1. Ch.10 Long-Term Liabilities
Prof. J. Wang

2. Balance Sheet Classification of Liabilities1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 28 29 30 31 27
Current liabilities:
Long-term liabilities:
Due within one year of the balance sheet date
Due beyond one year
LO1

3. Long-Term Liabilities
Bonds payable
Notes payable
Leases
Deferred taxes
Pensions
Postretirement benefits

4. Bonds 1,000 Investor Borrower Long-term borrowing arrangement
due 2019
Investor
Borrower
Interest for
Investor
Borrower
Long-term borrowing arrangement
Interest paid at stated rate and times
Principal repaid at maturity date
LO2

6. Bond Features
Collateralized backed by specific assets in event of default
Debentures backed only by general creditworthiness of issuer

7. Bond Features Term entire principal due on a specific single date
Serial principal repaid in installments over time 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 28 29 30 31 27

8. Bond Features Convertible into common stock
Callable / Redeemable may be retired before maturity date
Common
Stock
1,000

9. Bonds Prices Market rate v. stated rate
Market rate: interest rate offered by similar bonds in the market
Stated rate: interest offered by the specific bonds

10. On Jan. 1, 2006, Johnson Company issued $10,000,000 bonds with a stated interest rate of 10%. The bonds mature in 20 years and interest is paid annually on Jan. 1.

11. Johnson promised two things:
Principal: $10,000,000 paid at maturity
Interest: $1,000,000 paid each year for 20 years (10,000,000x10%)

12. Calculating Bond Prices
(1) Interest payments made each period
PV = ?
etc. $$ $$ $$ $$
(2) Principal due at maturity
PV = ?
$$$$$ 1

13. Investors earn the market interest rate (which is also referred to as the real/effective rate) regardless of the stated rate (which is also referred to as the nominal rate)

14. How much the bonds can be sold for depends on the market interest rate for similar bonds
Discount rate used in the present value calculations is the market interest rate

15. When stated rate is greater than the market rate, the bonds will sold at premium
When stated rate is less than the market rate, the bonds will sold at discount
When stated rate is equal to the market rate, the bonds will sold at face value

16. Compute the price of Johnson’s bonds assume the market interest rate is 12%

17. Calculating Bond Prices
(1) Interest payments (20 $1,000,000)
2006
2007
2008
2009
PV = ?
$1m
$1m
$1m
$1m
(2) Principal of $10,000,000 due at end of 2026
2026
$10,000,000
PV = ? 1

18. payment at stated rate (i.e., 10%)...
Example of Price Calculation
Compute interest
payment at stated rate (i.e., 10%)...
Present value:
Interest payments:
$1,000,000 × = $7,469,000
(PV; n = 20; i = 12%)
Principal payment:
$10,000,000 × = 1,040,000
Bond issue price: $8,509,000
…but
discount
@ market rate 2

19. Recording Bond Discounts
Cash ,509,000
Discount on Bonds Payable 1,491,000
Bonds Payable ,000,000
To record the issuance of bonds payable.
Assets = Liabilities + Owners’ Equity
+8,509,000 –1,491,000
+10,000,000
LO4

20. Balance Sheet Presentation of Bond Discount
Long-term liabilities:
Bonds payable $10,000,000
Less: Discount on bonds payable 1,491,000
$ 8,509,000

21. Determining Bond Prices
Compute the price of Johnson’s bonds assume the market interest rate is 8%

22. payment at stated rate (i.e., 10%)...
Example of Price Calculation
Compute interest
payment at stated rate (i.e., 10%)...
Present value:
Interest payments:
$1,000,000 × = $9,818,000
(PV; n = 20; i = 8%)
Principal payment:
$10,000,000 × = 2,150,000
Bond issue price: $11,968,000
…but
discount
@ market rate 2

23. Recording Bond Premiums
Cash 11,968,000
Bonds Payable ,000,000
Premium on Bonds Payable ,968,000
To record the issuance of bonds payable.
Assets = Liabilities + Owners’ Equity
+11,968, ,000,000
+1,968,000

24. Balance Sheet Presentation of Bond Premium
Long-term liabilities:
Bonds payable $10,000,000
Plus: Premium on bonds payable 1,968,000
$11,968,000

25. Bonds Sold at Face Value
Cash ,000
Bonds Payable 10,000
To record the issuance of bonds at face value.
Face value of bonds = Sales price
When stated rate=market rate

26. Interest Rates and Bond Prices
BONDS ISSUED: IF STATED RATE:
Above face value (at a premium)
At face value
Below face value (at a discount)
> MARKET RATE
= MARKET RATE
< MARKET RATE

27. Amortization of Bond Premiums and Discounts
Transferring an amount from the discount or premium account to interest expense over the life of the bond using the effective interest method
Premium
reduces
interest
expense
Discount
increases
interest
expense
LO5

28. When bonds are issued at discount:
Interest expense = (cash interest) + (discount amortization)
= $1,000,000 + (1,491,000/20)
= $1,074,550
12/31/06
Dr. Interest Expense 1,074,550
Cr. Interest payable 1,000,000
Cr. Discount on B/P ,500
1/1/07
Dr. Interest payable 1,000,000
Cr. Cash 1,000,000

29. Total interest expense during the life of the bonds = 1,000,000
= $21,491,000

30. Prepare appropriate journal entries for Johnson Company when the bonds were issued at premium