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Chapter 09 - Long-Term Liabilities
9-1
Chapter 9
Long-Term Liabilities
INSTRUCTOR’S MANUAL
Authors’ Perspectives
PART A: Types of Long-Term Debt
LO9-1 Explain financing alternatives.
Long-Term Liabilities – Typically, when instructors think about coverage of long-term
liabilities, they think about coverage of bonds. However, installment notes (home mortgages, car
payments) and leases (apartments, office buildings) are examples of long-term liabilities that
may be more relevant to college students as nearly all students will encounter these types of
Flexibility of Coverage – The design of the chapter is meant to give flexibility in the coverage
of long-term liabilities. Instructors who prefer an overview of long-term liabilities including
installment notes, leases, and bonds can cover Part A only. Instructors who prefer more detailed
coverage of bonds can cover Part B as well (Recording Bonds Payable). For those instructors
wanting to take the deepest dive into bonds, Part C is available (Pricing a Bond).
Debt versus Equity Financing – Part A begins with the basic accounting equation to contrast
Chapter 09 - Long-Term Liabilities
9-2
Leases – Many instructors may never have considered teaching leases in introductory financial
accounting. There are at least four good reasons to consider doing so:
1. Leases are the number one source of debt financing in the United States, making them
highly relevant. The Decision Maker’s Perspectives helps students to see why leasing is
Because this is introductory financial accounting, the lease coverage is purposely kept
simple. Students are shown how to record a long-term lease for the present value of the lease
payments. The important point for students is that a long-term lease creates an asset and a
Bonds – At this initial point in the chapter, the coverage of bonds includes only a discussion of
the different types of bonds and an example of what a bond is.
• Illustration 9-4 provides an easy summary of the bond types.
PART B: Accounting for Bonds Payable
LO9-5 Record the issuance of bonds and related interest.
LO9-6 Record the retirement of bonds.
Issuance – Part B illustrates the recording of bonds issued at face value, at a discount, and at a
Chapter 09 - Long-Term Liabilities
9-3
premium. This discussion teaches students the important concept of the time value of money,
even without calculating the present value. The Decision Maker’s Perspective provides
additional insights into why the issue price of a bond decreases as the market rate increases, and
vice versa.
Interest Payments – Interest expense is calculated based on the effective interest method, to be
consistent with GAAP. The straight-line interest method is not covered, because this method is
not GAAP. Also, introducing multiple methods adds confusion for students.
• Illustration 9-6 (with video) for discounts and Illustration 9-7 (with video) for premiums
Retirement – Part B concludes with recording the retirement of bonds, including a Decision
Maker’s Perspective explaining why a company may choose to buy back debt early.
PART C: Pricing a Bond
LO9-7 Calculate the issue price of a bond.
Some instructors feel strongly that students need to understand how to price a bond and that
pricing a bond provides a key example of present value concepts. Part C provide the details of
ANALYSIS
LO9-8 Assess the impact of long-term debt on risk and return.
Chapter 09 - Long-Term Liabilities
9-4
fall below the rate charged on borrowed funds, PepsiCo’s greater leverage will result in a lower
overall return to shareholders. That’s where the risk of borrowing comes in.
Using leverage to maximize profits is an essential and interesting business practice. Ask
students how much money they would borrow with an 8% interest rate if they were certain to
earn a 10% return by investing that borrowed amount. They should answer an infinite amount,
Self-Study Materials
■ Let’s Review—Record the issuance of bonds and related interest (p. 454).
■ Let’s Review—Calculate the issue price of a bond (p. 462).
Chapter 09 - Long-Term Liabilities
9-5
Key Points by Learning Objective
Throughout the chapter, Key Points provide quick synopses of the critical pieces of information
LO9-1 Explain financing alternatives.
Companies obtain external funds through debt financing (liabilities) and equity financing
LO9-2 Account for installment notes payable.
Most notes payable require periodic installment payments. Each installment payment includes an
LO9-3 Understand the balance sheet effects of leases.
LO9-4 Identify the characteristics of bonds.
The distinguishing characteristics of bonds include whether they are backed by collateral
LO9-5 Determine the price of a bond issue.
The issue price of a bond is equal to the present value of the face amount (principal) payable at
LO9-6 Account for the issuance of bonds.
When bonds issue at face amount, the carrying value and the corresponding interest expense
LO9-7 Record the retirement of bonds.
Chapter 09 - Long-Term Liabilities
9-6
No gain or loss is recorded on bonds retired at maturity. For bonds retired before maturity, we
Analysis
LO9-8 Make financial decisions using long-term liability ratios.
The debt to equity ratio is a measure of financial leverage. Assuming more debt (higher leverage)
Chapter 09 - Long-Term Liabilities
9-7
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Questions
Learning
Objective(s)
Topic
Time
(Min.)
1
LO9-1
Define capital structure
5
2
LO9-1
Compare borrowing with issuing stock
5
3
LO9-2
Relate interest expense to the carrying value of an
5
8
LO9-4
Define convertible bonds and explain how they
might benefit the investor and the issuer
5
10
LO9-5
Describe the difference in bond terms
5
11
LO9-5
Explain the relationship between the stated interest
rate and the market interest rate for bonds issued at
a discount
5
schedule are calculated
18
LO9-6
Explain why a company would choose to buy back
bonds before their maturity date
5
19
LO9-6
Describe the entry to record the early retirement of
bonds
5
Chapter 09 - Long-Term Liabilities
9-8
Brief
Exercises
Learning
Objective(s)
Topic
Time
(Min.)
BE9-1
LO9-2
Record installment notes
10
BE9-2
LO9-2
Record installment notes
10
BE9-3
LO9-3
Record leases
5
BE9-4
LO9-3
Understand balance sheet effect of leases
5
annual interest
BE9-10
LO9-5
Record bond issue at a discount and related annual
interest
10
BE9-11
LO9-5
Record bond issue at a premium and related annual
interest
10
BE9-12
LO9-5
Calculate interest expense
5
BE9-13
LO9-5
Calculate interest expense
5
Exercises
Learning
Objective(s)
Topic
Time
(Min.)
E9-1
LO9-1
Compare financing alternatives
10
E9-2
LO9-2
Record installment notes
15
E9-3
LO9-2
Record installment notes
20
Chapter 09 - Long-Term Liabilities
9-9
E9-14
LO9-5
Record bonds issued at face amount and related
annual interest
20
E9-15
LO9-5
Record bonds issued at a discount and related
annual interest
20
E9-16
LO9-5
Record bonds issued at a premium and related
annual interest
20
E9-17
LO9-6
Record the early retirement of bonds issued at a
discount
20
Problems
Learning
Objective(s)
Topic
Time
(Min.)
P9-1A
LO9-2
Record and analyze installment notes
25
P9-2A
LO9-2
Prepare an amortization schedule and record
installment notes
25
P9-7A
LO9-5, 9-7
Calculate the issue price of a bond and prepare
amortization schedules
30
P9-8A
LO9-8
Calculate and analyze ratios
30
P9-1B
LO9-2
Record and analyze installment notes
25
Chapter 09 - Long-Term Liabilities
9-10
Additional
Perspectives
Topic
Time
(Min.)
AP9-1
Continuing Problem: Great Adventures
20
AP9-2
Financial Analysis: American Eagle Outfitters, Inc.
25
Chapter 09 - Long-Term Liabilities
9-11
Alternate Let’s Review
Problem #1
Assume that on January 1, 2021, Adventure Island issues $500,000 of 8% bonds, due in 10
years, with interest payable semi-annually on June 30 and December 31 each year.
Required:
1. If the market rate is 8%, the bonds will issue at $500,000. Record the bond issue on January
1, 2021, and the first two semi-annual interest payments on June 30, 2021, and December 31,
2021.
Solution:
1.
January 1, 2021
Debit
Credit
Cash
500,000
Bonds Payable
500,000
(Bond issue at face amount)
2.
January 1, 2021
Debit
Credit
Cash
467,480
Discount on Bonds Payable
32,520
Chapter 09 - Long-Term Liabilities
3.
January 1, 2021
Debit
Credit
Cash
535,531
Bonds Payable
500,000
Premium on Bonds Payable
35,531
(Bond issue at a premium)
Chapter 09 - Long-Term Liabilities
9-13
Problem #2
Assume that on January 1, 2021, Adventure Island issues $500,000 of 8% bonds, due in 10
years, with interest payable semi-annually on June 30 and December 31 each year.
Required:
1. If the market rate is 8%, will the bonds issue at face amount, a discount, or a premium?
Solution:
1. If the market rate is 8%, the bonds will issue at face amount.
Calculator Input
Bond
Characteristics
Key
Amount
1. Face amount
FV
$500,000
Calculator Output
Issue price
PV
$500,000
Present value of principal = $500,000 × 0.45639*
$228,195
Present value of interest payments = $20,0001 × 13.59033**
271,807
2. If the market rate is 9%, the bonds will issue at a discount. The only change we make is that
now I = 4.5% rather than 4%.
Chapter 09 - Long-Term Liabilities
9-14
Calculator Input
Bond
characteristics
Key
Amount
1. Face amount
FV
$500,000
Present value of principal = $500,000 × 0.41464*
$207,321
Present value of interest payments = $20,0001 × 13.00794**
260,159
3. If the market rate is 7%, the bonds will issue at a premium. The only change we make is that
now I = 3.5%.
Calculator Input
Bond
characteristics
Key
Amount
1. Face amount
FV
$500,000
Present value of principal = $500,000 × 0.50257*
$251,285
Present value of interest payments = $20,0001 × 14.21240**
284,248
Chapter 09 - Long-Term Liabilities
9-15
Common Mistakes
Common Mistakes made by students are highlighted in each of the chapters. With greater
awareness of the potential pitfalls, student can avoid making the same mistakes and gain a deeper
understanding of the chapter material.
Common Mistake
Students sometimes incorrectly record interest expense using the stated rate rather than the
Common Mistake
The interest rate we use to calculate the bond issue price is always the market rate, never the
Chapter 09 - Long-Term Liabilities
9-16
Decision Points and Decision Maker’s Perspective
Decision Points and Decision Maker’s Perspectives are provided throughout each chapter to give
insight into how measurement and communication of financial accounting information help
decision makers.
Decision Points
Question
Accounting Information
Analysis
How do you
Balance sheet
A debt capital structure would have a
Question
Accounting Information
Analysis
Does the company
Disclosure of lease
Operating lease commitments are not
Question
Accounting Information
Analysis
Which company has
higher leverage?
Debt to equity ratio
Debt to equity is a measure of
financial leverage. Companies with
more debt will have a higher debt to
equity ratio and higher leverage.
Question
Accounting Information
Analysis
Chapter 09 - Long-Term Liabilities
9-17
Decision Maker’s Perspective
Why Do Many Companies Lease Rather Than Buy?
1. Leasing reduces the upfront cash needed to use an asset. Instead of paying cash upfront for
the full purchase of an asset, only the first month’s lease payment is needed to begin using the
asset. This is especially important for companies that have high credit risk and may not be
able to borrow enough cash to purchase an asset.
2. Lease payments often are lower than installment payments. Lease payments often are tied
Carrying Value and Market Value
Is the carrying value of bonds payable reported in the balance sheet really what the bonds are
worth? Yes, but only on the date issued and on the final maturity date. Between these two dates,
Chapter 09 - Long-Term Liabilities
9-18
Why Buy Back Debt Early?
In the example above, California Coasters recorded a loss of $7,476 due to a decrease in market
interest rates of 1%. One way a company can protect itself from decreases in interest rates is to
include a call feature allowing the company to repurchase bonds at a fixed price (such as 2%
Chapter 09 - Long-Term Liabilities
9-19
Ethical Dilemma
On January 1, 2020, West-Tex Oil issued $50 million of 8% bonds maturing in 10 years. The
market interest rate on the issue date was 9%, which resulted in the bonds being issued at a
discount. In December 2021, Tex Winters, the company CFO, notes that in the two years since
the bonds were issued, interest rates have fallen almost 3%. Tex suggests that West-Tex might
Bond prices move in the opposite direction of interest rates. When interest rates decrease, bond
prices increase. This makes the debt more expensive, resulting in a loss on repurchase equal to
the difference between the higher repurchase price and the current carrying value of the bonds.
Key Issues
• Is it ethical to time the repurchase of bonds to help meet earnings targets?
Option 1: Repurchase the bonds and reissue new bonds at the lower interest rates in 2021
• Interest rates have fallen almost 3% in 2021. Interest rates may go back up if they wait
Option 2: Wait until 2022 to repurchase the bonds
• By waiting until 2022, the company can meet earnings targets in 2021. Missing an
