14

Long-Term Liabilities
Bonds Payable

Basic Characteristics of Debt

Stated amount (principal or par)

Interest rate(s) Fixed Variable

Interest payment dates Maturity date(s) [Principal payment

date(s)]
Term--single maturity date Serial--multiple maturity dates

Bonds Payable
Key terms

Par (principal/face value) of the bond Stated/face interest rate--determines periodic cash interest payments Market/effective interest rate--rate of return required by the market Maturity date and interest period

Bonds Payable
Bonds can be issued at:

par--face interest rate = market interest rate discount--face interest rate < market interest rate premium--face interest rate > market interest rate Amortization of premium or discount Straight line method Effective interest method

Straight-line Amortization
Not GAAP if it yields results which

are materially different from the effective interest method. Yields a constant dollar amount of interest even though the carrying value of the debt is changing.

Effective Interest Method

Yields a constant rate of interest on a

changing carrying value of the debt.

Computation of Interest Expense

When bonds are issued at a discount

Interest paid + discount amortized

When bonds are issued at a premium

Interest paid - premium amortized

Issuance of Bonds & Interest Transactions (Exercise 3, Part 1)

1/1/14 Cash

200,000

Bonds Payable
7/1/14

200,000

Interest Expense 4,500 Cash 4,500 ($200,000 X 9% X 3/12) Quarterly interest 4,500

12/31/14 Interest Expense

Interest Payable 4,500 (Year end adjusting journal entry)

Issuing Bonds at a Discount Brief Exercise 3

Cash (98%x$300,000)

Discount on Bond Payable Bond Payable

Interest Expense

294,000 6,000 300,000 15,600 15,000 600

Cash Discount on Bond Payable ($6,000/10 = 600)

Issuing Bonds at a Discount Brief Exercise 3

Interest Expense

15,600
15,000 600

Interest Payable Discount on Bond Payable ($6,000/10 = $600)

Issuing Bonds at a Premium Exercise 4

1/1/14 Cash (600,000 X 102%) 612,000 Bonds Payable 600,000 Premium on Bond Payable 12,000 Interest Expense 29,700 Premium on Bond Payable 300 Cash 30,000 ($12,000/40 = $300) (600,000 X 10% X6/12)

7/1/14

12/31/14 Interest Expense 29,700 Premium on Bond Payable 300 Interest Payable

30,000

Aumont Company
Exercise 14 - 10 Issuance of Bonds at a Premium--Effective Interest Method

Determination of Proceeds
Interest Paid: Par value X Face rate Interest Paid: $500,000 X 12% = $60,000 n=5 i = 10% (market)
Principal: $500,000 X .62092 = $ 310,460
Interest:

$ 60,000 X 3.79079 = 227,447 PROCEEDS $ 537,907

Issuance of the Bonds

1/1/14

Cash
Premium--B/P Bond Payable

537,907
37,907 500,000

Carrying value of the debt at 1/1/14 is $537,907

Amortization of Bond Premium

Interest expense:
Carrying Value of Debt X Market Interest Rate $537,907 X .10 = $ 53,791

December 31, 2014 Interest Expense 53,791 Premium--BP 6,209 Cash

60,000

Balance Sheet Presentation at 12/31/14

Long Term Liabilities: Bonds Payable Premium Carrying Value

$ 500,000 31,698 $ 531,698

Amortization of Bond Premium

Interest expense:
Carrying Value of Debt X Market Interest Rate $ 531,698 X .10 = $ 53,170 (rounded)

December 31, 2015 Interest Expense 53,170 Premium--BP 6,830 Cash

60,000

Balance Sheet Presentation at 12/31/15

Long Term Liabilities: Bonds Payable Premium Carrying Value

$ 500,000 24,868 $ 524,868

Amortization of Bond Premium

Interest expense:
Carrying Value of Debt X Market Interest Rate $524,868 X .10 = $ 52,487 (rounded)

December 31, 2016 Interest Expense 52,487 Premium--BP 7,513 Cash

60,000

Balance Sheet Presentation at 12/31/16

Long Term Liabilities: Bonds Payable Premium Carrying Value

$ 500,000 17,355 $ 517,355

Bond Issue Costs

Reported as a deferred charge, which

is a long-term asset The issue costs are amortized over the term (life) of the bonds
straight-line approach is generally used
Can not be expensed unless the

amount is deemed to lack materiality

Bond Issue Costs: BE 10

January 1, 2014 Unamortized Bond Issue Costs 160,000 Cash December 31, 2014 Interest Expense 16,000 Unamortized Bond Issue Costs ($160,000 X 1/10)

160,000

16,000

Long-Term Debt: Disclosures

Required principal payments in each of

the next five years Restrictive debt covenants Collateral, if any Interest paid (3 years) Capitalized interest (3 years) Available sources of cash
Lines of credit Approved sale of debt securities

Special Characteristics of Debt

Callable debt at the option of the issuer at a predetermined price prior to its maturity date

Convertible debt exchange for stock at the option of the investor at a predetermined rate

Extinguishment of Debt Prior to Maturity

An ordinary gain or loss is reported

in the income statement in the period of the early extinguishment (redemption). Ordinary gain/loss = Reacquisition cost - Carrying value at the date of extinguishment (redemption)

Early Extinguishment: BE 11
Reacquisition cost: $500,000 X 99% = $495,000 Carrying Value: Bond Payable $500,000 Premium--BP 15,000 Unamort. Issue Cost (5,250) 509,750 Gain on Redemption $ 14,750 Bonds Payable 500,000 Premium on Bond Payable 15,000 Unamortized Issue Costs Cash Gain on Redemption of Bonds

5,250 495,000 14,750

Long-term Notes Payable

In substance the same as bonds

Valuation: Present value of the

future cash flows Types of notes

interest bearing at market rate interest bearing at a rate below market non-interest bearing

Non-interest bearing note Exercise 16

January 1, 2014 Land Discount on Note Payable Notes Payable 200,000 137,012 337,012

December 31, 2014 Interest Expense 22,000 Discount on Note Payable ($200,000 X 11%)

22,000

Interest Bearing Note at a Rate Below Market: Exercise 16

Determination of the Present Value of the Note

(Equipment acquisition cost) n = 8 i = 11% 1. Principal ($250,000 X .43393) $ 108,482 2. Interest ($15,000 X 5.14612) 77,192 Present value of the note $ 185,674
Interest Paid: $250,000 X 6% = $15,000

January 1, 2014 Equipment 185,674 Discount on Note Payable 64,326 Notes Payable

250,000

Interest Bearing Note at a Rate Below Market: Exercise 16

Interest Expense: $185,674 X 11% = $20,424 Interest Paid: $250,000 X 6% = $15,000 December 31, 2014 Interest Expense 20,424 Discount on Note Payable 5,424 Cash 15,000

End of Chapter 14