Chapter 10
Long-Term Liabilities
QUESTIONS
1. Notes payable generally involve borrowing from a single creditor, whereas bonds
2. A bond is a liability of the issuing company. A share of stock represents an ownership
3. Bonds can allow a company’s owners to increase their return on equity without investing
4. A bond indenture is a legal contract between the issuing company and the bondholders
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
balance is growing (a discount) or decreasing (a premium).
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
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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
12. The debt-to-equity ratio is calculated by dividing total liabilities by total equity. The
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
15. KTM’s long-term interest-bearing loans increased by €2,941 thousand (€132,898
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 10-1 (10 minutes)
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:
$231,250 / 20 semiannual periods = $11,563 (rounded to whole dollars)
Quick Study 10-2B (10 minutes)
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 10-3 (10 minutes)
2013
Jan. 1
218,750
31,250
250,000
Jan. 1
281,400
240,000
41,400
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Quick Study 10-4 (10 minutes)
a. Using facts in QS 10–1, 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*
*Agrees with $218,750 as given in QS 10-1, except for rounding difference.
(Instructor note: The price in QS 10-1 is rounded to 87.5 from 87.5388, yielding the $97 difference.)
b. Using facts in QS 10-2, 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 10-2, except for rounding difference.
(Instructor note: The price in QS 10-2 is rounded to 117.25 from 117.29, yielding the $96 difference.)
Quick Study 10-5 (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 10-6 (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 10-7 (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 10-8 (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 10-9 (10 minutes)
Amount of annual payment =
Initial cash proceeds from note
Table B.3 present value for 5 payments
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560
Quick Study 10-10 (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 10–11C (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 10–12D (10 minutes)
Rental Expense …………………………………………..…………
250
Cash (or Payable)…………………………………..…………
250
To record rental expense for car lease.
Quick Study 10–13D (10 minutes)
Leased Asset—Office Equipment ………………..…………
15,499
Lease Liability ……………………………………….…………
15,499
To record capital lease of office equipment.
Quick Study 10-14 (10 minutes)
Quick Study 10-15 (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
in present value tables of Appendix A). Given that the 4.625%
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.
EXERCISES
Exercise 10-1 (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 10-2 (30 minutes)
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
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564
Exercise 10-3B (30 minutes)
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 10-4 (30 minutes)
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
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Exercise 10-5B (30 minutes)
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 10-6 (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
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568
Exercise 10-7 (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 10-8 (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 10-9 (25 minutes)
1. Semiannual cash interest payment = $800,000 x 6% x ½ year = $24,000
2. Number of payments = 10 years x 2 per year = 20 semiannual payments
Cash Flow
Present Value
Par (maturity) value ……..
Cash ………………………………………………………………..……
691,287
Discount on Bonds Payable……………………………………
108,713
Bonds Payable …………………………………………………