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Slide 10-1. Slide 10-2 Chapter 10 Liabilities Financial Accounting, Seventh Edition.

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Presentation on theme: "Slide 10-1. Slide 10-2 Chapter 10 Liabilities Financial Accounting, Seventh Edition."— Presentation transcript:

1 Slide 10-1

2 Slide 10-2 Chapter 10 Liabilities Financial Accounting, Seventh Edition

3 Slide Explain a current liability, and identify the major types of current liabilities Describe the accounting for notes payable Explain the accounting for other current liabilities Explain why bonds are issued, and identify the types of bonds Prepare the entries for the issuance of bonds and interest expense Describe the entries when bonds are redeemed or converted Describe the accounting for long-term notes payable Identify the methods for the presentation and analysis of long-term liabilities. Study Objectives

4 Slide 10-4 Current Liabilities Notes payable Sales taxes payable Payroll and payroll taxes Unearned revenues Current maturities of long- term debt Statement presentation and analysis Bond basics Accounting for bond issues Accounting for bond retirements Accounting for long-term notes payable Statement presentation and analysis Long-Term Liabilities LiabilitiesLiabilities

5 Slide 10-5 Current liability is debt with two key features: 1. Company expects to pay the debt from existing current assets or through the creation of other current liabilities. 2. Company will pay the debt within one year or the operating cycle, whichever is longer. What is a Current Liability? SO 1 Explain a current liability, and identify the major types of current liabilities. Current liabilities include notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes payable, salaries payable, and interest payable. Section 1 Current Liabilities

6 Slide 10-6 To be classified as a current liability, a debt must be expected to be paid: a.out of existing current assets. b.by creating other current liabilities. c.within 2 years. d.both (a) and (b). Question SO 1 Explain a current liability, and identify the major types of current liabilities. What is a Current Liability?

7 Slide 10-7 SO 2 Describe the accounting for notes payable. Notes Payable Written promissory note. Require the borrower to pay interest. Issued for varying periods. What is a Current Liability?

8 Slide 10-8 Illustration: On March 1, 2011, Cole Williams borrows $100,000 from First National Bank on a 4-month, 12% note. Instructions a)Prepare the entry on March 1. b)Prepare the adjusting entry on June 30, assuming monthly adjusting entries have not been made. c)Prepare the entry at maturity (July 1). SO 2 Describe the accounting for notes payable. What is a Current Liability?

9 Slide 10-9 Illustration: On March 1, 2011, Cole Williams borrows $100,000 from First National Bank on a 4-month, 12% note. a)Prepare the entry on March 1. Notes payable100,000 Cash100,000 Interest payable4,000 Interest expense4,000 $100,000 x 12% x 4/12 = $4,000 b)Prepare the adjusting entry on June 30. SO 2 Describe the accounting for notes payable. What is a Current Liability?

10 Slide Illustration: On March 1, 2011, Cole Williams borrows $100,000 from First National Bank on a 4-month, 12% note. c) Prepare the entry at maturity (July 1). Interest payable4,000 Notes payable100,000 Cash104,000 SO 2 Describe the accounting for notes payable. What is a Current Liability?

11 Slide SO 3 Explain the accounting for other current liabilities. Sales Tax Payable Sales taxes are expressed as a stated percentage of the sales price. Either rung up separately or included in total receipts. Retailer collects tax from the customer. Retailer remits the collections to the state’s department of revenue. What is a Current Liability?

12 Slide Illustration: The March 25 cash register reading for Cooley Grocery shows sales of $10,000 and sales taxes of $600 (sales tax rate of 6%), the journal entry is: Sales10,000 Cash10,600 Sales tax payable600 SO 3 Explain the accounting for other current liabilities. What is a Current Liability?

13 Slide The term “payroll” pertains to both: Salaries - managerial, administrative, and sales personnel (monthly or yearly rate). Wages - store clerks, factory employees, and manual laborers (rate per hour). Determining the payroll involves computing three amounts: (1) gross earnings, (2) payroll deductions, and (3) net pay. SO 3 Explain the accounting for other current liabilities. Payroll and Payroll Taxes Payable What is a Current Liability?

14 Slide Illustration: Assume a corporation records its payroll for the week of March 7 as follows: SO 3 Explain the accounting for other current liabilities. Record the accrual of this payroll on March 7. What is a Current Liability? PAYCHECK: 3/7/2011 GROSS PAY (assume a LOT of employees!)$amount avg rate $ 20/hour 5,000 hours $100,000 FICA (soc + medicare) $ 7, % up to a cap FIT(fed'l income tax withholding) $21,864 Amount varies per employee SIT(state income tax withholding) $ 2,922 Note: Not Wash State! Medical Union dues Retirment contribution (32,436) NET PAY ($ AMOUNT OF PAYCHECK) $67,564 Employee receives paycheck for the net amount. Employer withholds the difference between Gross and Net and then remits to various authorities. Although it is a withholding fro the employee's paycheck; it is the employer's job to withhold and remit. See Course Pack

15 Slide Illustration: Assume a corporation records its payroll for the week of March 7 as follows: Salaries and wages expense100,000 Federal income tax payable21,864 FICA tax payable7,650 State income tax payable2,922 Salaries and wages payable67,564 SO 3 Explain the accounting for other current liabilities. Record the payment of this payroll on March 11. Mar. 7 What is a Current Liability? See Course Pack

16 Slide Illustration: Assume a corporation records its payroll for the week of March 7 as follows: Salaries and wages expense100,000 Federal income tax payable21,864 FICA tax payable7,650 State income tax payable2,922 Salaries and wages payable67,564 SO 3 Explain the accounting for other current liabilities. Cash67,564 Salaries and wages payable 67,564Mar. 11 Record the payment of this payroll on March 11. Mar. 7 What is a Current Liability?

17 Slide Payroll tax expense results from three taxes that governmental agencies levy on employers. These taxes are: FICA tax (7.65% up to a cap) Federal unemployment tax (0.8%) State unemployment tax (5.4%) SO 3 Explain the accounting for other current liabilities. What is a Current Liability? See Course Pack Based on the corporation’s $100,000 payroll, record the employer’s expense and liability for these payroll taxes.

18 Slide Illustration: Based on the corporation’s $100,000 payroll, the company would record the employer’s expense and liability for these payroll taxes as follows. Payroll tax expense13,850 Federal unemployment tax payable800 FICA tax payable7,650 State unemployment tax payable 5,400 SO 3 Explain the accounting for other current liabilities. What is a Current Liability?

19 Slide Employer payroll taxes do not include: a.Federal unemployment taxes. b.State unemployment taxes. c.Federal income taxes. d.FICA taxes. NOTE: SO 3 Explain the accounting for other current liabilities. What is a Current Liability? Why not?

20 Slide SO 3 Explain the accounting for other current liabilities. Unearned Revenue Revenues that are received before the company delivers goods or provides services. What is a Current Liability? 1.Company debits Cash, and credits a current liability account (unearned revenue). 2.When the company earns the revenue, it debits the Unearned Revenue account, and credits a revenue account.

21 Slide Illustration: Assume that Superior University sells 10,000 season football tickets at $50 each for its five-game home schedule. The university makes the following entry for the sale of season tickets: SO 3 Explain the accounting for other current liabilities. Unearned revenue500,000 Cash 500,000Aug. 6 Ticket revenue100,000 Unearned revenue 100,000Sept. 7 As the school completes each of the five home games, it would record the revenue earned. What is a Current Liability?

22 Slide Current Maturities of Long-Term Debt Portion of long-term debt that comes due in the current year. No adjusting entry required. SO 3 Explain the accounting for other current liabilities. What is a Current Liability?

23 Slide Statement Presentation and Analysis Illustration 10-5 SO 3

24 Slide Working capital is calculated as: a.current assets minus current liabilities. b.total assets minus total liabilities. c.long-term liabilities minus current liabilities. d.both (b) and (c). Question Statement Presentation and Analysis SO 3 Explain the accounting for other current liabilities.

25 Slide Liquidity refers to the ability to pay maturing obligations and meet unexpected needs for cash. The current ratio permits us to compare the liquidity of different-sized companies and of a single company at different times. Illustration 10-7 Illustration 10-6 Statement Presentation and Analysis SO 3 Explain the accounting for other current liabilities. Analysis

26 Slide Types of bonds Bond Contracts Journal Entries for bonds Issuing Paying or accruing semi-annual interest Retiring bonds (paying back principal) Amortizing bonds Converting bonds SO 4 Explain why bonds are issued, and identify the types of bonds. Section 2 Long-Term Liabilities Bond Basics

27 Slide No, not this Bond....

28 Slide Long-term bonds Bonds are long-term debt agreements The contractual agreement specifies a fixed series of repayments to include  A series of either annual or semi-annual interest payments  A lump sum payment (face value)

29 Slide Advantages of Bond Financing over Common Stock Stockholder control Stockholder control Tax expense Tax expense Earnings per share Earnings per share

30 Slide 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 must be paid. c.that neither interest nor principal is tax deductible. d.that interest must be paid and principal repaid. Question Bond Basics SO 4 Explain why bonds are issued, and identify the types of bonds.

31 Slide Types of Bonds Secured and Unsecured (debenture) bonds. Term and Serial bonds. Registered and Bearer (or coupon) bonds. Convertible and Callable bonds. Bond Basics SO 4 Explain why bonds are issued, and identify the types of bonds.

32 Slide Secured Bonds... Have specific assets of the issuer pledged as collateral for bonds, e.g., real estate, or sinking fund Have specific assets of the issuer pledged as collateral for bonds, e.g., real estate, or sinking fund

33 Slide Unsecured or Debenture Bonds... Are issued against the general credit of the borrower. Are issued against the general credit of the borrower.

34 Slide Term Bonds... Are due for payment (mature) at a single specified future date. Are due for payment (mature) at a single specified future date.

35 Slide Serial Bonds... Mature in installments. Mature in installments.

36 Slide Convertible or Callable Bonds... Convertible into Stock at Bondholders option. Callable – retired early at Issuing Company’s option Read the bond indenture!

37 Slide 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 is too large for one lender to supply. Bond Basics SO 4 Explain why bonds are issued, and identify the types of bonds.

38 Slide Bond Basics Issuer of Bonds Issuer of Bonds Maturity Date Maturity Date Illustration Contractual Interest Rate Contractual Interest Rate Face or Par Value Face or Par Value DUE SO 4

39 Slide How do you keep them straight? Indenture? – Bond Contract Indenture? – Bond Contract Debenture? – Type of bond (issued on general credit of company) Debenture? – Type of bond (issued on general credit of company)

40 Slide Indenture Think pilgrims, think servants, think indentured servants.... An indentured servant worked 7 years to pay for his trip to America. He/she signed a CONTRACT.

41 Slide DEBENTURE – DIE HARD Okay, maybe you didn’t see the movie, but they robbed the safe of millions of dollars worth of bonds, debenture bonds…..

42 Slide Face Value... The amount of principal due at maturity date. Contractual Interest Rate... (Face Interest Rate) Is the rate used to determine the amount of cash interest the borrower pays and investor receives.

43 Slide Market Interest Rate... The rate that investors demand for loaning funds. Not the same as contract (bond indenture) rate.

44 Slide Accounting for Bond Issues Bonds may be issued at: Face value – (e.g., 10% contract rate ) Face value – (e.g., 10% contract rate ) Below face value-discount or (e.g, market is 12%) Below face value-discount or (e.g, market is 12%) Above face value-premium (e.g., market is 8%) Above face value-premium (e.g., market is 8%)

45 Slide Accounting for Bond Issues JOURNAL ENTRIES: Issuing Bonds Paying semi annual interest Accruing semi annual interest Retiring Bonds SO 4 Explain why bonds are issued, and identify the types of bonds. See Course Pack for summary on bond and journal entries

46 Slide Accounting for Bond Issues SO 4 Explain why bonds are issued, and identify the types of bonds. See Course Pack for summary on bond and journal entries CHAPTER 10 - LIABILITIES -- Accounting for Bonds Determining the Market Value of bonds ContractMarketBonds Sell at: issue date:1/1/200110% < 10%Premium to charge buyer for higher contract int. rate 100 five year, 10%, payable semiannually10% = 10%Face Value $1000 bonds at 100 (face value)10% > 10%Discount to attract buyer 1/1/2001face value -- issue at: discount --issue at: premium -- issue at: Cash 100,000 Cash 92,639 Cash 108,111 Bond Payable 100,000Discount on B/Pay 7,361 Premium on Bond Pay 8,111 Bond Payable 100,000 Bond Payable 100,000 To record sale of bonds 7/1/2001Bond Interest Exp. 5,000 Bond Interest Exp. 5,736 Bond Interest Exp. 4,189 Cash 5,000Discount on B/Pay 736Premium on B/Pay 811 Cash 5,000Cash 5,000 To record payment of interest To record payment of interest/amort of disc.To record payment of interest/amort of premium 12/31/2001Bond Interest Exp. 5,000 Bond Interest Exp. 5,736 Bond Interest Exp. 4,189 Bond Int. Payable 5,000Discount on B/Pay 736Premium on B/Pay 811 Bond Int. Payable 5,000 Bond Int. Payable 5,000 To record accrual of interest To record accrual of interest/amort of disc.To record accrual of interest/amort of premium 1/1/2002 Bond Int. Payable 5,000 Bond Int. Payable 5,000 Bond Int. Payable 5,000 Cash 5,000Cash 5,000Cash 5,000 To record payment of interest Cost of borrowing: 5,000 Cost of borrowing: 5,000 Cost of borrowing: 5,000 Total Payments10 Total Payments10 Total Payments10 50,000 Plus discount 7,361 Less: premium (8,111) Total cost of borrowing 50,000 Total cost of borrowing 57,361 Total cost of borrowing 41,889 At maturity Bond Payable 100,000 Bond Payable 100,000 Bond Payable 100,000 Cash 100,000Cash 100,000Cash 100,000

47 Slide Illustration: On January 1, 2011, Candlestick Corporation issues $100,000, five-year, 10% bonds at 100 (100% of face value). Interest payable semiannually. The entry to record the sale is: Jan. 1Cash 100,000 Bonds payable100,000 Accounting for Bond Issues Issuing Bonds at Face Value SO 4 Explain why bonds are issued, and identify the types of bonds.

48 Slide Illustration: On January 1, 2011, Candlestick Corporation issues $100,000, five-year, 10% bonds at 100 (100% of face value). Assume that interest is payable semiannually on January 1 and July 1. Prepare the entry to record the payment of interest on July 1, 2011, assume no previous accrual. July 1Bond interest expense 5,000 Cash5,000 Issuing Bonds at Face Value SO 4 Explain why bonds are issued, and identify the types of bonds.

49 Slide Illustration: On January 1, 2011, Candlestick Corporation issues $100,000, five-year, 10% bonds at 100 (100% of face value). Assume that interest is payable semiannually on January 1 and July 1. Prepare the entry to record the accrual of interest on December 31, 2011, assume no previous accrual. Dec. 31Bond interest expense 5,000 Bond interest payable5,000 Issuing Bonds at Face Value SO 4 Explain why bonds are issued, and identify the types of bonds.

50 Slide Question: What is the TOTAL cost of borrowing? Issuing Bonds at Face Value SO 4 Explain why bonds are issued, and identify the types of bonds. $5,000 x 10 periods = $50,000 Bond interest expense

51 Slide 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. The features of a bond (callable, convertible, and so on) affect the market rate of the bond. Bond Basics SO 4 Explain why bonds are issued, and identify the types of bonds.

52 Slide Bond Prices Vary Inversely With Changes in Market Interest Rates

53 Slide Bond Discount... When the investor pays less than the face value of the bond. WHY? To adjust the contractual interest to the market interest rate. To adjust the contractual interest to the market interest rate.

54 Slide SO 5 Prepare the entries for the issuance of bonds and interest expense. Illustration: On January 1, 2011, Candlestick, Inc. sells $100,000, five-year, 10% bonds for $92,639 (92.639% of face value). Interest is payable on July 1 and January 1. The entry to record the issuance is: Jan. 1Cash 92,639 Discount on bonds payable7,361 Bond payable100,000 Accounting for Bond Issues Issuing Bonds at a Discount

55 Slide Statement Presentation SO 5 Prepare the entries for the issuance of bonds and interest expense. Illustration Issuing Bonds at a Discount

56 Slide SO 5 Prepare the entries for the issuance of bonds and interest expense. Total Cost of Borrowing Illustration Illustration Issuing Bonds at a Discount

57 Slide SO 5 Prepare the entries for the issuance of bonds and interest expense. 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 Issuing Bonds at a Discount

58 Slide Bond Prices Vary Inversely With Changes in Market Interest Rates

59 Slide Bond Premium... When the investor pays more than the face value of the bond. When the investor pays more than the face value of the bond.WHY? To adjust the contractual interest to the market interest rate. To adjust the contractual interest to the market interest rate.

60 Slide 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 Accounting for Bond Issues SO 4 Explain why bonds are issued, and identify the types of bonds.

61 Slide SO 5 Prepare the entries for the issuance of bonds and interest expense. Illustration: On January 1, 2011, Candlestick, Inc. sells $100,000, five-year, 10% bonds for $108,111 ( % of face value). Interest is payable on July 1 and January 1. The entry to record the issuance is: Jan. 1Cash 108,111 Bonds payable100,000 Premium on bond payable8,111 Accounting for Bond Issues Issuing Bonds at a Premium

62 Slide Statement Presentation SO 5 Prepare the entries for the issuance of bonds and interest expense. 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. Illustration Issuing Bonds at a Premium

63 Slide SO 5 Prepare the entries for the issuance of bonds and interest expense. Total Cost of Borrowing Illustration Illustration Issuing Bonds at a Premium

64 Slide Bond Trading Bonds traded on national securities exchanges. Newspapers and the financial press publish bond prices and trading activity daily. Read as: Outstanding 5.125%, $1,000 bonds that mature in Currently yield a 5.747% return. On this day, $33,965,000 of these bonds were traded. Closing price was % of face value, or $ (per bond). “Bond Speak” Bond Basics - example SO 4 Explain why bonds are issued, and identify the types of bonds.

65 Slide Amortizing Bond Discount - Appendix 10-C Amortizing Bond Discount - Appendix 10-C Although Bond Discounts eventually get written off to Bond Interest Expense, this must be Amortized over the life of the Bond:

66 Slide Amortizing Bond Discount or Premium Amortizing Bond Discount or Premium Candlestick would amortize the $7,361 discount/premium as follows: $7,361 ÷ 10 Interest Periods = $736 Semiannually

67 Slide Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2011, for $92,639 (discount of $7,361). Interest is payable on July 1 and January 1. The bond discount amortization for each interest period is $736 ($7,361/10). Illustration 10C-2 Amortizing Bond Discount Straight-Line Amortization – Bond Discount SO 11 Apply the straight-line method of amortizing bond discount and bond premium. Appendix 10C

68 Slide Illustration 10C-2 Straight-Line Amortization – Bond Discount SO 11 Apply the straight-line method of amortizing bond discount and bond premium. Appendix 10C

69 Slide Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2011, for $92,639 (discount of $7,361). Interest is payable on July 1 and January 1. The bond discount amortization for each interest period is $736 ($7,361/10). Journal entry on July 1, 2011, to record the interest payment and amortization of discount is as follows: Interest Expense 5,736 Cash5,000 Discount on Bonds Payable 736 July 1 Amortizing Bond Discount Straight-Line Amortization SO 11 Apply the straight-line method of amortizing bond discount and bond premium.

70 Slide Redeeming Bonds at Maturity SO 6 Describe the entries when bonds are redeemed or converted. Assuming that the company pays and records separately the interest for the last interest period, Candlestick records the redemption of its bonds at maturity as follows: Bond payable 100,000 Cash100,000 Accounting for Bond Retirements

71 Slide 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 bond premium at the redemption date. SO 6 Describe the entries when bonds are redeemed or converted. Accounting for Bond Retirements

72 Slide SO 6 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 Accounting for Bond Retirements

73 Slide Illustration: Assume Candlestick, Inc. has sold its bonds at a premium. At the end of the eighth period, Candlestick retires these bonds at 103 after paying the semiannual interest. The carrying value of the bonds at the redemption date is $101,623. Candlestick makes the following entry to record the redemption at the end of the eighth interest period (January 1, 2015): Bonds payable 100,000 Premium on bonds payable1,623 Loss on redemption1,377 Cash103,000 SO 6 Describe the entries when bonds are redeemed or converted. Accounting for Bond Retirements

74 Slide 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. SO 6 Describe the entries when bonds are redeemed or converted. Accounting for Bond Retirements Note: Know theory, not Journal Entry

75 Slide 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 face value. SO 7 Describe the accounting for long-term notes payable. Accounting for Long-Term Notes Payable Note: Know theory, not Journal Entry

76 Slide 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 SO 7 Describe the accounting for long-term notes payable. Accounting for Long-Term Notes Payable

77 Slide Presentation SO 8 Identify the methods for the presentation and analysis of long-term liabilities. Statement Presentation and Analysis Illustration 10-20

78 Slide Analysis Two ratios that provide information about debt- paying ability and long-run solvency are: Total debt Total 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. SO 8 Identify the methods for the presentation and analysis of long-term liabilities. Statement Presentation and Analysis

79 Slide Two ratios that provide information about debt- paying ability and long-run solvency are: Income before income taxes and interest expense Interest expense Times interest earned = Indicates the company’s ability to meet interest payments as they come due. 2. SO 8 Identify the methods for the presentation and analysis of long-term liabilities. Analysis Statement Presentation and Analysis

80 Slide Illustrate: Kellogg Company had total liabilities of $8,871 million, total assets of $11,397 million, interest expense of $319 million, income taxes of $444 million, and net income of $1,103 million. SO 8 Identify the methods for the presentation and analysis of long-term liabilities. Analysis Illustration Statement Presentation and Analysis

81 Slide Advantages of Bond Financing over Common Stock, an illustration Stockholder control Stockholder control Tax expense Tax expense Earnings per share Earnings per share

82 Slide Effects on earnings per share—stocks vs. bonds. Illustration 10-9 Bond Basics SO 4 Explain why bonds are issued, and identify the types of bonds.

83 Slide 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 must be paid. c.that neither interest nor principal is tax deductible. d.that interest must be paid and principal repaid. Question Bond Basics SO 4 Explain why bonds are issued, and identify the types of bonds.

84 Slide Good Bye and Good Luck! Solutions to Bond exercise next End of Chapter 10

85 Slide “Copyright © 2010 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” CopyrightCopyright

86 Slide Chapter 10: Bonds! Solutions to exercise THREE INDEPENDENT SCENARIOS Scenario #1Scenario #2Scenario #3 Face Value of a single Bond$1,000 Coupon Rate10% Term of the Bond (life)/ Date Issued, frequency of interest 5 year/ 1/1/2001, every 6 months How many bonds did you issue?1,000 What is the face value of the bond issuance? $1,000,000 Market interest rate for bonds of similar risk? 10%10.52%9.49% Which bond is more attractive to buyer and why? NeitherMarketOurs! How often is interest paid? Yearly or semiannually? When do you pay interest? Every 6 months Jan 1 and July 1 How much interest do you pay?$50,000 Selling price per bond, In “bondspeak” What was your Selling price (average) in $ per bond? $1,000$980$1,020 How much did you receive for all of the bonds? $1,000,000$980,000$1,020,000 At the end of the life of the bond, what is the principal that you OWE the bondholders? $1,000,000 How much did this bond COST you?$500,000$520,000$480,000

87 Slide Chapter 10: Bonds! Solutions to exercise Accounting 202 – BOND REVIEW On January 1 st, 2001, Yao Corporation issued 6 year, $200,000 face value bonds (5% coupon) at Interest is payable semiannually on January 1 and July 1. Prepare the journal entry to record the issuance of the bonds on January 1, 2001 (2 pts) Prepare the journal entry to record the first interest payment on July 1, 2001 (3 pts) Prepare the journal entry to record the accrual of interest on December 31, 2001 (3 pts) Prepare the journal entry to record the retirement of the bond on Jan 1, 2007, after the last interest payment has been made (2 pts). Calculate the total interest expense recorded on the books of Yao Clothes and the total cash paid for interest during the life of the bond. If the amounts differ, calculate the difference and explain what caused it. (2 pts) Show an Amortization Schedule for this bond

88 Slide Chapter 10: Bonds! Solutions to exercise #DATEAccount Titles AND DescriptionDebitCredit a1/1/01Cash187,380 Discount on Bonds Payable 12,620 Bonds Payable200,000 To record bonds issued at discount b07/01/01Bond Interest Expense6,052 Discount on Bonds Payable1,052 Cash5,000 To record semiannual interest payment c12/31/01Bond Interest Expense6,052 Discount on Bonds Payable1,052 Interest Payable5,000 To record semiannual accrual of interest d01/01/07Bonds Payable200,000 Cash200,000 To record retirement of bonds eINTEREST EXP = $5,000 * 12 = $60,000 + $12,620 = $72,620 CASH INTEREST PAID = $5,000 * 12 = $60,000 The difference is the discount amount which cost the company an additional interest amount of $12,620.

89 Slide Chapter 10: Bonds! Solutions to exercise 2) Prepare a BOND AMORTIZATION Schedule ABCDE Semi-annual int. period Interest to be Paid (reduction to cash) Interest Expense to be Recorded Amount of Prem/Disc Amortization Unamortiz'd Prem/DiscBond Carrying Value Issue dt 1/1/01 12, ,380 7/1/2001 5,000 6,052 1,052 11, ,432 1/1/2002 5,000 6,0521,052 10,516189,484 7/1/2002 5,000 6,0521,052 9,464190,536 1/1/2003 5,000 6,0521,052 8,412191,588 7/1/2003 5,000 6,0521,052 7,360192,640 1/1/2004 5,000 6,0521,052 6,308193,692 7/1/2004 5,000 6,0521,052 5,256194,744 1/1/2005 5,000 6,0521,052 4,204195,796 7/1/2005 5,000 6,0521,052 3,152196,848 1/1/2006 5,000 6,0521,052 2,100197,900 7/1/2006 5,000 6,0521,052 1,048198,952 1/1/2007 5,000 6,048 1,048* 0200,000


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