Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
14-1
Chapter 14
LONG-TERM LIABILITIES
Student Learning Objectives and Related Assignment Materials*
Student Learning Objectives
Discussion
Questions
Quick
Studies
Exercises
Problems
Beyond the
Numbers
Conceptual objectives:
C1. Explain the types of notes and
prepare entries to account for
notes.
1
14-11
14-10, 14-11,
14-20
14-6
C2. Explain and compute bond
pricing. (Appendix 14A)
14-3, 14-5
14-3, 14-8
14-1, ES
C3. Describe accounting for leases
and pensions (Appendix 14C)
18, 19, 20
14-17, 14-18
14-15, 14-17,
14-18, 14-19
14-11
14-3
Analytical objectives:
A1. Compare bond financing with
stock financing.
2, 3, 4, 5, 6,
7, 13, 15
14-1
SP
14-1, 14-3,
14-7, 14-8
A2. Assess debt features and their
implications.
16
14-12
14-1, 14-5
A3. Compute the debt-to-equity
ratio and explain its use.
12, 17
14-13
14-12, 14-17
14-7, SP
14-2, 14-9
P1. Prepare entries to record bond
issuance and bond interest
expense.
10, 11, 14
14-2, 14-4,
14-7, 14-16,
14-19, 14-20
14-1, 14-4,
14-5, 14-6,
14-16
14-1, 14-2,
14-3, 14-4,
14-5, 14-8,
14-9, 14-10
P2. Compute and record
amortization of bond discount
using straight-line method.
8
14-6, 14-7
14-2, 14-4,
14-5, 14-9,
14-15
14-2, 14-5
14-6
P3. Compute and record
amortization of bond premium
using straight-line method.
14-8
14-6, 14-7,
14-8
14-3, 14-4,
14-5
14-4, 14-6
P4. Record the retirement of bonds.
14-9, 14-10
14-9
14-10
This grid is continued on next page
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
14-2
Student Learning Objectives
Quick
Studies
Problems
Beyond the
Numbers
P5. Compute and record
amortization of bond discount
using effective interest method.
(Appendix 14B)
14-14
14-8, 14-10
P6. Compute and record
amortization of bond premium
using effective interest method.
(Appendix 14B)
14-15
14-9, 14-10
*See additional information on next page that pertains to these quick studies, exercises and problems.
SP refers to the Serial Problem
ES refers to the Excel Simulations
Additional Information on Related Assignment Material
Connect
Available on the instructor’s course-specific website) repeats all numerical Quick Studies, all Exercises and
Problems Set A. Connect also provides algorithmic versions for Quick Study, Exercises and Problems. It allows
instructors to monitor, promote, and assess student learning. It can be used in practice, homework, or exam mode.
Connect Insight
The first and only analytics tool of its kind, Connect Insight is a series of visual data displays that are each framed
by an intuitive question and provide at-a-glance information regarding how an instructor’s class is performing.
Connect Insight is available through Connect titles.
The Serial Problem for Success Systems continues in this chapter.
General Ledger
Assignable within Connect, General Ledger (GL) problems offer students the ability to see how transactions post
from the general journal all the way through the financial statements. Critical thinking and analysis components are
added to each GL problem to ensure understanding of the entire process. GL problems are auto-graded and provide
instant feedback to the student.
Excel Simulations
Assignable within Connect, Excel Simulations allow students to practice their Excel skills—such as basic formulas
and formatting—within the context of accounting. These questions feature animated, narrated Help and Show Me
tutorials (when enabled). Excel Simulations are auto-graded and provide instant feedback to the student.
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
14-3
Synopsis of Chapter Revisions
NEW opener—Uber and entrepreneurial assignment.
Simplified Exhibit 14.1 for ease of learning.
Updated the IBM stock quote data.
New bond image from Minnesota Vikings stadium bonds.
New NTK 14-1 covering bonds issued at par.
Simplified Exhibit 14.6 on discount bonds.
New T-accounts with Exhibit 14.6 to show Bonds Payable and the Discount on Bonds Payable.
Simplified Exhibit 14.10 on premium bonds.
Bond pricing moved to Appendix 14A.
Simplified Exhibit 14.14 for note amortization schedule.
Updated “Missing Debt” box using new data from KPMG.
Sustainability section explains bond financing for Uber.
Updated debt-to-equity analysis using Amazon.
New margin Excel computations for bond pricing.
Added margin T-accounts for bonds in Appendix 14B.
Simplified lease example in Appendix 14C.
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
14-4
Chapter Outline
Notes
I. Basics of Bonds
Projects that demand large amounts of money often are funded from
bond issuances.
A. Bond Financing
1. A bond is its issuer’s written promise to pay an amount
identified as the par value of the bond with interest.
a. Most bonds require the issuer to make periodic interest
payments.
b. The par value of a bond, also called the face amount or
face value, is paid at a specified future date known as the
maturity date.
c. Most bonds also require the issuer to make semiannual
interest payments. Interest paid is computed as par (face
amount) value x contract rate of interest.
2. Advantages of bonds
a. Bonds do not affect owner control.
b. Interest on bonds is tax deductible.
c. Bonds can increase return on equity. A company that earns
a higher return with borrowed funds than it pays in interest
on those funds increases its return on equity. This process is
called financial leverage or trading on the equity.
3. Disadvantages of bonds
a. Bonds can decrease return on equity. A company that earns
a lower return with borrowed funds than it pays in interest
on those funds decreases its return on equity.
b. Bonds require payment of both periodic interest and par
value at maturity. Equity financing, by contrast, does not
require any payments because cash withdrawals (dividends)
are paid at the discretion of the owner (board).
B. Bond Trading
1. Bonds are securities and can be readily bought and sold.
2. A bond issue consists of a large number of bonds
(denominations of $1,000 or $5,000, etc.) that are sold to many
different lenders.
3. Market value (price) is expressed as a percentage of par (face)
value. Examples: bonds issued at 103 ½ means that they are sold
for 103.5% of par value. Bonds issued at 95 means that they are
sold for 95% of par value.
C. Bond-Issuing Procedures
Authorization of bond issuances includes the number of bonds
authorized, their par value, and the contract interest rate.
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
14-5
Chapter Outline
Notes
1. Bond indenture is the contract between the bond issuer and the
bondholders; it identifies the obligations and rights of each
party. A bondholder may also receive a bond certificate that
includes the issuer’s name, the par value, the contract interest
rate, and the maturity date.
2. Issuing corporation normally sells its bonds to an investment
firm (the underwriter), which resells the bonds to the public.
3. A trustee (usually a bank or trust company) monitors the issuer
to ensure it complies with the obligations in the indenture.
II. Bond Issuances
A. Issuing Bonds at Par—bonds are sold for face amount.
Entries are:
1. Issue date: debit Cash, credit Bonds Payable (face amount).
2. Interest date: debit Interest Expense, credit Cash (face times
bond interest rate times interest period).
B. Bond Discount or Premium—bonds are sold for an amount different
than the face amount.
1. Contract rate—(also called coupon rate, stated rate, or nominal
rate) annual interest rate paid by the issuer of bonds (applied to
par value).
2. Market rate—annual rate borrowers are willing to pay and
lenders are willing to accept for a particular bond and its risk
level.
rate, bonds sell at a discount (below par).
3. When contract rate and market rate are equal, bonds sell at par
C. Issuing Bonds at a Discount—sell bonds for less than par value.
1. The discount on bonds payable is the difference between the
par (face) value of a bond and its lower issuance price.
2. Entry to record issuance at a discount: debit Cash (issue price),
debit Discount on Bonds Payable (amount of discount); credit
Bonds Payable (par value).
3. Discount on Bonds Payable is a contra liability account; it is
deducted from par value to yield the carrying (book) value of
the bonds payable.
4. Amortizing a Discount Bond
a. Total bond interest expense is the sum of all the cash interest
payments plus the bond discount (or can be computed by
3. Maturity date: debit Bonds Payable, credit Cash (face amount).
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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Chapter Outline
Notes
c. Requires crediting Discount on Bonds Payable when bond
interest expense is recorded (payment and/or accruals) and
increasing Interest Expense by the amortized amount.
5. Straight-line method—allocates an equal portion of the total
discount to bond interest expense in each of the six-month
interest periods.
a. We divide the total bond interest expense by the number of
semiannual periods in the bonds’ life.
b. During the bonds’ life, the discount decreases each period by
the semiannual amortization amount.
semiannual amortization amount.
D. Issuing Bonds at a Premium—sell bonds for more than par value.
1. The premium on bonds payable is the difference between the
par value of a bond and its higher issuance price.
2. Entry to record issuance at a premium: debit Cash (issue price),
credit Premium on Bonds Payable (amount of premium), credit
Bonds Payable (par value).
3. Premium on Bonds Payable is an adjunct liability account; it is
4. Amortizing a Premium Bond
a. Total bond interest expense incurred is the sum of the
interest payments less the bond premium.
premium to bond interest expense in each of the six-month
5. Straight-line method allocates an equal portion of the total
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
14-7
Chapter Outline
Notes
III. Bond Retirement
A. Bond Retirement at Maturity
1. Carrying value at maturity will always equal par value.
2. Entry to record bond retirement at maturity: debit Bonds
Payable, credit Cash.
B. Bond Retirement Before Maturity
1. Two common approaches to retire bonds before maturity:
2. Difference between the purchase price and the bonds’ carrying
value is recorded as a gain (or loss) on retirement of bonds.
C. Bond Retirement by Conversion
Convertible bondholders have the right to convert their bonds to
stock. If converted, the carrying value of bonds is transferred to
equity accounts and no gain or loss is recorded.
IV. Long-Term Notes Payable
Notes are issued to obtain assets, such as cash. Notes are typically
transacted with a single lender, such as a bank.
A. Installment Notes—obligations requiring a series of periodic
payments to the lender.
2. Payments include interest expense accruing to the date of the
payment plus a portion of the amount borrowed (principal).
a. Equal total payments consist of changing amounts of interest
and principal.
b. Entry to record installment payment: debit Interest Expense
B. Mortgage Notes and Bonds
A mortgage is a legal agreement that helps protect a lender if a
borrower fails to make required payments. A mortgage contract
describes the mortgage terms.
1. Accounting for mortgage notes and bonds—same as accounting
for unsecured notes and bonds.
V. Decision Analysis—Debt Features and the Debt-to-Equity Ratio
Collateral Agreements—reduce the risk of loss for both bonds and notes;
unsecured bonds and notes are riskier because the issuer’s obligation to
pay interest and principal has the same priority as all other unsecured
liabilities in the event of bankruptcy.
A. Features of Bonds and Notes
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
14-8
3. Debt-to-equity ratio measures the risk of a company’s financing
structure.
Chapter Outline
1. Secured or Unsecured
a. Secured bonds and notes have specific assets of the issuer
pledged (or mortgaged) as collateral.
b. Unsecured bonds and notes also called debentures, are backed
riskier than secured debt.
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
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. Debt-to-Equity Ratio
2. A company financed mainly with debt is riskier than a company
financed mainly with equity because liabilities must be repaid.
Notes
4. Debt-to-equity ratio is computed by dividing total liabilities by
total equity.
VI. Bond Pricing – (Appendix 14A)
The price of a bond is the present value of the bond’s future cash flows
discounted at the current market rate. Present value tables can be used to
compute price, which is the combination of the:
1. Present value of the maturity payment (par value) is found by
2. Present value of the semiannual interest payments is found by
3. Present values found in present value tables in Appendix B at the
end of this book.
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
14-9
Chapter Outline
Notes
VII. Effective Interest Amortization (Appendix 14B)
A Effective Interest Amortization of a Discount Bond
1. The straight-line method yields changes in the bonds’ carrying
2. The effective interest method allocates total bond interest
3. The key difference between the two methods lies in computing
bond interest expense. Instead of assigning an equal amount of
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
1. As noted above, the effective interest method allocates total
entries recording the expense and updating the Premium on
2. Except for differences in amounts between the two methods (that
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
14–10
Chapter Outline
Notes
VIII. Leases and Pensions (Appendix 14C)
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.
Lease accounting will change over the next few years, whereby
operating leases are likely to be accounted for similar to capital
leases.
1. Operating leases are short-term (or cancelable) leases in which
2. Capital leases are long-term (or noncancelable) leases in which
the lessor transfers substantially all risks and rewards of
ownership to the lessee.
a. The lease must meet any one of the four following criteria:
i. Transfer title of leased asset to lessee.
ii. Contain a bargain purchase option.
iii. Have lease term of 75% or more of leased asset’s useful
life.
iv. Have present value of lease payment of 90% or more of
leased asset’s market value.
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
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
14–11
Chapter 14 Alternate Demonstration Problem
Note: Instructor can choose the interest amortization method. Solution one
demonstrates the straight line method and solution two demonstrates the
effective interest method.
ABC Company issued $200,000 face value bonds on January 1, 2017, 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. On January 1, 2020, 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%. Show calculation of issue price. If using the effective interest
method of amortization, prepare a schedule showing the bond interest
expense and amounts of amortization for the life of the bonds. If using
straight line, show the calculation of the periodic amortization within
the appropriate journal entries explanations.
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%.
14–12
1. Calculation of cash received upon issuance of bonds (issue price):
at 4.5% per period
2.
1/1/17
Bonds Payable ………………………………………..
Premium on Bonds Payable …………………….
3.
6/30/17
Bond Interest Expense …………………………………
9,309.30
Premium on Bonds Payable ………………………….
10,000.00
(7,907 / 10 periods = 790.70 per period)
12/31/17
Bond Interest Expense …………………………………
9,309.70
Premium on Bonds Payable
10,000.00
4.
1/1/20
Bonds Payable ……………………………………………..
80,000.00
Premium on Bonds Payable ………………………….
79,000.00
2,265.12**
Redemption Price $79,000 = Gain $2,265.12
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
14–13
Part B
1. * Calculation of cash received upon issuance of bonds (issue price):
2.
1/1/17
Discount on Bonds Payable ………………………….
Bonds Payable ………………………………………..
3.
6/30/17
Bond Interest Expense …………………………………
14,025.90
(40,259/10 periods = 4,025.90 per period)
4.
12/31/17
Bond Interest Expense …………………………………
14,025.90
1/1/20
Bonds Payable ……………………………………………..
79,000.00
at 8% per period
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
14–14
Chapter 14 Solution Two: Alternate Demonstration Problem
Using Effective Interest Method of Amortization
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
*
* Calculation of cash received upon issuance of bonds:
at 4.5% per period
2.
1/1/17
Bonds Payable ………………………………………..
Premium on Bonds Payable …………………….
3.
6/30/17
Premium on Bonds Payable ………………………….
1
$207,907
$9,356
$10,000
$644
7,263
207,263
2
207,263
9,327
673
6,590
206,590
3
206,590
9,297
703
5,887
205,887
4
205,887
9,265
735
5,152
205,152
5
205,152
9,232
768
4,384
204,384
6
204,384
9,197
803
3,581
203,581
7
203,581
9,161
839
2,742
202,742
8
202,742
9,123
877
1,865
201,865
9
201,865
9,084
916
949
200,949
200,949
9,051
949
0
200,000
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
12/31/17
4.
1/1/20
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
3,002
34,478
165,522
3
165,522
13,242
3,242
31,236
168,764
4
168,764
13,501
3,501
27,735
172,265
5
172,265
13,781
3,781
23,954
176,046
6
176,046
14,084
4,084
19,870
180,130
7
180,130
14,410
4,410
15,460
184,540
8
184,540
14,763
4,763
10,697
189,303
9
189,303
15,144
5,144
5,553
194,447
194,447
15,553
5,553
0
200,000
14–16
2.
1/1/17
Discount on Bonds Payable ………………………….
40,259
Bonds Payable ………………………………………..
3.
6/30/17
Bond Interest Expense …………………………………
12,779
Discount on Bonds Payable …………………….
2,779
Cash ……………………………………………………….
10,000
4.
12/31/17
Bond Interest Expense …………………………………
13,002
Discount on Bonds Payable …………………….
3,002
Cash ……………………………………………………….
10,000
1/1/20
Bonds Payable ……………………………………………..
80,000
6,948
Discount on Bonds Payable …………………….
7,948
Cash ……………………………………………………….
79,000