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Chapter 10, Slide #1 Ch.10 Long-Term Liabilities Prof. J. Wang.

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Presentation on theme: "Chapter 10, Slide #1 Ch.10 Long-Term Liabilities Prof. J. Wang."— Presentation transcript:

1 Chapter 10, Slide #1 Ch.10 Long-Term Liabilities Prof. J. Wang

2 Chapter 10, Slide #2 Balance Sheet Classification of Liabilities Current liabilities: Long-term liabilities: Due within one year of the balance sheet date Due beyond one year LO1

3 Chapter 10, Slide #3 Long-Term Liabilities  Bonds payable  Notes payable  Leases  Deferred taxes  Pensions  Postretirement benefits

4 Chapter 10, Slide #4 Interest for Investor Borrower Bonds $10,000, 9% bond due 2019  Long-term borrowing arrangement  Interest paid at stated rate and times  Principal repaid at maturity date 1,000 Investor Borrower LO2

5 Chapter 10, Slide #5

6 Chapter 10, Slide #6 Bond Features Collateralized backed by specific assets in event of default Debentures backed only by general creditworthiness of issuer

7 Chapter 10, Slide #7 Bond Features Term entire principal due on a specific single date Serial principal repaid in installments over time

8 Chapter 10, Slide #8 Bond Features Convertible into common stock Callable / Redeemable may be retired before maturity date Common Stock 1,000

9 Chapter 10, Slide #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 Chapter 10, Slide #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 Chapter 10, Slide #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 Chapter 10, Slide #12 PV = ? Calculating Bond Prices $$ ( 2 ) Principal due at maturity PV = ? $$$$$ ( 1 ) Interest payments made each period etc. $$

13 Chapter 10, Slide #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 Chapter 10, Slide #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 Chapter 10, Slide #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 Chapter 10, Slide #16 Compute the price of Johnson’s bonds assume the market interest rate is 12%

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

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

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

20 Chapter 10, Slide #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 Chapter 10, Slide #21 Determining Bond Prices Compute the price of Johnson’s bonds assume the market interest rate is 8%

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

23 Chapter 10, Slide #23 Recording Bond Premiums Cash11,968,000 Bonds Payable 10,000,000 Premium on Bonds Payable 1,968,000 To record the issuance of bonds payable. Assets = Liabilities + Owners’ Equity +11,968, ,000,000 +1,968,000

24 Chapter 10, Slide #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 Chapter 10, Slide #25 Bonds Sold at Face Value Cash 10,000 Bonds Payable10,000 To record the issuance of bonds at face value. Face value of bonds = Sales price When stated rate=market rate

26 Chapter 10, Slide #26 Interest Rates and Bond Prices Above face value (at a premium) At face value Below face value (at a discount) = MARKET RATE BONDS ISSUED:IF STATED RATE: > MARKET RATE < MARKET RATE

27 Chapter 10, Slide #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 Discount increases interest expense Premium reduces interest expense LO5

28 Chapter 10, Slide #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 Expense1,074,550 Cr. Interest payable1,000,000 Cr. Discount on B/P 74,500 1/1/07 Dr. Interest payable 1,000,000 Cr. Cash1,000,000

29 Chapter 10, Slide #29 Total interest expense during the life of the bonds = 1,000,000*20 + 1,491,000 = $21,491,000

30 Chapter 10, Slide #30 Prepare appropriate journal entries for Johnson Company when the bonds were issued at premium


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