978-0078025549 Chapter 9 Lecture Note Part 1

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Chapter 9

Long-Term Liabilities

INSTRUCTOR’S MANUAL

Learning Objectives

 LO9-1 Explain financing alternatives.

 LO9-2 Identify the characteristics of bonds.

 LO9-3 Determine the price of a bond issue.

 LO9-4 Account for the issuance of bonds.

 LO9-5 Record the retirement of bonds.

 LO9-6 Identify other major long-term liabilities.

Analysis

 LO9-7 Make financial decisions using long-term liability ratios.

Teaching Suggestions

Historically, long-term liabilities, especially bonds, are one of the toughest topics in a financial

accounting course. Some financial accounting textbooks combine current and long-term

liabilities into only one chapter, opting to skim over the topics related to long-term liabilities. We

think long-term liabilities are important enough (and challenging enough) for a separate chapter.

Note that Chapters 4–12 each focus on a separate underlying industry theme. Chapter 9

focuses on amusement parks, as these companies tend to carry a very high level of debt.

References to Six Flags and Cedar Fair are made in the feature story and continue periodically

throughout the chapter. The end-of-chapter material and supplements continue the amusement

park theme.

Chapter 9 starts with the basic accounting equation to contrast debt financing with equity

financing. Students need to understand the advantages and disadvantages of borrowing money

(debt financing) in comparison to obtaining additional investment from stockholders (equity

financing). Part A provides an overview of long-term debt.

Part B is a standalone section explaining how bond prices are determined. As a separate

section, Part B allows instructors flexibility to choose whether to include the topic of bond

pricing in reading and homework assignments. Some instructors feel strongly that students need

to understand how to price a bond and that pricing a bond provides a key example of present

value concepts. Other instructors feel equally strongly that bond pricing is better left for finance

and intermediate accounting courses. The chapter is designed to leave the choice up to you. Bond

pricing is shown using a financial calculator, excel spreadsheets, or present value tables as all

three methods are used by instructors.

Part C illustrates the recording of bonds issued at face value, at a discount, and at a premium.

We record bonds payable, net of the discount or premium. Recording bonds payable net of the

discount or premium is (1) consistent with the actual method used by companies to report bonds

payable on the balance sheet, and (2) easier for students to understand. Interest expense is

calculated based on the effective interest method, as this is GAAP. We do not cover the

straight-line interest method, as this method is not true GAAP and introducing multiple methods

adds confusion for students. Part C concludes with recording the retirement of bonds including a

decision maker’s perspective explaining why a company may choose to buy back debt early.

Companies report many long-term liabilities other than bonds payable. In Part D, we discuss

installment notes such as car or home loans and leases. The chapter concludes with debt analysis

using the actual financial statements of Coca-Cola and PepsiCo. PepsiCo’s higher leverage

increases risk. In good times, PepsiCo’s higher leverage results in higher return on equity.

However, in down times, their higher leverage results in lower return on equity.

Assignment Charts

Questions Learning

Objective(s) Topic

Time

(Min.)

1 LO9-1 Define capital structure 5

2 LO9-1 Compare borrowing with issuing stock 5

3 LO9-1 Describe bond issue costs 5

4 LO9-1 Compare borrowing from a bank to issuing bonds 5

5 LO9-2 Contrast bond characteristics 5

6 LO9-2 Define convertible bonds and explain how they

might benefit the investor and the issuer

7 LO9-3 Explain how to calculate the issue price of bonds 5

8 LO9-3 Describe the difference in bond terms 5

9 LO9-3 Explain the relationship between the stated interest

rate and the market interest rate for bonds issued at

a discount

10 LO9-3 Explain the relationship between the stated interest

rate and the market interest rate for bonds issued at

a premium

11 LO9-3 Calculate the interest payment for a bond issue 5

12 LO9-3 Calculate the issue price of bonds 5

13 LO9-4 Explain the relationship between the carrying value

of bonds payable and the amount recorded for

interest expense for bonds issued at a discount

14 LO9-4 Explain the relationship between the carrying value

of bonds payable and the amount recorded for

interest expense for bonds issued at a premium

15 LO9-4 Describe how the columns in an amortization

schedule are calculated

16 LO9-5 Explain why a company would choose to buy back

bonds before their maturity date

17 LO9-5 Describe the entry to record the early retirement of

bonds

18 LO9-6 Relate interest expense to the carrying value of an

installment note with fixed monthly payments

19 LO9-6 Explain the difference between an operating lease

and a capital lease

20 LO9-7 Describe the potential risks and rewards of carrying

additional debt

Brief

Exercises Learning

Objective(s) Topic

Time

(Min.)

BE9-1 LO9-2 Explain the conversion feature of bonds 5

BE9-2 LO9-3 Calculate the issue price of bonds 5

BE9-3 LO9-3 Calculate the issue price of bonds 5

BE9-4 LO9-3 Calculate the issue price of bonds 5

BE9-5 LO9-4 Record bond issue and related semiannual interest 10

BE9-6 LO9-4 Record bond issue and related semiannual interest 10

BE9-7 LO9-4 Record bond issue and related semiannual interest 10

BE9-8 LO9-4 Record bond issue and related annual interest 10

BE9-9 LO9-4 Record bond issue and related annual interest 10

BE9-10 LO9-4 Record bond issue and related annual interest 10

BE9-11 LO9-4 Calculate interest expense 5

BE9-12 LO9-4 Calculate interest expense 5

BE9-13 LO9-4 Interpret a bond amortization schedule 5

BE9-14 LO9-4 Interpret a bond amortization schedule 5

BE9-15 LO9-5 Record early retirement of bonds issued at a

discount

BE9-16 LO9-5 Record early retirement of bonds issued at a

premium

BE9-17 LO9-6 Record installment notes 10

BE9-18 LO9-7 Calculate ratios 15

Exerc

ises Learning

Objective(s) Topic

Time

(Min.)

E9-1 LO9-1 Compare financing alternatives 10

E9-2 LO9-2 Match bond terms with their definitions 10

E9-3 LO9-3 Calculate the issue price of bonds 15

E9-4 LO9-3 Calculate the issue price of bonds 15

E9-5 LO9-4 Record bonds issued at face amount 10

E9-6 LO9-4 Record bonds issued at a discount 20

E9-7 LO9-4 Record bonds issued at a premium 20

E9-8 LO9-4 Record bonds issued at face amount 10

E9-9 LO9-4 Record bonds issued at a discount 20

E9-10 LO9-4 Record bonds issued at a premium 20

E9-11 LO9-4 Record bonds issued at face amount with interest

payable annually

E9-12 LO9-4 Record bonds issued at face amount with interest

payable annually

E9-13 LO9-4 Record bonds issued at face amount with interest

payable annually

E9-14 LO9-5 Record the retirement of bonds 20

E9-15 LO9-5 Record the retirement of bonds 20

E9-16 LO9-6 Record installment notes 15

E9-17 LO9-6,9-7 Compare operating and capital leases 20

E9-18 LO9-7 Calculate and analyze ratios 20

Problems Learning

Objective(s) Topic

Time

(Min.)

P9-1A LO9-3,9-4 Calculate the issue price of a bond and prepare

amortization schedules

P9-2A LO9-4 Record bond issue and related interest 30

P9-3A LO9-4 Understand a bond amortization schedule 15

P9-4A LO9-4 Prepare a bond amortization schedule and record

entries for the issuer of the bonds

P9-5A LO9-6 Record and analyze installment notes 25

P9-6A LO9-6,9-7 Explore the impact of leases on the debt to equity

ratio

P9-7A LO9-7 Calculate and analyze ratios 30

P9-1B LO9-3,9-4 Calculate the issue price of a bond and prepare

amortization schedules

P9-2B LO9-4 Record bond issue and related interest 30

P9-3B LO9-4 Understand a bond amortization schedule 15

P9-4B LO9-4 Prepare a bond amortization schedule and record

entries for the issuer of the bonds

P9-5B LO9-6 Record and analyze installment notes 25

P9-6B LO9-6,9-7 Explore the impact of leases on the debt to equity

ratio

P9-7B LO9-7 Calculate and analyze ratios 30

Additional

Perspectives Topic

Time

(Min.)

AP9-1 Continuing Problem: Great Adventures 20

AP9-2 Financial Analysis: American Eagle Outfitters, Inc. 25

AP9-3 Financial Analysis: The Buckle, Inc. 25

AP9-4 Comparative Analysis: American Eagle Outfitters, Inc., vs. The

Buckle, Inc.

AP9-5 Ethics 25

AP9-6 Internet Research 20

AP9-7 Written Communication 15

AP9-8 Earnings Management 30

Chapter Quiz Questions

The following multiple-choice questions are 10 unique quiz questions that correspond to the 10

questions at the end of each chapter. Each question covers the same learning objective but with a

little different twist. The correct answer is highlighted in bold for each item.

LO9-1

1. Which of the following is not a common long-term debt?

a. Bonds payable.

b. Notes payable.

c. Leases payable.

d. Accounts payable.

LO9-2

2. Bonds can be secured or unsecured. Likewise, bonds can be term or serial bonds. Which is

more common?

a. Secured and term.

b. Secured and serial.

c. Unsecured and term.

d. Unsecured and serial.

LO9-2

3. Convertible bonds:

a. Provide potential benefits only to the lender.

b. Provide potential benefits only to the borrower.

c. Provide potential benefits to both the lender and the borrower.

d. Provide no potential benefits.

LO9-3

4. Bonds issued at a discount are:

a. Issued above face value.

b. Issued below face value.

c. Issued at face value.

d. Riskier bonds sold at a bargain price.

LO9-4

5. Which of the following is true for bonds issued at a premium?

a. The stated interest rate is greater than the market interest rate.

b. The market interest rate is greater than the stated interest rate.

c. The stated interest rate and the market interest rate are equal.

d. The stated interest rate and the market interest rate are unrelated.

LO9-4

6. The cash paid for interest on bonds payable is calculated as:

a. Face amount times the stated interest rate.

b. Carrying value times the market interest rate.

c. Face amount times the market interest rate.

d. Carrying value times the stated interest rate.

LO9-4

7. When bonds are issued at a premium, what happens to the carrying value and interest

expense over the life of the bonds?

a. Carrying value and interest expense increase.

b. Carrying value and interest expense decrease.

c. Carrying value decreases and interest expense increases.

d. Carrying value increases and interest expense decreases.

LO9-5

8. Douglas County Fairgrounds retires a $50 million bond issue when the carrying value of the

bonds is $52 million, but the market value of the bonds is only $47 million. The entry to

record the retirement will include:

a. A debit of $5 million to loss on early extinguishment.

b. A credit of $5 million to gain on early extinguishment.

c. No gain or loss on retirement.

d. A debit to cash for $47 million.

LO9-6

9. Which of the following leases is simply a rental?

a. An operating lease.

b. A capital lease.

c. Both an operating and a capital lease.

d. Neither an operating lease nor a capital lease.

LO9-7

10. Financial leverage is best measured by which of the following ratios?

a. The return on assets ratio.

b. The return on equity ratio.

c. The times interest earned ratio.

d. The debt to equity ratio.

Alternate Let’s Review

Problem #1

Assume that on January 1, 2015, Adventure Island issues $500,000 of 8% bonds, due in ten

years, with interest payable semi-annually on June 30 and December 31 each year.

Required:

1. If the market rate is 8%, will the bonds issue at face amount, a discount, or a premium?

Calculate the issue price.

2. If the market rate is 9%, will the bonds issue at face amount, a discount, or a premium?

Calculate the issue price.

3. If the market rate is 7%, will the bonds issue at face amount, a discount, or a premium?

Calculate the issue price.

Solution:

1. If the market rate is 8%, the bonds will issue at face amount.

Calculator Input

Bond

Characteristics Key Amount

1. Face amount FV $500,000

2. Interest payment each period PMT $20,000 = $500,000 x 8% x ½ year

3. Market interest rate each period I 4% = 8% / 2 semi-annual periods

4. Periods to maturity N 20 = 10 years x 2 periods each year

Calculator Output

Issue price PV $500,000

Present value of principal = $500,000 x 0.45639* $228,195

Present value of interest payments = $20,0001 x 13.59033** 271,807

Issue price of the bonds $500,002***

1 $500,000 x 8% x ½ year = $20,000

* Table 2, i = 4% , n = 20

**Table 4, i = 4% , n = 20

*** $2 difference due to rounding