Long-Term Liabilities pptx

Bonds: An Introduction• A bond is an interest bearing long-term note payable.. July 1Paid semiannual interest and amortized discount on bonds payable Straight-Line Amortization of Bond D

Long-Term Liabilities

Chapter

15

Bonds: An Introduction

• A bond is an interest bearing long-term note payable

• Bonds are groups of notes payable issued

to multiple lenders called bondholders

– principal

– interest rate

Types of Bonds

Term bonds

Serial bonds

Secured or mortgage bonds

Debenture bonds

Present Value

• The amount invested today receives a

greater amount at a future date which is

called the present value of a future amount

• It depends upon

– the amount of the future receipt

– the length of time to the future receipt

Issuing Bonds Payable

Issuing Bonds Payable

Issuing Bonds and Notes Payable

Between Interest Dates

• On March 31, Granite Corp sells

$1,0000,000 of 10%, 10-year bonds dated January 1

March 31

Issuing Bonds and Notes Payable Between Interest Dates

• What is the July 1 interest expense?

A 10-year, $1,000,000 bond issue is sold by

Granite Corp at 99¼ on January 1

The contract rate of interest is 10% (20 periods)

Account for bonds payable

Transactions.

Objective 1

Straight-Line Amortization

of Bond Discount

• This method amortizes the bond discount

by dividing it into equal amounts for each interest period

• Granite Corp would amortize the $7,500 discount over 20 periods

• $7,500 ÷ 20 = $375 per period

July 1

Paid semiannual interest and amortized discount

on bonds payable

Straight-Line Amortization

of Bond Discount

Granite Corp sold a 10%, 10-year (20 periods),

$1,000,000 bond issue at a price of 101 on Jan 1

Issuing Bonds Payable

at a Premium

Issuing Bonds Payable

at a Premium

Granite Balance Sheet(immediately after issuance of the bonds)

Long-term liabilities:

Bonds payable, 10%, due 20xx $1,000,000

July 1

Paid semiannual interest and amortized

premium on bonds payable

Straight-Line Amortization

of Bond Premium

Granite Balance Sheet (December 31)

Long-term liabilities:

Bonds payable, 10%, due 20xx $1,000,000

$1,009,000

Reporting Bonds Payable

Adjusting Entries for Interest

Expense

• San Antonio Corporation issued $150,000

of its 8%, 10-year bonds at a $3,000 discount

Adjusting Entries for Interest

Adjusting Entries for Interest

Expense

December 31, 2002

Accrued three months’ interest and

amortized discount on bonds payable

Adjusting Entries for Interest

Discount on Bonds Payable 75

Paid semiannual interest, part of which

Measure interest expense by the effective-interest method.

Objective 2

Effective-Interest Method

of Amortization

• The effective-interest method keeps

interest expense at the same percentage over any bond’s life

• Generally accepted accounting principles require that interest expense be measured

Effective-Interest Method:

Bond Discount

• Assume that Granite Corp issues $100,000

of its 9% bonds at a discount of $3,851, at a time when the market rate of interest is 10%

• These bonds mature in five years and pay

interest semiannually

Effective-Interest Method:

Bond Discount

Effective-Interest Method:

Bond Premium

• Assume the Granite Corp issues a

$100,000, 5-year, 9% bond to yield 8%,

at a premium of $4,100

• The first period interest expense is

computed as follows:

• $104,100 × 8% × 6/12 = $4,164

Effective-Interest Method:

Bond Premium

Account for retirement and

conversion

of bonds payable.

Objective 3

Retirement of Bonds Payable

• To retire a bond early, the issuer can

– purchase the bonds in the open market, or– exercise a call option

bond issuer to redeem the bonds at a

specified price (usually a few points over par) on or after a specified date

Retirement of Bonds Payable

Example

$500,000 of 12% bonds with an unamortized premium

of $20,000 are purchased for $498,000 and retired

Convertible Bonds and Notes

• Convertible bonds and notes give the

holder the option of exchanging the bond for a specified number of shares of

common stock

• If a bond issue or a note payable is

converted into common stock,

stockholders’ equity is increased by the

Current Portion of Long-Term

Report Liabilities on the

Balance Sheet Objective 4

Report Liabilities on the

Balance Sheet

• Notes payable and bonds payables are

reported as liabilities on the balance sheet

as either current or long-term

Current Liabilities:

Notes payable, current………$200,000Long-term Liabilities

Show the advantages and disadvantages of borrowing.

Objective 5

•Equity financing creates

not dilute control.

earnings per share.

income and may impose financial restrictions

Issuing Bonds versus Stock

Advantage of Issuing Bonds

versus Stock Example

• Suppose that Granite Corp., with net

income of $300,000 and with 100,000

shares of common stock outstanding, needs

$500,000 for expansion

• Money can be borrowed at 10% interest

• The income tax rate is 40%

Advantage of Issuing Bonds

versus Stock Example

• 50,000 shares of common stock can be

Advantage of Issuing Bonds

versus Stock Example

Borrow $500,000

Expected net income on the new project $200,000

Advantage of Issuing Bonds

versus Stock Example

Issue 50,000 shares of common stock at $10 per share

Expected net income on the new project $200,000

Advantage of Issuing Bonds

versus Stock Example

Borrow $500,000:

$390,000 ÷ 100,000 = $3.90 earnings per share

Issue $500,000 of common stock:

$420,000 ÷ 150,000 = $2.80 earnings per share

Time Value of Money

• What is the present value of $4,500 interest

to be received for 10 periods at 5%?

• The present value annuity table indicates that 7.722 is the factor for 10 periods at

5%

• The present value of the future interest is

$4,500 × 7.722 = $34,749.

• What is the present value of a lump sum of

$100,000, 10 periods from now at 5%?

• The present value table indicates that 614

is the factor to be used in determining the value of $100,000 to be received 10

periods from now at 5%

• $100,000 × 614 = $61,400

Total present value = $34,749 + $61,400 = $96,149What is the total present value of these amounts?

Appendix

• What is the present value of $4,500 interest

to be received for 10 periods at 4%?

• The present value annuity table indicates that 8.111 is the factor for 10 periods at

4%

• The present value of the future interest is

$4,500 × 8.111 = $36,500.

• What is the present value of a lump sum of

$100,000, 10 periods from now at 4%

• The present value table indicates that 676

is the factor to be used in determining the value of $100,000 to be received 10

periods from now at 4%

• $100,000 × 676 = $67,600

Total present value = $36,500 + $67,600 = $104,100What is the total present value of these amounts?

End of Chapter

15