LONG-TERM LIABILITIES
Chapter 14
© 2009 The McGraw-Hill
Companies, Inc.,
A1
BOND FINANCING
Advantages Disadvantages
Bonds do not affect Requires payment of
stockholder control. both periodic interest
and par value at
maturity.
Interest on bonds is tax
deductible. Can decrease return on
equity when the
company pays more in
Bonds can increase interest than it earns on
return on equity. the borrowed funds.
McGraw-Hill/Irwin Slide 2
A2
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.
McGraw-Hill/Irwin Slide 3
A2
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.
McGraw-Hill/Irwin Slide 4
A1
BASICS OF BONDS
Corporation Investors
Bond Selling Price
Bond Certificate
at Par Value
McGraw-Hill/Irwin Slide 5
A1
BASICS OF BONDS
Bond Interest Payments
Corporation Investors
Bond Interest Payments
Bond Issue Interest Payment =
Date Bond Par Value × Stated Interest Rate
McGraw-Hill/Irwin Slide 6
P1
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)
DR CR
Jan 1 Cash 800,000
Bonds Payable 800,000
Sold bonds at par.
McGraw-Hill/Irwin Slide 7
P1
ISSUING BONDS AT PAR
On June 30, 2009, to record the first semiannual interest
payment is . . .
DR CR
Jun 30 Bond Interest Expense 36,000
Cash 36,000
Paid semiannual interest on bonds
$800,000 × 9% × ½ year = $36,000
This entry is made every six months until the
bonds mature.
McGraw-Hill/Irwin Slide 8
P2
BOND DISCOUNT OR PREMIUM
Bond Sets Market Sets
Contract Market Contract rate > Market rate Bonds sell at
Rate Rate Premium
Contract rate = Market rate Bonds sell at
Par
Contract rate < Market rate Bonds sell at
Discount
McGraw-Hill/Irwin Slide 9
P2
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)
McGraw-Hill/Irwin Slide 10
P2
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
McGraw-Hill/Irwin Slide 11
P2
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)
McGraw-Hill/Irwin Slide 12
P2
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
McGraw-Hill/Irwin Slide 13
P2
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.
McGraw-Hill/Irwin Slide 14
P3
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% Bond will sell at a premium.
Market Interest Rate = 10%
Interest Dates = 6/30 and 12/31
Bond Date = Jan. 1, 2009
Maturity Date = Dec. 31, 2010 (2 years)
McGraw-Hill/Irwin Slide 15
P3
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
McGraw-Hill/Irwin Slide 16
P3
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 Premium
Using the straight-line method, the premium amortization will
be $887(rounded) every six months.
$3,546 ÷ 4 periods = $887(rounded)
McGraw-Hill/Irwin Slide 17
P3
AMORTIZING A BOND PREMIUM
Adidas 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 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
McGraw-Hill/Irwin Slide 18
P3
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.
McGraw-Hill/Irwin Slide 19
C2
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)
McGraw-Hill/Irwin Slide 20
C2
PRESENT VALUE OF A
DISCOUNT BOND
Table Present
Cash Flow Table Value Amount Value
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
McGraw-Hill/Irwin Slide 21
P4
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.
McGraw-Hill/Irwin Slide 22
P4
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
McGraw-Hill/Irwin Slide 23
P4
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
McGraw-Hill/Irwin Slide 24
C1
LONG-TERM NOTES PAYABLE
Cash
Company Note
Note Payable
Payable Lender
When is the repayment of the principal
and interest going to be made?
Note Date Note Maturity
Date
McGraw-Hill/Irwin Slide 25
C1
LONG-TERM NOTES PAYABLE
Single Payment of
Principal plus Interest
Company Lender
Single Payment of
Principal plus
Interest
Note Date Note Maturity
Date
McGraw-Hill/Irwin Slide 26
C1
LONG-TERM NOTES PAYABLE
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 Note Maturity
or equal payments. Date
McGraw-Hill/Irwin Slide 27
C1 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
McGraw-Hill/Irwin Slide 28
P5 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.
McGraw-Hill/Irwin Slide 29
P5 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
McGraw-Hill/Irwin Slide 30
C1 MORTGAGE NOTES AND
BONDS
AA legal
legal agreement
agreement that that helps
helps protect
protect the
the lender
lender ifif
the
the borrower
borrower fails
fails to
to make
make thethe required
required payments.
payments.
Gives
Gives the
the lender
lender the
the right
right to
to be
be paid
paid out
out of
of the
the
cash
cash proceeds
proceeds from
from thethe sale
sale of
of the
the borrower’s
borrower’s
assets
assets specifically
specifically identified
identified inin the
the mortgage
mortgage
contract.
contract.
McGraw-Hill/Irwin Slide 31
A2
FEATURES OF BONDS AND
NOTES
Secured and Convertible
Unsecured and Callable
Term and Registered
Serial and Bearer
McGraw-Hill/Irwin Slide 32
A3
DEBT-TO-EQUITY RATIO
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
McGraw-Hill/Irwin Slide 33
C2 14A – PRESENT VALUES OF
Present Value of $1
BONDS AND NOTES
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
McGraw-Hill/Irwin Slide 34
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
8 7.0197 6.7327 6.4632
$4,000 × 3.5460 = $14,184 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
McGraw-Hill/Irwin Slide 35
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
McGraw-Hill/Irwin Slide 36
C3 14C - ISSUING BONDS BETWEEN
INTEREST DATES
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
McGraw-Hill/Irwin To record first interest payment Slide 37
C4
14D - LEASES AND PENSIONS
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.
McGraw-Hill/Irwin Slide 38
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.
McGraw-Hill/Irwin Slide 39
END OF CHAPTER 14
McGraw-Hill/Irwin Slide 40
