Chapter 9 – Long-Term Liabilities
Chapter 9
Long-Term Liabilities
REVIEW QUESTIONS
Question 9-1 (LO 9-1)
Capital structure is the mixture of liabilities and stockholders’ equity a business uses. Companies
Question 9-2 (LO 9-1)
One of the primary reasons a company chooses to borrow money rather than issue additional
Question 9-3 (LO 9-2)
Both interest expense and the carrying value of the note decrease over time. Interest expense
Question 9-4 (LO 9-3)
A lease is a contractual arrangement by which the lessor (owner) provides the lessee (user) the
Question 9-5 (LO 9-4)
Bond issue costs include underwriting services, legal, accounting, registration, and printing fees
Chapter 9 – Long-Term Liabilities
9-2 Financial Accounting, 5e
Answers to Review Questions (continued)
Question 9-6 (LO 9-4)
A company that borrows by issuing bonds is effectively by-passing the bank and borrowing
Question 9-7 (LO 9-4)
(a) Secured bonds are supported by assets pledged as collateral. Unsecured bonds, also referred
Question 9-8 (LO 9-4)
Convertible bonds allow the investor to convert each bond into a specified number of shares of
Question 9-9 (LO 9-5)
(a) The face amount is the amount that will be repaid at maturity. The carrying value is the
balance in the Bonds Payable account minus any discount or plus any premium. For example a
Chapter 9 – Long-Term Liabilities
Answers to Review Questions (continued)
Question 9-10 (LO 9-5)
The bonds issue at a discount when the stated interest rate is less than the market interest rate.
The bonds are paying less than the going rate and, therefore, issue at a discount.
Question 9-11 (LO 9-5)
Question 9-12 (LO 9-5)
If bonds issue at a discount, the carrying value of the bonds and interest expense will increase
Question 9-13 (LO 9-5)
If bonds issue at a premium, the carrying value of the bonds and interest expense will decrease
market interest rate. As carrying value decreases, interest expense also decreases.
Question 9-14 (LO 9-5)
Cash paid is calculated as the face amount of the bonds times the stated interest rate. Interest
expense is the carrying value times the market rate. The difference between interest expense and the
Question 9-15 (LO 9-6)
If interest rates decrease, a company may choose to buy back high interest rate bonds and reissue
bonds at a lower interest rate. A company can help protect itself from decreases in interest rates by
Chapter 9 – Long-Term Liabilities
9-4 Financial Accounting, 5e
Answers to Review Questions (continued)
Question 9-16 (LO 9-6)
A loss of $50,000 is recorded by the issuer retiring the bonds as follows:
Bonds Payable
250,000
Premium on Bonds Payable
330,000
Question 9-17 (LO 9-7)
We calculate the issue price of a bond as the present value of the principal (the face amount on
Question 9-18 (LO 9-7)
The cash payment every six months is $15,000 ($500,000 × .06 × 6/12). There will be 40 interest
payments over the 20 years – one every six months.
Question 9-19 (LO 9-7)
(a) $562,757
Question 9-20 (LO 9-8)
Additional debt increases risk. Failure to repay debt or the interest associated with the debt on a
Chapter 9 – Long-Term Liabilities
BRIEF EXERCISES
Brief Exercise 9-1 (LO 9-2)
January 1, 2021
Equipment
30,000
Notes Payable
30,000
(Issue a note payable)
January 31, 2021
125.00
441.14
566.14
Brief Exercise 9-2 (LO 9-2)
January 1, 2021
Building
600,000
Notes Payable
600,000
(Issue a note payable)
January 31, 2021
597.30
Brief Exercise 9-3 (LO 9-3)
January 1, 2021
Lease Asset
100,000
Lease Payable
100,000
(Sign a lease)
Chapter 9 – Long-Term Liabilities
9-6 Financial Accounting, 5e
Brief Exercise 9-4 (LO 9-3)
Assets
Liabilities
Stockholders’
Equity
Balance before:
Balance after:
Exercise 9-5 (LO 9-4)
Terms
__e___ 1. Sinking fund.
__g___ 2. Secured bond.
__d___ 7. Convertible bond.
Definitions
a. Allows the issuer to pay off the bonds early at a fixed price.
b. Matures in installments.
Chapter 9 – Long-Term Liabilities
Brief Exercise 9-6 (LO 9-5)
1.
January 1, 2021
Cash
70,000
(Issue bonds at face amount)
2.
June 30, 2021
(Pay semiannual interest)
Brief Exercise 9-7 (LO 9-5)
1.
January 1, 2021
Cash
63,948
Discount on Bonds Payable
6,052
Bonds Payable
70,000
(Issue bonds at a discount)
2.
June 30, 2021
2,558
(Pay semiannual interest)
Chapter 9 – Long-Term Liabilities
9-8 Financial Accounting, 5e
Brief Exercise 9-8 (LO 9-5)
1.
January 1, 2021
Cash
76,860
Bonds Payable
70,000
Premium on Bonds Payable
2.
Premium on Bonds Payable (difference)
Brief Exercise 9-9 (LO 9-5)
1.
January 1, 2021
Cash
70,000
Bonds Payable
70,000
December 31, 2021
Interest Expense
(Issue bonds at face amount)
Chapter 9 – Long-Term Liabilities
Brief Exercise 9-10 (LO 9-5)
1.
January 1, 2021
Cash
2.
December 31, 2021
Interest Expense ($64,008 × 8%)
5,121
Brief Exercise 9-11 (LO 9-5)
1.
January 1, 2021
Cash
76,799
6,799
2.
December 31, 2021
Interest Expense ($76,799 × 6%)
4,608
Premium on Bonds Payable (difference)
292
Chapter 9 – Long-Term Liabilities
9-10 Financial Accounting, 5e
Brief Exercise 9-12 (LO 9-5)
$2,653 ($88,443 × 6% × ½).
Brief Exercise 9-13 (LO 9-5)
Interest expense for the year ended December 31, 2021 would be $4,157. Interest
Brief Exercise 9-14 (LO 9-5)
1.
Cash
63,948
Discount on Bonds Payable
6,052
2.
Interest Expense
2,558
3. Interest expense increases each period because the carrying value of the debt issued
at a discount increases over time.
Chapter 9 – Long-Term Liabilities
Brief Exercise 9-15 (LO 9-5)
1.
Cash
76,860
Bonds Payable
70,000
Premium on Bonds Payable
6,860
2.
Interest Expense
2,306
Premium on Bonds Payable
3. Interest expense decreases each period because the carrying value of the debt
issued at a premium decreases over time.
Brief Exercise 9-16 (LO 9-6)
Bonds Payable
70,000
Loss
3,832
Discount on Bonds Payable
5,832
Cash
Brief Exercise 9-17 (LO 9-6)
Bonds Payable
70,000
Premium on Bonds Payable
4,567
Cash
72,000
Chapter 9 – Long-Term Liabilities
9-12 Financial Accounting, 5e
Brief Exercise 9-18 (LO 9-7)
If the market rate is 7%, the bonds will issue at $60,000 (face amount).
Calculator Input
Bond
Characteristics
Key
Amount
1. Face amount
FV
$60,000
2. Interest payment
3. Periods to maturity
4. Market interest rate
Calculator Output
Issue price
PV
$60,000
Chapter 9 – Long-Term Liabilities
Brief Exercise 9-19 (LO 9-7)
If the market rate is 8%, the bonds will issue at $54,812 (a discount).
Calculator Input
Bond
Characteristics
Key
Amount
1. Face amount
FV
$60,000
2. Interest payment
3. Periods to maturity
4. Market interest rate
Calculator Output
PV
Brief Exercise 9-20 (LO 9-7)
If the market rate is 6%, the bonds will issue at $66,934 (a premium).
Calculator Input
Bond
Characteristics
Key
Amount
1. Face amount
FV
$60,000
2. Interest payment
3. Periods to maturity
4. Market interest rate
Calculator Output
Issue price
PV
$66,934
Chapter 9 – Long-Term Liabilities
9-14 Financial Accounting, 5e
Brief Exercise 9-21 (LO 9-8)
1.
÷
=
2.
Net
Income
÷
Average Total
Assets
=
Return on Assets
Ratio
$66
÷
$722.5*
=
9.1%
3.
Net Income +
÷
=
Chapter 9 – Long-Term Liabilities
EXERCISES
Exercise 9-1 (LO 9-1)
Requirement 1
Issue Note
Issue Stock
Operating income
$11,000,000
$11,000,000
Interest expense (note only)
2,450,000
Income before tax
Income tax expense (35%)
Net income
# of shares
4,000,000
5,000,000
Earnings per share (Net income / # of shares)
Requirement 2
Issuing stock results in higher earnings per share. Issuing the note results in earnings
Chapter 9 – Long-Term Liabilities
Exercise 9-2 (LO 9-2)
January 1, 2021
Cash
50,000
Notes Payable
50,000
(Issue a note payable)
January 31, 2021
Interest Expense ($50,000 × 6% × 1/12)
250.00
Notes Payable (difference)
578.64
February 28, 2021
Interest Expense ([$50,000-578.64] × 6% × 1/12)
247.11
828.64
Chapter 9 – Long-Term Liabilities
Exercise 9-3 (LO 9-2)
Requirement 1
January 1, 2021
Land
800,000
Requirement 2
June 30, 2021
Interest Expense ($800,000 × 6% × 6/12)
24,000.00
December 31, 2021
Notes Payable (difference)
Requirement 3
Notes Payable = $800,000 − $191,221.64 − $196,958.29 = $411,820.07
Chapter 9 – Long-Term Liabilities
9-18 Financial Accounting, 5e
Exercise 9-4 (LO 9-3, LO 9-8)
Requirement 1
Assets
=
Liabilities
+
Stockholders’
Equity
Requirement 2
Total
Liabilities
÷
Stockholders’
Equity
=
Debt to Equity Ratio
Requirement 3
Total
Liabilities
÷
Stockholders’
Equity
=
Debt to Equity Ratio
Requirement 4
Exercise 9-5 (LO 9-3)
Requirement 1
PV of lease payments = $3,618.18 × 22.110544* = $80,000 (rounded)
Requirement 2
June 1, 2021
Lease Asset
80,000
Chapter 9 – Long-Term Liabilities
Exercise 9-6 (LO 9-3)
Requirement 1
Requirement 2
June 30, 2021
Lease Asset
500,000
Exercise 9-7 (LO 9-5)
January 1, 2021
Cash
500,000
Bonds Payable
500,000
(Issue bonds at face amount)
June 30, 2021
Interest Expense
(Pay semiannual interest)
December 31, 2021
Interest Expense
Chapter 9 – Long-Term Liabilities
9-20 Financial Accounting, 5e
Exercise 9-8 (LO 9-5)
Requirement 1
(1)
Date
(2)
Cash
Paid
(3)
Interest
Expense
(4)
Increase in
Carrying
Value
(5)
Carrying
Value
Face Amount
Carrying Value
Prior Carrying
Requirement 2
January 1, 2021
Cash
457,102
Discount on Bonds Payable
42,898
Bonds Payable
500,000
(Issue bonds at a discount)
June 30, 2021
Interest Expense
22,855
355
(Pay semiannual interest)
December 31, 2021
(Pay semiannual interest)