Chapter 10

Reporting and Analyzing

Long-Term Liabilities

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Conceptual Learning Objectives

C1: Explain the types and payment patterns of
notes
C2: Appendix 10A: Explain and compute the
present value of an amount to be paid at a
future date
C3: Appendix 10C: Describe the accrual of
bond interest when bond payments do not
align with accounting periods
C4: Appendix 10D: Describe accounting for
leases
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Analytical Learning Objectives

A1: Compare bond financing with stock
financing
A2: Assess debt features and their
implications
A3: Compute the debt-to-equity ratio and
explain its use

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Procedural Learning Objectives

P1: Prepare entries to record bond
issuance and bond interest expense
P2: Compute and record amortization of
bond discount
P3: Compute and record amortization of
bond premium
P4: Record the retirement of bonds
P5: Prepare entries to account for notes
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A1

Advantages of Bonds
Bonds
Bonds do
do not
not affect
affect
stockholder
stockholder control.
control.
Interest
Interest on
on bonds
bonds is
is
tax
tax deductible.
deductible.
Bonds
Bonds can
can increase
increase
return
return on
on equity.
equity.

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A1

Disadvantages of Bonds

Bonds
Bonds require
require payment
payment of
of both
both
periodic
periodic interest
interest and
and par
par value
value at
at
maturity.
maturity.
Bonds
Bonds can
can decrease
decrease return
return on
on
equity
equity when
when the
the company
company pays
pays
more
more in
in interest
interest than
than itit earns
earns on
on
the
the borrowed
borrowed funds.
funds.
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A1

Bond Trading
Bond market values
are expressed as a
percent of their par
value.

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A1

Bond Issuing Procedures

A company sells the

bonds to. . .

. . . investors
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. . .an investment firm

called an underwriter.
The underwriter sells
the bonds to. . .
A trustee
monitors
the bond
issue.
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A1

Basics of Bonds

Investors

Corporation
Bond Selling Price

Bond Certificate
at Par Value

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A1

Basics of Bonds
Bond Interest Payments

Corporation

Investors
Bond Interest Payments

Bond Issue
Date
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Interest Payment =
Bond Par Value Stated Interest Rate
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A2

Basics of Bonds
Bond Par Value
at Maturity Date

Corporation

Bond Issue
Date
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Investors

Bond
Maturity
Date

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P1

Issuing Bonds at Par

King
King Co.
Co. issues
issues the
the following
following bonds
bonds on
on January
January 1,
1, 2008
2008
Par
Par Value
Value == $1,000,000
$1,000,000
Stated
Stated Interest
Interest Rate
Rate == 10%
10%
Interest
Interest Dates
Dates == 6/30
6/30 and
and 12/31
12/31
Bond
Bond Date
Date == Jan.
Jan. 1,
1, 2008
2008
Maturity
Maturity Date
Date == Dec.
Dec. 31,
31, 2027
2027 (20
(20 years)
years)

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P1

Issuing Bonds at Par

The
The entry
entry on
on June
June 30,
30, 2008,
2008, to
to record
record the
the
first
first semiannual
semiannual interest
interest payment
payment is
is .. .. ..

$1,000,000
$1,000,000 10%
10%
year
year == $50,000
$50,000
This
This entry
entry is
is made
made every
every six
six months
months until
until
the
the bonds
bonds mature.
mature.
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P1

Issuing Bonds at Par

On
On Dec.
Dec. 31,
31, 2027,
2027, the
the bonds
bonds mature,
mature, King
King
Co.
Co. makes
makes the
the following
following entry
entry .. .. ..

The debt has now been

extinguished.
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Bond Discount or Premium

P1

Contract rate is:

Above market rate
Equal to market rate
Below market rate

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Bond sells:
At a premium
At par value
At a discount

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P2

Issuing Bonds at a Discount

Prepare
Prepare the
the entry
entry for
for Jan.
Jan. 1,
1, 2008,
2008, to
to record
record the
the
following
following bond
bond issue
issue by
by Rose
Rose Co.
Co.
Par
Par Value
Value == $1,000,000
$1,000,000
Issue
Issue Price
Price == 92.6405%
92.6405% of
of par
par value
value
Stated
Stated Interest
Interest Rate
Rate == 10%
10% Bond will sell at a discount.
Market
Market Interest
Interest Rate
Rate == 12%
12%
Interest
Interest Dates
Dates == 6/30
6/30 and
and 12/31
12/31
Bond
Bond Date
Date == Jan.
Jan. 1,
1, 2008
2008
Maturity
Maturity Date
Date == Dec.
Dec. 31,
31, 2012
2012 (5
(5 years)
years)

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P2

Issuing Bonds at a Discount

Cash
Cash
Proceeds
Par
Discount
Proceeds
Par Value
Value
Discount
$$1,000,000
1,000,000 -- $$926,405
926,405 == $$ 73,595
73,595

$1,000,000
$1,000,000 92.6405%
92.6405%
Amortizing
Amortizing the
the discount
discount increases
increases
Interest
Interest Expense
Expense over
over the
the outstanding
outstanding
life
life of
of the
the bond.
bond.
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P2

Issuing Bonds at a Discount

On
On Jan.
Jan. 1,
1, 2008,
2008, Rose
Rose Co.
Co. would
would record
record the
the
bond
bond issue
issue as
as follows.
follows.

Contra-Liability
Account
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P2

Issuing Bonds at a Discount

Maturity Value
Using
Using the
the straight-line
straight-line method,
method, the
the
discount
discount amortization
amortization will
will be
be $7,360
$7,360
every
every six
six months.
months.
$73,595
$73,595 10
10 periods
periods == $7,360*
$7,360*
McGraw-Hill/Irwin

*(rounded)
*(rounded)

Carrying Value

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P2

Issuing Bonds at a Discount

Make
Make the
the following
following entry
entry every
every six
six months
months to
to
record
record the
the cash
cash interest
interest payment
payment and
and the
the
amortization
amortization of
of the
the discount.
discount.

$73,595 10 periods = $7,360 (rounded)

$1,000,000 10% = $50,000
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P2

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P2

Straight-Line and Effective Interest

Methods
Both methods report the same amount of
interest expense over the life of the bond.

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P3

Issuing Bonds at a Premium

Prepare
Prepare the
the entry
entry for
for Jan.
Jan. 1,
1, 2008,
2008, to
to record
record the
the
following
following bond
bond issue
issue by
by Rose
Rose Co.
Co.
Par
Par Value
Value == $1,000,000
$1,000,000
Issue
Issue Price
Price == 108.1145%
108.1145% of
of par
par value
value
Stated
Stated Interest
Interest Rate
Rate == 10%
10% Bond will sell at a premium.
Market
Market Interest
Interest Rate
Rate == 8%
8%
Interest
Interest Dates
Dates == 6/30
6/30 and
and 12/31
12/31
Bond
Bond Date
Date == Jan.
Jan. 1,
1, 2008
2008
Maturity
Maturity Date
Date == Dec.
Dec. 31,
31, 2012
2012 (5
(5 years)
years)

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P3

Issuing Bonds at a Premium

Cash
Cash
Proceeds
Par
Premium
Proceeds
Par Value
Value
Premium
$$1,081,145
1,081,145 -- $$1,000,000
1,000,000 == $$ 81,145
81,145

$1,000,000
$1,000,000
108.1145%
108.1145%
Amortizing
Amortizing the
the premium
premium decreases
decreases Interest
Interest
Expense
Expense over
over the
the life
life of
of the
the bond.
bond.
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P3

Issuing Bonds at a Premium

On
On Jan.
Jan. 1,
1, 2008,
2008, Rose
Rose Co.
Co. would
would record
record the
the
bond
bond issue
issue as
as follows.
follows.

Adjunct-Liability
Adjunct-Liability
Account
Account

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P3

Issuing Bonds at a Premium

Using
Using the
the straight-line
straight-line method,
method, the
the premium
premium
amortization
amortization will
will be
be $8,115
$8,115 every
every six
six months.
months.
$81,145
$81,145 10
10 periods
periods == $8,115
$8,115 (rounded)
(rounded)

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P3

Issuing Bonds at a Premium

This
This entry
entry is
is made
made every
every six
six months
months to
to
record
record the
the cash
cash interest
interest payment
payment and
and the
the
amortization
amortization of
of the
the premium.
premium.

$81,145
$81,145 10
10 periods
periods == $8,115
$8,115 (rounded)
(rounded)
$1,000,000
$1,000,000 10%
10%
== $50,000
$50,000
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P3

McGraw-Hill/Irwin

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C3

Accruing Bond Interest Expense

Jan. 1

End of
accounting
Interest Payment Dates
period
Apr. 1
Oct. 1
Dec. 31
3 months
accrued interest

At
At year-end,
year-end, an
an adjusting
adjusting entry
entry isis necessary
necessary to
to
recognize
recognize bond
bond interest
interest expense
expense accrued
accrued since
since
the
the most
most recent
recent interest
interest payment.
payment.
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C2

Present Value of a Discount Bond

Calculate
Calculate the
the issue
issue price
price of
of Rose
Rose Inc.s
Inc.s bonds.
bonds.
Par
Par Value
Value == $1,000,000
$1,000,000
Issue
Issue Price
Price == ??
Stated
Stated Interest
Interest Rate
Rate == 10%
10%
Market
Market Interest
Interest Rate
Rate == 12%
12%
Interest
Interest Dates
Dates == 6/30
6/30 and
and 12/31
12/31
Bond
Bond Date
Date == Jan.
Jan. 1,
1, 2008
2008
Maturity
Maturity Date
Date == Dec.
Dec. 31,
31, 2012
2012 (5
(5 years)
years)

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C2

Present Value of a Discount Bond

Cash Flow
Par value of the bond
Interest (annuity)

Table
PV of $1
PV of an
Annuity of $1

Table
Present
Value
Amount
Value
0.5584 $ 1,000,000 $ 558,400
7.3601

50,000

Price of bond

368,005
$ 926,405

1.
1. Semiannual
Semiannual rate
rate == 6%
6% (Market
(Market rate
rate 12%
12% 2)
2)
2.
2. Semiannual
Semiannual periods
periods == 10
10 (Bond
(Bond life
life 55 years
years 2)
2)
$1,000,000 10% = $50,000
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P4

Bond Retirement

At Maturity

Before Maturity

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Carrying Value > Retirement Price = Gain

Carrying Value < Retirement Price = Loss
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P4

Bond Retirement

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The carrying value of the bond at maturity

should equal its par value.
Sometimes bonds are retired prior to their
maturity.
Two common ways to retire bonds are
through the exercise of a callable option or
through purchasing them on the open
market.
Callable bonds present several accounting
issues including calculating gains and losses.
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C1

Long-Term Notes Payable

Are you
ready to
discuss longterm notes
payable?
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C1

Long-Term Notes Payable

Cash

Company

Note
Note Payable
Payable

Lender

When is the repayment of the principal

and interest going to be made?
Note Date
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Note Maturity
Date
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C1

Long-Term Notes Payable

Single Payment of
Principal plus Interest
Company

Lender

Single Payment of
Principal plus
Interest
Note Date
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Note Maturity
Date
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C1

Long-Term Notes Payable

Regular Payments of
Principal plus Interest

Company

Lender

Regular Payments of Principal plus Interest

Note Date
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Payments can either be

equal principal payments
plus interest or equal
payments.

Note Maturity
Date
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C1

Installment Notes with Equal Principal

Payments
Annual
payments
decrease.

The
The principal
principal payments
payments are
are $10,000
$10,000 each
each year.
year.
Interest
Interest expense
expense decreases
decreases each
each year.
year.
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Installment Notes with Equal

Payments

C1

Annual
payments are
constant.

The
The principal
principal payments
payments increase
increase each
each year.
year.
Interest
Interest expense
expense decreases
decreases each
each year.
year.
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Types of Bonds

A2

Secured
Secured and
and
Unsecured
Unsecured
Term
Term and
and
Serial
Serial

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Convertible
Convertible
and
and Callable
Callable
Registered
Registered
and
and Bearer
Bearer

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C1

Mortgage Notes and Bonds

AA legal
legal agreement
agreement that
that helps
helps protect
protect the
the
lender
lender ifif the
the borrower
borrower fails
fails to
to make
make the
the
required
required payments.
payments.

Gives
Gives the
the lender
lender the
the right
right to
to be
be paid
paid out
out of
of
the
the cash
cash proceeds
proceeds from
from the
the sale
sale of
of the
the
borrowers
borrowers assets
assets specifically
specifically identified
identified in
in
the
the mortgage
mortgage contract.
contract.

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A3

Debt-to-Equity Ratio

Debt-toEquity Ratio

Total Liabilities
Total Equity

This ratio helps investors determine the risk of

investing in a company by dividing its total liabilities
by total equity.

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C3

Issuing Bonds Between

Interest Dates

Jan. 1, 2008
Bond Date

Apr. 1, 2008
Bond Issue
Date

June 30, 2008

First Interest
Payment

Accrued interest
Investor pays bond purchase
price + accrued interest.

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C3

Issuing Bonds Between

Interest Dates

Jan. 1, 2008
Bond Date

Apr. 1, 2008
Bond Issue
Date

Accrued interest

June 30, 2008

First Interest
Payment

Earned interest
Investor
receives 6
months
interest.

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C3

Issuing Bonds Between

Interest Dates

Prepare
Prepare the
the entry
entry to
to record
record the
the following
following bond
bond
issue
issue by
by King
King Co.
Co. on
on Apr.
Apr. 1,
1, 2008.
2008.
Par
Par Value
Value == $1,000,000
$1,000,000
Stated
Stated Interest
Interest Rate
Rate == 10%
10%
Market
Market Interest
Interest Rate
Rate == 10%
10%
Interest
Interest Dates
Dates == 6/30
6/30 and
and 12/31
12/31
Bond
Bond Date
Date == Jan.
Jan. 1,
1, 2008
2008
Maturity
Maturity Date
Date == Dec.
Dec. 31,
31, 2012
2012 (5
(5 years)
years)

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C3

Issuing Bonds Between Interest

Dates

At the date of issue the following entry is made:

The first interest payment on June 30, 2005 is:

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End of Chapter 10

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