of 10 percent payable semiannually on
January 1 and July 1, it records the issuance as follows.
Cash ($800,000 × .97) 776,000
Discount on Bonds Payable 24,000
Note: Assuming the use of the straight-line method, $1,200 of the
discount is amortized to interest expense each period for 20 periods
($24,000 ÷ 20).
Bonds Issued at Discount on Interest
Date (2 of 2)
Illustration: Buchanan records the first semiannual interest
payment and the bond discount on July 1, 2020, as follows.
Cash 40,000
Buchanan makes the following adjusting entry (12/31/20).
Bonds Issued at Premium on Interest
Date (1 of 2)
Illustration: If Buchanan Company issues $800,000 of 10-year
bonds on January 1, 2020, at 103, and bearing interest at an
annual rate of 10 percent payable semiannually on January 1
and July 1, it records the issuance as follows.
Cash ($800,000 × 1.03) 824,000
Premium on Bonds Payable 24,000
Note: With the bond premium of $24,000, Buchanan amortizes $1,200 to
interest expense each period for 20 periods ($24,000 ÷ 20).
Bonds Issued at Premium on Interest
Date (2 of 2)
Illustration: Buchanan records the first semiannual interest
payment and the bond premium on July 1, 2020, as follows.
Cash 40,000
Buchanan makes the following adjusting entry (12/31/20).
Bonds Issued Between Interest Dates (1 of 2)
When companies issue bonds on other than the interest
payment dates,
•Buyers will pay the seller the interest accrued from the
last interest payment date to the date of issue.
•On the next semiannual interest payment date,
purchasers will receive the full six months’ interest
payment.

Bonds Issued Between Interest Dates (2 of 2)
Illustration: On March 1, 2020, Taft Corporation issues
10-year bonds, dated January 1, 2020, with a par value of
$800,000. These bonds have an annual interest rate of 6
percent, payable semiannually on January 1 and July 1.
Taft records the bond issuance at par plus accrued
interest as follows.
Cash 808,000
Interest Expense ($800,000´ .06´ 2 / 12) 8,000

Bonds Issued Between Interest Dates
Interest
On July 1, 2020, four months after the date of purchase,
Taft pays the purchaser six months’ interest and makes
the following entry.
Cash ($800,000´ .06´ 6 / 12) 24,000

Bonds Issued Between Interest Dates
Bonds Issued at 102
If, however, Taft issued the 6 percent bonds at 102, its March
1 entry would be:
Cash 824,000
Bonds Payable *
800,000
  2 
* $800,000  1.02    $800,000  .06  
  12 

Effective Interest Method
Bond Discount and Premium Amortization Computation
Produces a periodic interest expense equal to a constant

percentage of the carrying value of the bonds.

Effective-Interest Method
Bonds Issued at a Discount
Illustration: Evermaster Corporation issued $100,000 of 8%
term bonds on January 1, 2020, due on January 1, 2025, with
interest payable each July 1 and January 1. Investors require an
effective-interest rate of 10%. Calculate the bond proceeds.
Maturity value of bonds payable $100,000
Present value of $100,000 due in 5 years at 10%, interest payable
semiannually (Table 6.2); FV(PVF10,5%); ($100,000 × .61391) $ 61,391
Present value of $4,000 interest payable semiannually for 5 years at 10% 30,887
annually (Table 6.4); R(PVF-OA10,5%); ($4,000 × 7.72173)
Less: Proceeds from sale of bonds 92,278
Discount on bonds payable $ 7,722

Table 6.2 Present Value of 1 (Present Value of a Single Sum)
$100,000 .61391 $61,391

× =
Face Value Factor Present Value

Table 6.4 Present Value of an Ordinary Annuity of 1
$4,000 7.72173 $30,887

× =
Semiannual Payment Factor Present Value

Bond Discount Amortization Schedule
Schedule of Bond Discount Amortization
Effective-Interest Method—Semiannual Interest Payments
5-Year, 8% Bonds Sold to Yield 10%
Cash Interest Discount Carrying Amount

Date Paid Expense Amortized of Bonds a 6
$4,000  $100,000  .08 
1/1/20 $ 92,278 12
7/1/20 $ 4,000a $ 4,614b $ 614c 92,892d
b 6
1/1/21 4,000 4,645 645 93,537 $4,614  $92,278  .10 
12
7/1/21 4,000 4,677 677 94,214
c
$614 = $4,614 − $4,000
1/1/22 4,000 4,711 711 94,925
7/1/22 4,000 4,746 746 95,671 d
$92,892 = $92,892 + $614
1/1/23 4,000 4,783 783 96,454
7/1/23 4,000 4,823 823 97,277
1/1/24 4,000 4,864 864 98,141
7/1/24 4,000 4,907 907 99,048
1/1/25 4,000 4,952 952 100,000
$ 40,000 $47,722 $7,722

Bonds Issued at a Discount (Jan. 1, 2020)
Cash 92,278
Bonds Issued at a Discount (July 1, 2020)
Journal entry on July 1, 2020.

Discount on Bonds Payable 614
Cash 4,000
Bonds Issued at a Discount (Dec. 31, 2020)
Journal entry on December 31, 2020.

Discount on Bonds Payable 645
Bonds Issued at a Premium
Illustration: Evermaster Corporation issued $100,000 of 8%
term bonds on January 1, 2020, due on January 1, 2025, with
interest payable each July 1 and January 1. Investors require
an effective-interest rate of 6%. Calculate the bond proceeds.
Maturity value of bonds payable $100,000
Present value of $100,000 due in 5 years at 6%, interest payable $ 74,409
semiannually (Table 6.2); FV(PVF10,3%); ($100,000 × .74409)
Present value of $4,000 interest payable semiannually for 5 years at 6%
annually (Table 6.4); R(PVF-OA10,3%); ($4,000 × 8.53020) 34,121
Less: Proceeds from sale of bonds 108,530
Premium on bonds payable $ 8,530

Table 6.2 Present Value of 1 (Present Value of a Single Sum)
$100,000 .74409 $74,409

× =
Face Value Factor Present Value

Table 6.4 Present Value of an Ordinary Annuity of 1
$4,000 8.53020 $34,121

× =
Semiannual Payment Factor Present Value

Bond Premium Amortization Schedule
Schedule of Bond Premium Amortization
Effective-Interest Method—Semiannual Interest Payments
5-Year, 8% Bonds Sold to Yield 6%
Interest Discount Carrying Amount of

Date Cash Paid Expense Amortized Bonds
1/1/20 $ 108,530
7/1/20 $ 4,000a $ 3,526b $ 744c 107,786d a 6
$4,000  $100,000  .08 
1/1/21 4,000 3,234 766 107,020 12
b 6
7/1/21 4,000 3,211 789 106,231 $3,256  $108,530  .06 
1/1/22 4,000 3,187 813 105,418
12
7/1/22 4,000 3,162 838 104,580 c
$744 = $4,000 − $3,256
1/1/23 4,000 3,137 863 103,717
d
$107,786 = $108,530 − $744
7/1/23 4,000 3,112 888 102,829
1/1/24 4,000 3,085 915 101,914
7/1/24 4,000 3,057 943 100,971
1/1/25 4,000 3,029 971 100,000
$ 40,000 $31,470 $8,530

Bonds Issued at a Premium (Jan. 1, 2020) (1 of 2)
Cash 108,530
Bonds Issued at a Premium (July 1, 2020) (2 of 2)
Journal entry on July 1, 2020.

Premium on Bonds Payable 744
Cash 4,000
Exhibit 10.2
The Change in the Book Value of a Bond Over Time
Bond Issue Maturit

Issue Date y
Price Date
Bond payable book value
at end of period
1 2 3
At a
$103,630 4
premium
$100,000
At par $100,000 maturity
amount
At a $96,535
discount 1 2 3
4 PERIOD
Computation of Interest Expense
What happens if Evermaster prepares financial statements at
the end of February 2020? In this case, the company prorates
the premium by the appropriate number of months to arrive
at the proper interest expense, as follows.
 2
Interest accrual $4,000 × 
6
$1,333.33

 2
Premium amortized  $744  
6
(248.00)

Interest expense (Jan.-Feb.) $1,085.33

Accrued Interest
2
Interest accrual  $4,000 ×  $1,333.33
 6
 2
Premium amortized  $744  
6
(248.00)
Interest expense (Jan.-Feb.) $1,085.33
Evermaster records this accrual as follows.

Interest Expense 1,085.33
Premium on Bonds Payable 248.00
Interest Payable 1,333.33
Classification of Discount and Premium
Bond Discount
•A liability valuation account.
•Reduces the face or maturity amount of the liability.
•Referred to as a contra account.
Bond Premium
•A liability valuation account.
•Adds to the face or maturity amount of the liability.
•Referred to as a adjunct account.
Practice
E 14.10

Explain the Accounting for Long-Term Notes
Payable

Long-Term Notes Payable
Accounting for notes and bonds is quite similar.
•A note is valued at the present value of its future
interest and principal cash flows.
•Company amortizes any discount or premium over the
life of the note.

Notes Not Issued at Face Value (1 of 2)
Illustration: Scandinavian Imports issues a $10,000, three-
year note, at face value to Bigelow Corp. The stated rate and
the effective rate were both 10 percent. Scandinavian would
record the issuance of the note as follows.
Cash 10,000
Notes Payable 10,000
Recognize interest incurred each year as follows.
Cash 1,000
($10,000 × 10% = $1,000)

Notes Not Issued at Face Value (2 of 2)
Zero-Interest-Bearing Notes
Issuing company records the difference between the face
amount and the present value (cash received) as
•a discount and
•amortizes that amount to interest expense over the life
of the note.

Zero-Interest-Bearing Notes
Illustration: Turtle Cove Company issued the three-year,
$10,000, zero-interest-bearing note to Jeremiah Company.
The implicit rate that equated the total cash to be paid
($10,000 at maturity) to the present value of the future cash
flows ($7,721.80 cash proceeds at date of issuance) was 9
percent.

Issuance of Zero-Interest-Bearing Note
Illustration: Turtle Cove Company issued the three-year,
$10,000, zero-interest-bearing note to Jeremiah Company.
The implicit rate that equated the total cash to be paid
($10,000 at maturity) to the present value of the future cash
flows ($7,721.80 cash proceeds at date of issuance) was 9
percent.
Cash 7,721.80
Discount on Notes Payable 2,278.20
Notes Payable 10,000.00

Zero-Interest-Bearing Note Schedule
SCHEDULE OF NOTE DISCOUNT AMORTIZATION
EFFECTIVE-INTEREST METHOD
0% NOTE DISCOUNTED AT 9%
Cash Paid Interest Discount Amortized Carrying Amount of Note

Expense
Date of issue $ 7,721.80
End of year 1 $–0– $ 694.96a $ 694.96b 8,416.76c
End of year 2 –0– 757.51 757.51 9,174.27
End of year 3 –0– 825.73d 825.73 10,000.00
$–0– $2,278.20 $2,278.20
a
$7,721.80 × .09 = $694.96 c
$7,721.80 + $694.96 = $8,416.76
b
$694.96 − 0 = $694.96 d
5¢ adjustment to compensate for rounding.
Interest accrual at the end of the first year:

Interest Expense 694.96
Discount on Notes Payable 694.96
Interest-Bearing Notes
Illustration: Marie Co. issued for cash a $10,000, three-
year note bearing interest at 10 percent to Morgan Corp.
The market rate of interest is 12 percent and the stated
rate is 10%. The present value of the note is calculated to
be $9,520. Marie Co. records the issuance of the note as
follows.
Cash 9,520
Discount on Notes Payable 480

Interest-Bearing Note Schedule
SCHEDULE OF NOTE DISCOUNT AMORTIZATION
EFFECTIVE-INTEREST METHOD
10% NOTE DISCOUNTED AT 12%
Interest
Cash Paid Expense Discount Amortized Carrying Amount of Note
Date of issue $ 9,520
End of year 1 $1,000a $ 1,142b $ 142c 9,662d
End of year 2 1,000 1,159 159 9,821
End of year 3 1,000 1,179 179 10,000
$3,000 $3,480 $480
a
$10,000 × 10% = $1,000 $1,142 − $1,000 = $142
c
b
$9,520 × 12% = $1,142 d
$9,520 + $142 = $9,662
Entry required at the end of the first year:

Discount on Notes Payable 142
Cash 1,000
Special Notes Payable Situations
Notes Issued for Property, Goods, or Services
When exchanging the debt instrument for property,
goods, or services in a bargained transaction, the stated
interest rate is presumed to be fair unless:
1.No interest rate is stated, or
2.The stated interest rate is unreasonable, or
3.The face amount is materially different from the
current cash price for the same or similar items or from
the current fair value of the debt instrument.

Special Notes Payable Situations
Choice of Interest Rates
If a company cannot determine the fair value of the
property, goods, services, or other rights, and if the note
has no ready market, company must approximate an
applicable interest rate.
Choice of rate is affected by:
•Prevailing rates for similar instruments.
•Factors such as restrictive covenants, collateral,
payment schedule, the existing prime interest rate.

Illustration: On December 31, 2020, Wunderlich Company
issued a promissory note to Brown Interiors Company for
architectural services. The note has a face value of $550,000,
a due date of December 31, 2025, and bears a stated interest
rate of 2 percent, payable at the end of each year.
Wunderlich cannot readily determine the fair value of the
architectural services, nor is the note readily marketable. On
the basis of Wunderlich’s credit rating, the absence of
collateral, the prime interest rate at that date, and the
prevailing interest on Wunderlich’s other outstanding debt,
the company imputes an 8 percent interest rate as
appropriate in this circumstance.
Time Diagram
Face value of the note $550,000

Present value of $550,000 due in 5 years at 8% interest payable
annually (Table 6.2); FV(PVF5,8%); ($550,000 × .68058) $374,319
Present value of $11,000 interest payable annually for 5 years at
8%; R(PVF-OA5,8%); ($11,000 × 3.99271) 43,920
Present value of the note (418,239)
Discount on notes payable $131,761
Note Issuance
Wunderlich records issuance of the note on Dec. 31, 2020, in
payment for the architectural services as follows.
Building (or Construction in Process) 418,239

Discount on Notes Payable 131,761

Amortization Schedule
Schedule of Note Discount Amortization
2% Note Discounted at 8% (Imputed)
Date Cash Paid (2%) Interest Expense (8%) Discount Amortized Carrying Amount of Note
12/31/20 $418,239
12/31/21 $11,000a $ 33,459b $ 22,459c 440,698d
12/31/22 11,000 35,256 24,256 464,954
12/31/23 11,000 37,196 26,196 491,150
12/31/24 11,000 39,292 28,292 519,442
12/31/25 11,000 41,558e 30,558 550,000
$55,000 $186,761 $131,761
a
$550,000 × .02 = $11,000 d
$418,239 + $22,459 = $440,698
Journal entry on
December 31,
b
$418,239 × .08 = $33,459 e
$3 adjustment to compensate for rounding.
2021. c
$33,459 − $11,000 = $22,459
Cash 11,000
Mortgage Notes Payable
A promissory note secured by a document called a
mortgage that pledges title to property as security for
the loan.
•Most common form of long-term notes payable.
•Payable in full at maturity or in installments.
•Fixed-rate mortgage.
•Variable-rate mortgages.

Practice: E 14.16

Indicate How to Present and Analyze Long-
Term Debt

Reporting and Analyzing Liabilities
Fair Value Option
Companies have the option to record fair value in their
accounts for most financial assets and liabilities,
including bonds and notes payable.
The FASB believes that fair value measurement for
financial instruments, including financial liabilities,
provides more relevant and understandable information
than amortized cost.

Fair Value Option
Fair Value Measurement
If companies choose the fair value option, noncurrent
liabilities, such as bonds and notes payable, are reported
at fair value.
In addition, companies report unrealized holding gains or
losses as
•part of net income or
•in other comprehensive income, depending on the
circumstances.
Fair Value (Net Income)
Illustrations: Edmonds Company has issued $500,000 of 6
percent bonds at face value on May 1, 2020. Edmonds
chooses the fair value option for these bonds. At December
31, 2020, the value of the bonds is now $480,000 because
interest rates in the market have increased to 8 percent.

Unrealized Holding Gain or Loss—Income 20,000
($500,000 − $480,000)

Fair Value (Other Comprehensive Income)
Illustrations: The FASB now requires that the credit-risk
portion of gains or losses on a financial liability be reported in
other comprehensive income. To illustrate, assume that the
Edmonds Company fair value change on its bonds is due to
its credit rating dropping from AA to BB. In this case,
Edmonds makes the following entry to record the fair value
change in other comprehensive income.
Unrealized Holding Gain or Loss—Equity 20,000

Off-Balance-Sheet Financing
Off-balance-sheet financing is an attempt to borrow
monies in such a way to prevent recording the
obligations.
Different Forms
1.Non-Consolidated Subsidiary
2.Special-Purpose Entity (SPE)

Off-Balance-Sheet Financing
Rationale
• Removing debt enhances the quality of the balance
sheet and permits credit to be obtained more readily
and at less cost.
• Loan covenants often limit the amount of debt a
company may have. These types of commitments
might not be considered in computing the debt
limitation.
• Some argue that the asset side of the balance sheet is
severely understated.
Presentation of Long-Term Debt
Note disclosures generally indicate the nature of the
liabilities, maturity dates, interest rates, call provisions,
conversion privileges, restrictions imposed by the
creditors, and assets designated or pledged as security.
Fair value of the debt should be disclosed.
Must disclose future payments for sinking fund
requirements and maturity amounts of long-term debt
during each of the next five years.

Analysis of Long-Term Debt
Debt to Assets Ratio
Two ratios that provide information about debt-paying
ability and long-run solvency are:
Total liabilities
Debtt o Assets Ratio 
Total Assets
The higher the percentage of liabilities to total assets, the

greater the risk that the company may be unable to meet
its maturing obligations.

Times Interest Earned
Two ratios that provide information about debt-paying
ability and long-run solvency are:
Net Income + Interest Expense + Income Tax Expense

Times interest earned 
Interest Expense
Indicates the company’s ability to meet interest payments

as they come due.

Illustration: Target has total liabilities of $26,653 ($12,564 +
$14,089) million, total assets of $38,999 million, interest
expense of $666 million, income taxes of $718 million, and
income from continuing operations of $2,928 million. We
compute Target’s debt to total assets and times interest earned
ratios as follows.
$26,653
Debtt o assets   68.3%
$38,999
Times interest earned 

 $2,928  $666  $718 
 6.47 times
$666

Exercise
E 14.10
E 14.16
E14.19
P14.1
P14.4

Intermediate: Accounting

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Kieso; Weygandt; Warfield

Copyright ©2019 John Wiley & Sons, Inc. 2

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(Stated Rate × Face Value of the Bond)

How do you calculate the amount of interest that is

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Present value of the principal: $100,000 × .59345 (Table 6.2) $59,345.00

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Journal entry on date of issue, Jan. 1, 2020.

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Interest Expense 40,000

Journal entry to accrue interest expense at Dec. 31, 2020.

Interest Expense 40,000

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Cash ($800,000´ .06´ 6 / 12) 24,000

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Produces a periodic interest expense equal to a constant

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$100,000 .61391 $61,391

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$4,000 7.72173 $30,887

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Cash Interest Discount Carrying Amount

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Journal entry on date of issue, Jan. 1, 2020.

Journal entry on July 1, 2020.

Journal entry on December 31, 2020.

Interest Expense 4,645

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$100,000 .74409 $74,409

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$4,000 8.53020 $34,121

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Interest Discount Carrying Amount of

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Journal entry on date of issue, Jan. 1, 2020.

Journal entry on July 1, 2020.

Interest Expense 3,256

Bond Issue Maturit

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Evermaster records this accrual as follows.

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Cash Paid Interest Discount Amortized Carrying Amount of Note

Interest accrual at the end of the first year:

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