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Chapter 10 - Long-Term Liabilities
Chapter Outline
2. Term or Serial
a. Term bonds and notes are scheduled for maturity on one
specified date.
b. Serial bonds and notes mature at more than one date (often in
series) and are usually repaid over a number of periods.
3. Registered or Bearer
a. Registered bonds are issued in the names and addresses of
their holders. Bond payments are sent directly to registered
holders.
b. Bearer bonds, also called unregistered bonds, are made
payable to whoever holds them (the bearer). Many bearer bonds
are also coupon bonds; which are interest coupons that are
attached to the bonds.
4. Convertible and/or Callable
a. Convertible bonds and notes can be exchanged for a fixed
number of shares of the issuing company’s common stock.
b. Callable bonds and notes have an option exercisable by the
issuer to retire them at a stated dollar amount before maturity.
B. Debt-to-Equity Ratio
1. Knowing the level of debt helps in assessing the risk of a
company’s financing structure.
2. A company financed mainly with debt is riskier than a company
financed mainly with equity because liabilities must be repaid.
3. Debt-to-equity ratio measures the risk of a company’s financing
structure.
4. Debt-to-equity ratio is computed by dividing total liabilities by
A. Present Value Concepts
1. Cash paid (or received) in the future has less value now than the
same amount of cash paid (or received) today.
4. Present Value tables can be used to determine the present value
of future cash payments of a single amount or an annuity.
B. Present Value Tables (Complete tables in Appendix B)
Chapter 10 - Long-Term Liabilities
Chapter Outline
Notes
3. Present value of an annuity of $1 table is used to compute
present value of a series of equal payments (annuity).
C. Applying a Present Value Table (Complete tables in Appendix B)
1. Determine the column with the interest rate.
2. Determine the row with the periods hence.
3. The column and row will intersect at the factor number.
4. To convert the single payment to its present value, multiply this
amount by the factor.
D. Present Value of an Annuity (Complete tables in Appendix B)
1. Determine the column with the interest rate.
2. Determine the row with the number of periods.
3. The column and row will intersect at the factor number.
4. To convert the annuity to its present value, multiply the annuity
amount by the factor.
E. Compounding Periods Shorter than a Year
1. Interest rates are generally stated as annual rates.
2. They can be allocated to shorter periods of time.
VIII. Effective Interest Amortization (Appendix 10B)
A Effective Interest Amortization of a Discount Bond
1. The straight-line method yields changes in the bonds’ carrying
value while the amount for bond interest expense remains
constant.
2. The effective interest method allocates total bond interest
expense over the bonds’ life in a way that yields a constant rate
of interest.
3. The key difference between the two methods lies in computing
bond interest expense. Instead of assigning an equal amount of
bond interest expense in each period, the effective interest
method assigns a bond interest expense amount that increases
over the life of a discount bond.
4. Both methods allocate the same amount of bond interest expense
to the bonds’ life, but in different patterns.
5. Except for differences in amounts, journal entries recording the
expense and updating the Discount on Bonds Payable account
balance are the same under both methods.
B Effective Interest Amortization of a Premium Bond
constant rate of interest.
2. Except for differences in amounts between the two methods (that
is, the straight-line and effective interest methods), journal
Chapter 10 - Long-Term Liabilities
Chapter Outline
Notes
entries recording the expense and updating the Premium on
Bonds Payable account are the same under both methods.
IX. Issuing Bonds Between Interest Dates (Appendix 10C)
A. Procedure used to simplify recordkeeping:
1. Buyers pay the purchase price plus any interest accrued since the
prior interest payment date.
2. This accrued interest is repaid to these buyers on the next
interest date.
3. Entry to record issuance of bonds between interest dates: debit
Cash, credit Interest Payable (for any interest accrued since the
prior interest payment date), credit Bonds Payable.
4. Entry to record first semiannual interest payment for bonds
issued between interest dates: debit Interest Payable (for amount
accrued in entry above), debit Interest Expense (for interest
accrued since issuance date), credit Cash.
B. Accruing Bond Interest Expense
1. Necessary when bond’s interest period does not coincide with
issuer's accounting period.
2. Adjusting entry is necessary to record bond interest expense
accrued since the most recent interest payment and requires
amortization of the premium or discount for this period.
3. Affects the subsequent interest payment date entry.
X. Leases and Pensions (Appendix 10D)
A. Lease Liabilities
A lease is a contractual agreement between a lessor (asset owner)
and a 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.
1. Operating leases are short-term (or cancelable) leases in which
the lessor retains the risks and rewards of ownership.
a. Lessee records lease payments as expenses.
b. Lessor records lease payments as revenues.
2. Capital leases are long-term (or noncancelable) leases in which
the lessor transfers substantially all risks and rewards of
ownership to the lessee. The lease must meet any one of the four
following criteria:
d. Have present value of leased payments of 90% or more of
leased asset's market value.
Chapter 10 - Long-Term Liabilities
Chapter Outline
Notes
Failure to meet one of the criteria results in off-balance-
sheet financing (not recorded on the balance sheet).
Capital leases are recorded as assets and liabilities. The asset
is depreciated. At each lease payment date, the liability is
amortized to record interest expense incurred.
B. Pension Liabilities
A pension plan is a contractual agreement between an employer and
its employees for the employer to provided benefits (payments) to
employees after they have retired.
1. Employer records their payment into pension plan as a debit to
Pension Expense and a credit to Cash.
2. Based on contracted benefits, pension plans can be overfunded
(resulting in plan assets) or underfunded (resulting in plan
liabilities).
Chapter 10 - Long-Term Liabilities
website, in whole or part. 10-13
Chapter 10 – Alternate Demonstration Problem #1
(Appendix 10B)
ABC Company issued $200,000 face value bonds on January 1, 2012 with
semiannual interest payments to be made on June 30 and December 31
at a contract rate of 10%. The bonds were scheduled to mature five years
after they were issued. ABC Company uses the effective interest method
of amortization.
On January 1, 2015, three years after the bonds were issued, the
company repurchased 40% of the outstanding bonds for $79,000.
Required:
Part A
1. Assume that the bonds were issued when the market rate of interest
was 9%. Prepare a schedule showing the bond interest expense and
amounts of amortization for the life of the bonds.
2. Prepare the journal entry to record the bond issuance.
3. Prepare journal entries for the first two interest payments.
4. Prepare the journal entry to recognize the partial repurchase of the
bonds.
Part B
Redo Part A under the assumption that the market rate on the bonds
when issued was 16%.
Chapter 10 - Long-Term Liabilities
Solution: Chapter 10 – Alternate Demonstration Problem #1
Part A
1.
Period
Beginning
of Period
Carrying
Amount
Interest
Expense
to be
Recorded
Interest
to be Paid
to Bond-
holders
Premium
to be
Amortized
Unamortized
Premium end
of Period
End-of-
Period
Carrying
Amount
0
$7,907
$207,907
*
1
$207,907
$9,356
$10,000
$644
7,263
207,263
2
207,263
9,327
10,000
673
6,590
206,590
3
206,590
9,297
10,000
703
5,887
205,887
4
205,887
9,265
10,000
735
5,152
205,152
5
205,152
9,232
10,000
768
4,384
204,384
6
204,384
9,197
10,000
803
3,581
203,581
7
203,581
9,161
10,000
839
2,742
202,742
8
202,742
9,123
10,000
877
1,865
201,865
9
201,865
9,084
10,000
916
949
200,949
10
200,949
9,051
10,000
949
0
200,000
Chapter 10 - Long-Term Liabilities
Solution: Chapter 10 – Alternate Demonstration Problem #1, continued
12/31/12
Bond Interest Expense .......................................
9,327
Premium on Bonds Payable ...............................
673
Cash ................................................................
10,000
4.
1/1/15
Bonds Payable .....................................................
80,000
Premium on Bonds Payable ...............................
1,432
Cash ................................................................
79,000
Gain on the Retirement of Bonds ................
2,432
Part B
1.
Period
Beginning
of-Period
Carrying
Amount
Interest
Expense
to be
Recorded
Interest to
be Paid
to Bond-
holders
Discount
to be
Amortized
Unamortized
Discount end
of Period
End-of-
Period
Carrying
Amount
0
$40,259
$159,741
*
1
$159,741
$12,779
$10,000
$2,779
37,480
162,520
2
162,520
13,002
10,000
3,002
34,478
165,522
3
165,522
13,242
10,000
3,242
31,236
168,764
4
168,764
13,501
10,000
3,501
27,735
172,265
5
172,265
13,781
10,000
3,781
23,954
176,046
6
176,046
14,084
10,000
4,084
19,870
180,130
7
180,130
14,410
10,000
4,410
15,460
184,540
8
184,540
14,763
10,000
4,763
10,697
189,303
9
189,303
15,144
10,000
5,144
5,553
194,447
10
194,447
15,553
10,000
5,553
0
200,000
Chapter 10 - Long-Term Liabilities
website, in whole or part. 10-16
Solution: Chapter 10 – Alternate Demonstration Problem #1, continued
2.
1/1/12
Cash ......................................................................
159,741
Discount on Bonds Payable ...............................
40,259
Bonds Payable ...............................................
200,000
3.
6/30/12
Bond Interest Expense .......................................
12,779
Discount on Bonds Payable .........................
2,779
Cash ................................................................
10,000
4.
12/31/12
Bond Interest Expense .......................................
13,002
Discount on Bonds Payable .........................
3,002
Cash ................................................................
10,000
1/1/15
Bonds Payable .....................................................
80,000
Loss on the Retirement of Bonds ......................
6,948
Discount on Bonds Payable .........................
7,948
Cash ................................................................
79,000
