Chapter 14
Long-Term Liabilities
QUESTIONS
1. Notes payable generally involve borrowing from a single creditor, whereas bonds
payable are usually sold to many different lenders (bondholders).
2. A bond is a liability of the issuing company. A share of stock represents an ownership
interest in the company.
3. Bonds can allow a company’s owners to increase their return on equity without investing
additional amounts. This result occurs as long as the rate of return on the assets
advantage with bonds when issued by corporations.
4. A bond indenture is a legal contract between the issuing company and the bondholders
that identifies the obligations and rights of both parties. It specifies such items as the
5. A trustee for bondholders has the responsibility of monitoring the issuer’s actions,
6. The contract rate (also known as the coupon rate, stated rate, or nominal rate) is the rate
7. In general, the supply of and demand for bonds affect market rates. The market rate for
8.B The effective interest method creates a constant rate of interest over a bond’s life
because the market rate at the time of issuance is multiplied by the beginning balance
9.C When issuing bonds between interest dates, a company collects accrued interest from
the purchasers to avoid keeping detailed records of bond purchasers and the dates
10. The price of bonds can be computed by finding the present value of both the par value at
11. The issue price of a $2,000 bond sold at 98 ¼ is 98.25% of $2,000, or $1,965. The issue
price of a $6,000 bond priced at 101 ½ is 101.5% of $6,000, or $6,090.
12. The debt-to-equity ratio is calculated by dividing total liabilities by total equity. The
higher a company’s debt–to-equity ratio, the higher proportion of a company’s assets
13. An entrepreneur (owner) must repay the bondholders the principal (par value) according
14. Polaris has $100,000,000 of long-term debt on its balance sheet, of which none of it is
current.
15. KTM’s long-term interest-bearing loans increased by €2,941 thousand (€132,898
thousand – €129,957 thousand) during the year ended December 31, 2011.
16. Per Piaggio’s statement of cash flows (financing section), the company made €112,727
17. The balance sheet of Arctic Cat indicates that for the year ended March 31, 2011, the
18.D If a lease qualifies to be recorded as a capital lease, an asset account for the leased
19.D An operating lease is a short-term or cancelable lease in which the lessor retains the
risks and rewards of ownership. The lessee expenses operating lease payments when
20.D Pension plans can be designed as defined benefit plans or defined contribution plans. In
a defined benefit plan the employer estimates the contribution necessary to pay a pre-
defined benefit amount to its retirees. For example, an employee’s monthly pension
QUICK STUDIES
Quick Study 14-1 (10 minutes)
1. Bond’s cash proceeds: $250,000 x 0.875 = $218,750
2.
Twenty semiannual interest payments of $10,000* …………...
$200,000
Plus bond discount ($250,000 – $218,750) ………………………...
31,250
Total bond interest expense …………………………………………….
$231,250
*$250,000 x 0.08 x ½ = $10,000
3. Bond interest expense on first payment date:
Quick Study 14-2B (10 minutes)
1. Bond’s cash proceeds: $240,000 x 1.1725 = $281,400
2.
Thirty semiannual interest payments of $12,000* ……………...
$360,000
Less premium ($281,400 – $240,000) ………………………………...
(41,400)
Total bond interest expense …………………………………………….
$318,600
*$240,000 x 0.10 x ½ = $12,000
3. Bond interest expense on first payment date:
Quick Study 14-3 (10 minutes)
2013
Jan. 1
218,750
31,250
250,000
Jan. 1
281,400
240,000
41,400
Quick Study 14-4 (10 minutes)
a. Using facts in QS 14–1, the bond’s cash proceeds for the bond selling at
a discount are computed as follows
Cash Flow
Table Value
Present Value
$250,000 par (maturity) value …………....
0.3769
$ 94,225
$10,000 interest payment …………………..
12.4622
124,622
Price of Bond …………………………………
$218,847*
b. Using facts in QS 14-2, the bond’s cash proceeds for the bond selling at
a premium are computed as
Cash Flow
Table Value
Present Value
$240,000 par (maturity) value …………....
0.3083
$ 73,992
$ 12,000 interest payment ………………...
17.2920
207,504
Price of Bond …………………………………
$281,496*
*Agrees with $281,400 as given in QS 14-2, except for rounding difference.
Quick Study 14-5 (15 minutes)
2012
(a)
Dec. 31
Cash ………………………………………………………..……………
92,640
Discount on Bonds Payable ……………………..……
7,360
Bonds Payable …………………………………………………
100,000
Sold bonds at discount.
2013
(b)
June 30
Bond Interest Expense ……………………………..……………
5,736
Discount on Bonds Payable* ……………….………….
736
Cash** ………………………………………………..……..
5,000
Paid semiannual interest and record amor-
tization. *$7,360- $6,624 **$100,000 x10% x1/2
(c)
Dec. 31
Bond Interest Expense ……………………………..……………
5,736
Discount on Bonds Payable* ……………….………….
736
Cash** ………………………………………………..……..
5,000
Paid semiannual interest and record amor-
tization. *$6,624 – $5,888 **$100,000 x10% x1/2
Quick Study 14-6 (10 minutes)
2013
July 1
Bonds Payable ………………………………………………………
400,000
Premium on Bonds Payable ………………………..…
16,000
Gain on Retirement of Bonds* ………………..…………
8,000
Cash ……………………………………………………....
408,000
To record retirement of bonds before maturity.
*$8,000 = $416,000 – $408,000
Quick Study 14-7 (10 minutes)
2013
Jan. 1
Bonds Payable ……………………………………………..………..
2,000,000
Common Stock* …………………………………………………
1,000,000
Paid-In Capital in Excess of Par Value ………..…………
1,000,000
To record retirement of bonds by stock
conversion. *1,000,000 shares x $1.00
Quick Study 14-8 (10 minutes)
1.
A
Registered bond
5.
E
Convertible bond
2.
C
Serial bond
6.
D
Bond Indenture
3.
H
Secured bond
7.
G
Sinking fund bond
4.
F
Bearer bond
8.
B
Debenture
Quick Study 14-9 (10 minutes)
Amount of annual payment =
a. 4%: Payment = $340,000 / 4.4518 = $76,374*
Initial cash proceeds from note
Table B.3 present value for 5 payments
Quick Study 14-10 (10 minutes)
Ratio of debt to equity
Atlanta Company
Spokane Company
Total liabilities ……………………..
$429,000
$ 548,000
Total equity ………………………….
$572,000
$1,827,000
Debt–to-equity ratio ………………
0.75
0.30
Analysis and interpretation: Atlanta Company’s debt–to-equity ratio of 0.75
implies a riskier financing structure than Spokane Company’s 0.30 debt-to–
equity ratio.
Quick Study 14-11C (10 minutes)
2013
Mar. 1
Cash ……………………………………………………………….…….
405,333
Interest payable* ………………………………………..…….
5,333
Bonds payable …………………………………………..…….
400,000
Sold $400,000 of bonds with two months’
accrued interest. *($400,000 x .08 x 2/12)
Quick Study 14-12D (10 minutes)
Rental Expense …………………………………………..…………
250
Cash (or Payable)…………………………………..…………
250
To record rental expense for car lease.
Quick Study 14-13D (10 minutes)
Leased Asset—Office Equipment ………………..…………
15,499
Lease Liability ……………………………………….…………
15,499
To record capital lease of office equipment.
Quick Study 14-14 (10 minutes)
a. The par value of the 4.625% bond issuance is £ 311 million. The
carrying value is £ 338 million.
Quick Study 14-15 (10 minutes)
a. There is an inverse relation between market rates and bond prices (to
see this, look at the decreasing discount rate as the yield rate increases
b. No, the change in market rates since it issued the bonds does not affect
interest expense. Once the bonds are recorded on the balance sheet,
c. Because the bonds trade at a discount in the market (98.0), it would be
paying less to retire the bonds than the balance sheet (carrying) value.
d. Vodafone must repay the par amount of the bonds at maturity. Because
this is the only cash flow that the bondholders will receive, the market
EXERCISES
Exercise 14-1 (15 minutes)
2. Journal entries
2013
(a)
Jan. 1
Cash ……………………………………………………....
3,400,000
Bonds Payable …………………………………………………
3,400,000
Sold bonds at par.
(b)
June 30
Bond Interest Expense …………………………..
153,000
Cash ………………………………………………..……..
153,000
Paid semiannual interest on bonds.
(c)
Dec. 31
Bond Interest Expense …………………………..
153,000
Cash ………………………………………………..……..
153,000
Paid semiannual interest on bonds.
3.
2013
(a)
Jan. 1
Cash* …………………………………………………….…
3,332,000
Discount on Bonds Payable …………………..………
68,000
Bonds Payable …………………………………………………
3,400,000
Sold bonds at 98. *($3,400,000 x 0.98)
(b)
Jan. 1
Cash* …………………………………………………….…
3,468,000
Premium on Bonds Payable ……………..……………
68,000
Bonds Payable …………………………………………………
3,400,000
Sold bonds at 102. *($3,400,000 x 1.02)
Exercise 14-2 (30 minutes)
1. Discount = Par value – Issue price = $180,000 – $170,862 = $9,138
2. Total bond interest expense over the life of the bonds
Amount repaid
Six payments of $7,200* ……………..
$ 43,200
Par value at maturity ………………….
180,000
Total repaid ………………………………..
223,200
Less amount borrowed …………………
(170,862)
Total bond interest expense ………….
$ 52,338
*180,000 x 0.08 x ½ = $7,200
or:
Six payments of $7,200 ………………….…….
$ 43,200
Plus discount ………………………………..…….
9,138
Total bond interest expense …………..…….
$ 52,338
3. Straight-line amortization table ($9,138/6 = $1,523)
Semiannual
Period-End
Unamortized
Discount
Carrying
Value
(0)
1/01/2013 ……………..……..
$9,138
$170,862
(1)
6/30/2013 ……………..……..
7,615
172,385
(2)
12/31/2013 ……………..……..
6,092
173,908
(3)
6/30/2014 ……………..……..
4,569
175,431
(4)
12/31/2014 ……………..……..
3,046
176,954
(5)
6/30/2015 ……………..……..
1,523
178,477
(6)
12/31/2015 ……………..……..
0
180,000
Exercise 14-3B (30 minutes)
1. Discount = Par value – Issue price = $500,000 – $463,140 = $36,860
2. Total bond interest expense over the life of the bonds
Amount repaid
Six payments of $22,500* …………….…….
$135,000
Par value at maturity …………………..…….
500,000
Total repaid ……………………………………….
635,000
Less amount borrowed ………………….…….
(463,140)
Total bond interest expense …………..…….
$171,860
*$500,000 x 0.09 x ½ = $22,500
or
Six payments of $22,500 ………………..…….
$135,000
Plus discount ………………………………..…….
36,860
Total bond interest expense …………..…….
$171,860
3. Effective interest amortization table
Semiannual
Interest
Period-End
(A)
Cash Interest
Paid
[4.5% x $500,000]
(B)
Bond Interest
Expense
[6% x Prior (E)]
(C)
Discount
Amortization
[(B) – (A)]
(D)
Unamortized
Discount
[Prior (D) – (C)]
(E)
Carrying
Value
[$500,000 – (D)]
1/01/2013
$36,860
$463,140
6/30/2013
$ 22,500
$ 27,788
$ 5,288
31,572
468,428
12/31/2013
22,500
28,106
5,606
25,966
474,034
6/30/2014
22,500
28,442
5,942
20,024
479,976
12/31/2014
22,500
28,799
6,299
13,725
486,275
6/30/2015
22,500
29,176
6,676
7,049
492,951
12/31/2015
22,500
29,549 *
7,049
0
500,000
$135,000
$171,860
$36,860
*Adjusted for rounding.
Exercise 14-4 (30 minutes)
1. Premium = Issue price – Par value = $409,850 – $400,000 = $9,850
2. Total bond interest expense over the life of the bonds
Amount repaid
Six payments of $26,000* ……………
$156,000
Par value at maturity ………………….
400,000
Total repaid ………………………………..
556,000
Less amount borrowed …………………
(409,850)
Total bond interest expense ………….
$146,150
*$400,000 x 0.13 x ½ = $26,000
or
Six payments of $26,000 ……………….
$156,000
Less premium……………………………….
(9,850)
Total bond interest expense ………….
$146,150
3. Straight-line amortization table ($9,850/6 = $1,642)
Semiannual
Interest Period–End
Unamortized
Premium
Carrying
Value
1/01/2013
$9,850
$409,850
6/30/2013
8,208
408,208
12/31/2013
6,566
406,566
6/30/2014
4,924
404,924
12/31/2014
3,282
403,282
6/30/2015
1,640*
401,640
12/31/2015
0
400,000
*Adjusted for rounding.
Exercise 14-5B (30 minutes)
1. Premium = Issue price – Par value = $409,850 – $400,000 = $9,850
2. Total bond interest expense over the life of the bonds
Amount repaid
Six payments of $26,000* …………….…….
$ 156,000
Par value at maturity …………………..…….
400,000
Total repaid ……………………………………….
556,000
Less amount borrowed ………………….…….
(409,850)
Total bond interest expense …………..…….
$ 146,150
*$400,000 x 0.13 x ½ = $26,000
or
Six payments of $26,000 ………………..…….
$ 156,000
Less premium………………………………..…….
(9,850)
Total bond interest expense …………..…….
$ 146,150
3. Effective interest amortization table
Semiannual
Interest
Period-End
(A)
Cash Interest
Paid
[6.5% x $400,000]
(B)
Bond Interest
Expense
[6% x Prior (E)]
(C)
Premium
Amortization
[(A) – (B)]
(D)
Unamortized
Premium
[Prior (D) – (C)]
(E)
Carrying
Value
[400,000 + (D)]
1/01/2013
$9,850
$409,850
6/30/2013
$ 26,000
$ 24,591
$1,409
8,441
408,441
12/31/2013
26,000
24,506
1,494
6,947
406,947
6/30/2014
26,000
24,417
1,583
5,364
405,364
12/31/2014
26,000
24,322
1,678
3,686
403,686
6/30/2015
26,000
24,221
1,779
1,907
401,907
12/31/2015
26,000
24,093*
1,907
0
400,000
$156,000
$146,150
$9,850
*Adjusted for rounding.
Exercise 14-6 (20 minutes)
2013
(a)
Dec. 31
Cash ………………………………………………………..……………
186,534
Discount on Bonds Payable ……………………..……
13,466
Bonds Payable …………………………………………………
200,000
Sold bonds at discount.
2014
(b)
June 30
Bond Interest Expense ……………………………..……………
7,684
Discount on Bonds Payable** ……………..……………
1,684
Cash*………………………………………………….……
6,000
Paid semiannual interest and record amor-
tization. *$200,000 x6% x1/2 **13,466 – $11,782
(c)
Dec. 31
Bond Interest Expense ……………………………..……………
7,684
Discount on Bonds Payable** ……………..……………
1,684
Cash*………………………………………………….……
6,000
Paid semiannual interest and record amor-
tization. *$200,000 x6% x1/2 **$11,782 – $10,098
Exercise 14-7 (35 minutes)
2013
(a)
Dec. 31
Cash ……………………………………………………....
188,000
Discount on Bonds Payable …………………..………
12,000
Bonds Payable …………………………………………………
200,000
Sold bonds at discount.
(b)
2014
June 30
Bond Interest Expense …………………………..
8,000
Discount on Bonds Payable* …………….…………….
3,000
Cash** ……………………………………………..………..
5,000
Paid semiannual interest and record amor-
tization. *$12,000-$9,000 **$200,000x 5% x ½
Dec. 31
Bond Interest Expense …………………………..
8,000
Discount on Bonds Payable* …………….…………….
3,000
Cash** ……………………………………………..………..
5,000
Paid semiannual interest and record amor-
tization. *$9,000- $6,000 **$200,000x 5% x ½
2015
June 30
Bond Interest Expense …………………………..
8,000
Discount on Bonds Payable* …………….…………….
3,000
Cash** ……………………………………………..………..
5,000
Paid semiannual interest and record amor-
tization. *$6,000-$3,000 **$200,000 x 5% x ½
Dec. 31
Bond Interest Expense …………………………..
8,000
Discount on Bonds Payable* …………….…………….
3,000
Cash** ……………………………………………..………..
5,000
Paid semiannual interest and record amor-
tization. *$3,000 – $0 **$200,000 x 5% x ½
(c)
Dec. 31
Bonds Payable ………………………………………………………
200,000
Cash ………………………………………………..……..
200,000
Record maturity and payment of bonds.
Exercise 14-8 (20 minutes)
2012
(a)
Dec. 31
Cash ………………………………………………………..……………
216,222
Premium on Bonds Payable ………………..…………
16,222
Bonds Payable …………………………………………………
200,000
Sold bonds at premium.
2013
(b)
June 30
Bond Interest Expense ……………………………..……………
8,378
Premium on Bonds Payable* …………………….…….
1,622
Cash** ………………………………………………..……..
10,000
Paid semiannual interest and record amor-
tization. *$16,222- $14,600 **$200,000x 10% x ½
(c)
Dec. 31
Bond Interest Expense ………………………………….…………….
8,378
Premium on Bonds Payable* …………………………..
1,622
Cash** ……………………………………………………....
10,000
Paid semiannual interest and record amor-
tization. *$14,600-$12,978 **$200,000x 10% x ½
Exercise 14-9 (25 minutes)
1. Semiannual cash interest payment = $800,000 x 6% x ½ year = $24,000
4. Estimation of the market price at the issue date
Cash Flow
Table
Table Value*
Amount
Present Value
Par (maturity) value ……..
B.1
0.4564
$800,000
$365,120
Interest (annuity) ……..…..
B.3
13.5903
24,000
326,167
Price of bonds ……………..
$691,287
* Table values are based on a discount rate of 4% (half the annual market rate) and
20 periods (semiannual payments).
5.
Cash ………………………………………………………………..……
691,287
Discount on Bonds Payable……………………………………
108,713
Bonds Payable …………………………………………………
800,000
Sold bonds at a discount on the stated issue date.