Accounting principles 8th weygars kieso kimmel chapter 15

Chapter 15-4 Issuing bonds at face value Discount or premium Issuing bonds at a discount Issuing bonds at a premium Bonds Basics Accounting for Bond Issues Accounting for Bond Issues

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1. Explain why bonds are issued.

2. Prepare the entries for the issuance of bonds and

6. Identify the methods for the presentation and

analysis of long-term liabilities

Study Objectives

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Chapter

15-4

Issuing bonds

at face value Discount or premium Issuing bonds

at a discount Issuing bonds

at a premium

Bonds Basics

Accounting for Bond Issues

Accounting for Bond Retirements

Accounting for Other Long-Term Liabilities

Statement Presentation and Analysis

Converting bonds into common stock

Long-term notes payable Lease

liabilities

Presentation Analysis

Long-Term Liabilities Long-Term Liabilities

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Bonds are a form of interest-bearing notes

payable.

Three advantages over common stock:

Bond Basics

1. Stockholder control is not affected

2. Tax savings result

3. Earnings per share may be higher

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The major disadvantages resulting from the use of

bonds are:

a. that interest is not tax deductible and the

principal must be repaid

b. that the principal is tax deductible and interest

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Chapter

15-8

Types of Bonds

Secured and Unsecured (debenture) bonds

Term and Serial bonds

Registered and Bearer (or coupon) bonds

Convertible and Callable bonds

Bond Basics

LO 1 Explain why bonds are issued.

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Issuing Procedures

Bond contract known as a bond indenture.Represents a promise to pay:

(1) sum of money at designated maturity date, plus

(2) periodic interest at a contractual (stated) rate

on the maturity amount (face value)

Paper certificate, typically a $1,000 face value

Interest payments usually made semiannually

Generally issued when the amount of capital needed

Bond Basics

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Issuer of Bonds

Maturity Date

Illustration 15-3

Contractual Interest Rate

Face or Par Value Face or Par Value

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Bond Trading

Bonds traded on national securities exchanges

Newspapers and the financial press publish bond prices and trading activity daily

Bond Basics

Read as: Outstanding 5.125%, $1,000 bonds that mature in

2011 Currently yield a 5.747% return On this day,

$33,965,000 of these bonds were traded Closing price was

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Chapter

15-12

Determining the Market Value of Bonds

Market value is a function of the three factors that

determine present value:

1 the dollar amounts to be received,

2 the length of time until the amounts are received,

and

3 the market rate of interest

Bond Basics

LO 1 Explain why bonds are issued.

The features of a bond (callable, convertible, and so

on) affect the market rate of the bond

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8%

10%

Premium Face Value Discount

Assume Contractual Rate of 8%

Bonds Sold At Market Interest

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Chapter

15-14 LO 2 Prepare the entries for the issuance of bonds and interest expense.

The rate of interest investors demand for loaning

funds to a corporation is the:

a. contractual interest rate

b. face value rate

c. market interest rate

d. stated interest rate

Question

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Karson Inc issues 10-year bonds with a maturity value

of $200,000 If the bonds are issued at a premium,

this indicates that:

a the contractual interest rate exceeds the market

interest rate

b the market interest rate exceeds the contractual

interest rate

c the contractual interest rate and the market

interest rate are the same

d no relationship exists between the two rates.

Question

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Chapter

15-16

Illustration: On January 1, 2008, San Marcos HS

issues $100,000, three-year, 8% bonds at 100 (100% of face value) Interest is paid annually each Dec 31

Issuing Bonds at Face Value

LO 2 Prepare the entries for the issuance of bonds and interest expense.

Bonds payable 100,000Dec 31 Interest expense 8,000

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issues $100,000, three-year, 8% bonds for $95,027

(95.027% of face value)

Issuing Bonds at a Discount

Discount on bonds payable 4,973

Bonds payable 100,000

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Balance Sheet (partial)

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Discount on Bonds Payable:

a. has a credit balance

b. is a contra account

c. is added to bonds payable on the balance sheet

d. increases over the term of the bonds

Question

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Chapter

15-20

issues $100,000, three-year, 8% bonds for $105,346

(105.346% of face value)

Issuing Bonds at a Premium

Premium on bonds payable 5,346Bonds payable 100,000

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Balance Sheet (partial)

Issuing bonds at an amount different from face value is

quite common By the time a company prints the bond

certificates and markets the bonds, it will be a coincidence

if the market rate and the contractual rate are the same.

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Chapter

15-22

Redeeming Bonds at Maturity

LO 3 Describe the entries when bonds are redeemed or converted.

San Marcos HS records the redemption of its bonds at maturity as follows:

Bonds payable 100,000

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Redeeming Bonds before Maturity

When a company retires bonds before maturity, it is

necessary to:

1 eliminate the carrying value of the bonds at the

redemption date;

2 record the cash paid; and

3 recognize the gain or loss on redemption

The carrying value of the bonds is the face value of the

bonds less unamortized bond discount or plus unamortized

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Chapter

15-24 LO 3 Describe the entries when bonds are redeemed or converted.

When bonds are redeemed before maturity, the gain

or loss on redemption is the difference between the cash paid and the:

a. carrying value of the bonds

b. face value of the bonds

c. original selling price of the bonds

d. maturity value of the bonds

Question

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Illustration: The San Marcos HS, 8% bonds of

$100,000 issued on Jan 1, 2008, are recalled at 105 on Dec 31, 2009 Assume that the carrying value of the

bonds at the redemption date is $98,183

Journal entry at Dec 31, 2009:

Bonds payable 100,000Loss on bond redemption 6,817

Cash ($100,000 x 105%) 105,000Discount on bonds payable 1,817

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Chapter

15-26

Converting Bonds into Common Stock

Until conversion, the bondholder receives interest on

the bond

For the issuer, the bonds sell at a higher price and pay

a lower rate of interest than comparable debt

securities without the conversion option

Upon conversion, the company transfers the carrying

value of the bonds to paid-in capital accounts No gain

or loss is recognized

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E15-6 Nocioni Company issued $1,000,000 of bonds on January 1, 2008.

Instructions: Prepare the journal entry to record the

conversion of the bonds into 30,000 shares of $10 par value common stock Assume the bonds were issued at par

Bonds payable 1,000,000

Common stock (30,000 x $10) 300,000Paid-in capital in excess of par 700,000

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Chapter

15-28

When bonds are converted into common stock:

a. a gain or loss is recognized

b. the carrying value of the bonds is transferred

to paid-in capital accounts

c. the market price of the stock is considered in

the entry

d. the market price of the bonds is transferred to

paid-in capital

Question

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Long-Term Notes Payable

May be secured by a mortgage that pledges title to

specific assets as security for a loan Typically, the terms require the borrower to make installment payments over the term of the loan Each payment consists of

1 interest on the unpaid balance of the loan and

2 a reduction of loan principal.

Companies initially record mortgage notes payable at

Accounting for Other Long-Term Liabilities Accounting for Other Long-Term Liabilities

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Chapter

15-30

Exercise: Tucki Co receives $240,000 when it issues a

$240,000, 10%, mortgage note payable to finance the

construction of a building at December 31, 2008 The terms provide for semiannual installment payments of $16,000 on

June 30 and December 31 Prepare the journal entries to

record the mortgage loan and the first installment payment.

Mortgage notes payable 240,000

Jun 30 Interest expense 12,000

Mortgage notes payable 4,000

* ($240,000 x 10% x 6/12 = $12,000)

LO 4 Describe the accounting for long-term notes payable.

*

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Each payment on a mortgage note payable consists

of:

a. interest on the original balance of the loan

b. reduction of loan principal only

c. interest on the original balance of the loan and

reduction of loan principal

d. interest on the unpaid balance of the loan and

reduction of loan principal

Question

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Operating Lease Capital Lease

The issue of how to report leases is the case of substance versus

form Although technically legal title may not pass, the benefits

from the use of the property do.

Statement of Financial Accounting Standard No 13, “Accounting

A lease that transfers substantially all of the benefits and risks of property ownership should be capitalized (only noncancellable leases may be capitalized).

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Chapter

15-34

To capitalize a lease, one or more of four criteria

must be met:

1. Transfers ownership to the lessee

2. Contains a bargain purchase option

3. Lease term is equal to or greater than 75 percent

of the estimated economic life of the leased property

4. The present value of the minimum lease payments

(excluding executory costs) equals or exceeds 90 percent of the fair value of the leased property

LO 5 Contrast the accounting for operating and capital leases.

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Exercise: On January 1, 2008, Burke Corporation signed a

5-year noncancelable lease for a machine The machine has

an estimated useful life of 6 years and the present value of the lease payments is $36,144, which is equal to the fair

market value of the equipment There is no transfer of

ownership during the lease term, nor is there any bargain

purchase option.

Instructions

(a) What type of lease is this? Explain.

(b) Prepare the journal entry to record the lease on January

1, 2008.

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NO NO

Capital Lease?

LO 5 Contrast the accounting for operating and capital leases.

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Exercise: (b) Prepare the journal entry to record the

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b. contains any purchase option

c. term is 75% or more of the useful life of the

leased property

d. payments equal or exceed 90% of the fair

market value of the leased property

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Statement Analysis and Presentation

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Chapter

15-40

Analysis of Long-Term Debt

Two ratios that provide information about

debt-paying ability and long-run solvency are:

Total debtTotal assets

Debt to total assets =

The higher the percentage of debt to total assets,

the greater the risk that the company may be

unable to meet its maturing obligations

1.

LO 6 Identify the methods for the presentation

and analysis of long-term liabilities.

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Analysis of Long-Term Debt

Two ratios that provide information about

debt-paying ability and long-run solvency are:

Income before income taxes

and interest expenseInterest expense

Times interest

Indicates the company’s ability to meet interest

payments as they come due

2.

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Chapter

15-42

To illustrate present value concepts, assume that you are willing to invest a sum of money that will yield

$1,000 at the end of one year, and you can earn 10%

on your money What is the $1,000 worth today?

To compute the answer, divide the future amount by

1 plus the interest rate ($1,000/1.10 = $909.09

Present Value Concepts Related to Bond Pricing

LO 7 Compute the market price of a bond.

Illustration 15A-1

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To illustrate present value concepts, assume that you are willing

to invest a sum of money that will yield $1,000 at the end of

one year, and you can earn 10% on your money What is the

$1,000 worth today?

To compute the answer, divide the future amount by 1 plus the interest rate ($1,000/1.10 = $909.09 or use a Present Value of

1 table ($1,000 X 90909) = $909.09 (10% per period, one

period from now)

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Chapter

15-44

The selling price of a bond is equal to the

sum of two items :

1) The present value of the face value of the

bond discounted at the investor’s required rate of return

PLUS

2) The present value of the periodic interest

payments discounted at the investor’s required rate of return

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Assume 10%, 5-year bonds with a face value of $100,000 are sold and the investor’s required rate of return is 10% Interest payments are made semiannually.

Present Value Concepts Related to Bond Pricing Present Value Concepts Related to Bond Pricing

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Chapter

15-46

Assume 10%, 5-year bonds with a face value of $100,000 are sold and the investor’s required rate of return is 12% Interest is paid semiannually.

The 55839 factor is from the present value of 1 table for 10

periods at 6% per period The 7.36009 factor is from the present value of an annuity table for 10 periods at 6% per period.

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Under the effective-interest method, the

amortization of bond discount or bond premium

results in period interest expense equal to a constant percentage of the carrying value of the bonds The follow steps are required under the effective-

interest method

Effective-Interest Method of Bond Amortization Effective-Interest Method of Bond Amortization

1 Compute the bond interest expense

2 Compute the bond interest paid or accrued

3 Compute the amortization amount

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