1. LONG-TERM LIABILITIES
Pertemuan 18
LONG-TERM LIABILITIES

2. Tujuan Instruksional Khusus
Mahasiswa dapat menerangkan pembiayaan usaha yang didanai Modal Sendiri dan yang didanai dari pinjaman kepada pihak ketiga. (C2)
Mahasiswa dapat memberikan contoh tentang perhitungan dan pencatatan atas bunga obligasi (bonds). (C2)
Mahasiswa dapat memberikan contoh tentang perhitungan dan pencatatan berkenaan dengan kontrak leasing sederhana. (C2)

3. Tujuan Instruksional Khusus
Mahasiswa dapat memberikan contoh tentang perhitungan dan pencatatan sederhana berkenaan dengan dana pensiun (Pension Fund). (C2)
Mahasiswa dapat menghasilkan catatan transaksi dan pelaporan keuangan berkenaan dengan utang/kewajiban jangka panjang. (C3)

4. LONG-TERM LIABILITIES
Accounting Principles, 7th Edition
Weygandt • Kieso • Kimmel
Chapter 16
LONG-TERM LIABILITIES
Prepared by Naomi Karolinski
Monroe Community College
and
Marianne Bradford
Bryant College
John Wiley & Sons, Inc. © 2005

5. Long-term Liabilities
Obligations that are expected to be paid after one year
Include bonds, long-term notes, and lease obligations

6. Bond Basics
Bonds
interest-bearing notes payable
issued by corporations, universities, and governmental agencies
like common stock, can be sold in small denominations (usually a thousand dollars)
attract many investors
To obtain large amounts of long-term capital, corporate management usually must decide whether to issue bonds or to use equity financing (common stock).

7. Why Issue Bonds? Long-term financing, bonds, offer the
following advantages over common
stock:
1)Stockholder control not affected
2)Tax savings
3)Earnings per share may be higher

8. Disadvantages of Bonds
1)Interest must be paid on a periodic basis
2)Principal (face value) must be repaid at maturity

9. Types of Bonds Secured bonds 2) Unsecured bonds
Specific assets of the issuer pledged as collateral for the bonds( a mortgage bond is secured by real estate)
2) Unsecured bonds
Issued against the general credit of the borrower; they are also called debenture bonds.

10. Types of Bonds: Term and Serial Bonds
3) Term bonds
bonds that mature at a single specified future date
4) Serial bonds
bonds that mature in installments
Registered
Registered

11. Types of Bonds: Registered and Bearer
5)Registered bonds
issued in the name of the owner and have interest payments made by check to bondholders of record
6)Bearer or coupon bonds
not registered; thus bondholders must send in coupons to receive interest payments
Registered
Pay to: Joe Smith
Registered
Pay to: Bearer

12. Convertible and Callable
convert the bonds into common stock at holder’s option
Callable
subject to call and retirement at a stated dollar amount prior to maturity at the option of the issuer.
Registered
Stock

13. Authorizing a Bond Issue
State laws grant corporations the power to issue bonds
approval by both the board of directors and stockholders is usually required
Board of directors stipulate the number of bonds to be authorized, total face value, and contractual interest rate

14. Issuing Procedures Face value
amount of principal the issuer must pay at the maturity date
Contractual interest rate, or stated rate
rate used to determine the amount of cash interest the borrower pays and the investor receives
Bond indenture
terms of the bond issue are set forth in a formal legal document
Bond certificates
provide information such as name of issuer and maturity date, are printed

15. Bond Certificate

16. Bond Trading Corporate bonds
traded on national securities exchanges
bondholders have the opportunity to convert their holdings into cash by selling the bonds at the current market price
Bond prices are quoted as a percentage of the face value of the bond (usually $1,000).
Transactions between a bondholder and other investors are not journalized by the issuing corporation.
A corporation only makes journal entries when it issues or buys back bonds, and when bondholders convert bonds into common stock.

17. Determining the Market Value of Bonds
The market value (present value)
of a bond is determined by:
1) the dollar amounts to be received
2) the length of time until the amounts are received
3) the market rate of interest, which is the rate investors demand for loaning funds.
The process of finding the present value is referred to as discounting the future amounts.

18. Accounting for Bond Issues Issuing Bonds at Face Value
Bonds may be issued at face value, below face value (at a discount), or above face value (at a premium). They also are sometimes issued between interest dates. Assume that Devor Corporation issues 1,000, 10-year, 9% $1,000 bonds dated January 1, 2005, at 100 (100% of face value). The entry to record the sale is:
1,000, ,000,000
Bonds payable are reported in the long-term liability section of the balance sheet because the maturity date is more than one year away.

19. Accounting for Bond Issues Issuing Bonds at Face Value
Assume that interest is payable semiannually on January 1 and July 1 on the bonds, interest of $45,000 ($1,000,000 x 9% x 6/12)must be paid on July 1, The entry for the payment is:
45, ,000

20. Accounting for Bond Issues Issuing Bonds at Face Value
At December 31, an adjusting entry is required to recognize
the $45,000 of interest expense incurred since July 1.
The entry is:
45, ,000
Bond interest payable is classified as a current liability, because it is scheduled for payment within the next year. When interest is paid on January 1, 2006, Bond Interest Payable is debited, and Cash is credited for $45,000 in order to eliminate the liability.

21. Interest rates and bond prices
Market Rates Bonds Sell at:
Issued
when: 8%
Premium
BOND
CONTRACTUAL
INTEREST
RATE 10%
10%
Face Value
Discount
12%

22. Accounting for Bond Issues Discount or Premium on Bonds
Bonds may be issued below or above face value.
Market (effective) rate of interest is higher than the contractual (stated) rate
the bonds will sell at less than face value, or at a discount
Market rate of interest is less than the contractual rate
the bonds will sell above face value, or at a premium

23. Issuing Bonds at a Discount
Assume that on January 1, 2005, Candlestick, Inc. sells
$100,000, 5-year, 10% bonds for 92,639 (92.639% of face value) with interest payable on July 1 and January 1. The entry to record the issuance is:
Fix me.

24. Statement presentation of discount on bonds payable
Although Discount on Bonds Payable has a debit balance,
it is NOT an asset. Rather, it is a contra account, which
is deducted from bonds payable on the balance sheet, as
illustrated below:
The $92,639 represents the carrying (or book) value of the bonds. On the date of issue this amount equals the market price of the bonds.

25. Total cost of borrowing - bonds issued at discount
The difference between the issuance price and face value of the bonds-the discount-is an additional cost of borrowing that should be recorded as bond interest expense over the life of the bonds.
The total cost of borrowing, $92,639 for Candlestick, Inc., is $57,361, as computed as follows:

26. Alternatively, the total cost of borrowing can be computed as follows:
Alternative computation of total cost of borrowing - bonds issued at discount
Alternatively, the total cost of borrowing can be computed as follows:
Total cost of borrowing $57,361

27. Issuing Bonds at a Premium
The issuance of bonds at a premium we now assume the Candlestick, Inc. bonds described above are sold for $108,111 ( % of face value) rather than for $ 92,639.
108, , ,111

28. Statement presentation of bond premium
Premium on bonds payable is added to
bonds payable on the balance sheet,
as shown below:
Add: Premium on bonds payable

29. Total cost of borrowing-bonds issued at a premium
The sale of bonds above face value causes the total cost of borrowing to be less than the bond interest paid. The premium is considered to be a reduction in the cost of borrowing that should be credited to Bond Interest Expense over the life of the bonds.

30. Alternatively, the total cost of borrowing
Alternative computation of total cost of borrowing-bonds issued at a premium
Alternatively, the total cost of borrowing
can be determined as follows:
Total cost of borrowing $41,889

31. Redeeming Bonds at Maturity
Regardless of the issue price of bonds, the book value
of the bonds at maturity will equal their face value.
Assuming that the interest for the last interest period
is paid and recorded separately, the entry to record the redemption of the Candlestick bonds at maturity is:
1,000, ,000,000

32. Redeeming Bonds before Maturity
Assume that at the end of the eighth period, Candlestick, Inc.
retires its bonds at 103 after paying the semiannual interest.
The carrying value of the bonds at the redemption date is
$101,623. The entry to record the redemption at the end
of the eighth interest period (January 1, 2009) is:
100, ,623
1, ,000

33. The term used for bonds that are unsecured is:
a. callable bonds.
b. indenture bonds.
c. debenture bonds.
d. bearer bonds.
Chapter 16

34. The term used for bonds that are unsecured is:
a. callable bonds.
b. indenture bonds.
c. debenture bonds.
d. bearer bonds.
Chapter 16

35. Converting Bonds into Common Stock
In recording the conversion of bonds into common stock the current market prices of the bonds and the stock are ignored. Instead, the carrying value of the bonds is transferred to paid-in capital accounts. No gain or loss is recognized.
Assume that on July 1 Saunders Associates converts $100,000 bonds sold at face value into 2,000 shares of $10 par value common stock. Both the bonds and the common stock have a market value of $130,000. The entry to record the conversion is:
100, , ,000

36. Other Long-Term Liabilities
Long-term notes payable
similar to short-term interest-bearing notes payable except that the term of the note exceeds one year.
Mortgage notes payable
long-term note may be secured by a mortgage that pledges title to specific assets as security for a loan
are widely used by individuals to purchase homes and to acquire plant assets by many small and some large companies
recorded initially at face value
subsequent entries are required for each installment payment

37. Mortgage installment payment schedule
To illustrate, assume that Porter Technology Inc. issues a $500,000, 12%, 20-year mortgage note on December 31, 2005, to obtain needed financing for the construction of a new research laboratory. The terms provide for semiannual installment payment of $33,231. The installment payment schedule for the first year is shown below:
Issue date $500,000
1 $33, $30, $3, ,769
2 $33, , , ,344

38. Long-term Notes Payable Entries
The entries to record the mortgage loan and first
installment payment (per schedule on previous slide)
are as follows:
500, ,000
30, , ,231

39. Operating lease Operating Leases
intent is temporary use of the property by the lessee
lessor continues to own the property.
lease (or rental) payments are recorded as an expense by the lessee and as revenue by the lessor
Car rental
is an example
of an operating
lease

40. Capital Leases
The present value of the cash payments for the lease are capitalized and recorded as an asset
Capital lease is in substance an installment purchase by the lessee.

41. Capital Leases
Lessee records the lease as an asset (a capital lease) if any one of the following conditions exist:
a) Lease transfers ownership of the property to the lessee.
b) Lease contains a bargain purchase option
c) Lease term is equal to 75% or more of the economic life of the leased property.
d) Present value of the lease payments equals or exceeds 90% of the fair market value of the leased property.

42. Capital Lease Entries
Assume that Gonzalez Company decides to lease new equipment.
The lease period is 4 years; the economic life of the leased equipment is estimated to be 5 years. The present value of the lease payments is $190,000, which is equal to the fair market value of the equipment. There is no transfer of ownership during the lease term, nor is there any bargain purchase option.
IN THIS EXAMPLE, GONZALEZ HAS ESSENTIALLY PURCHASED
THE EQUIPMENT BECAUSE CONDITIONS (3) AND (4) HAVE
BEEN MET (SEE PREVIOUS SLIDE).
190, ,000

43. The renting of an apartment is an example of a(n):
a. capital lease.
b. lease liability.
c. operating lease.
d. lessor lease.
Chapter 16

44. The renting of an apartment is an example of a(n):
a. capital lease.
b. lease liability.
c. operating lease.
d. lessor lease.
Chapter 16

45. Presentation and Analysis of Long-Term Liabilities
Long-term debt
reported in the balance sheet or in schedules in the notes accompanying the statements
current maturities of long-term debt
reported under current liabilities if they are to be paid from current assets
reported in a separate section of the balance sheet immediately following current liabilities

46. Balance sheet presentation of long-term liabilities
The long-term liabilities for
LAX Corporation are shown below:

47. Debt to total assets 44% = $17,859 ÷ $40,566
The debt to total assets ratio measures the percentage of total assets provided by creditors, indicating the degree of leverage utilized. It is calculated by dividing total debt by total assets. Johnson & Johnson’s 2005 annual reported $17,859 million and total assets of $40,566 million. Their debt to total assets ratio is calculated below:
TOTAL DEBT DEBT TO TOTAL ASSETS = ———————— TOTAL ASSETS
44% = $17,859 ÷ $40,566

48. Times Interest Earned Ratio
The times interest earned ratio indicates the company’s ability to meet interest payments as they come due. It is computed by dividing income before income taxes and interest expense by interest expense. Johnson & Johnson’s annual report disclosed interest expense $160 million, income taxes of $2,694 , and net income of $6,597 million. The times interest earned ratio is computed below
????? See text-I AM CONFUSED.
TIMES INTEREST INCOME BEFORE INCOME TAXES AND INTEREST EXPENSE EARNED = ————————————————————————————— INTEREST EXPENSE
59.1 times = ($6,597+ $2,694 + $160) ÷ $160

49. Appendix 16A Present Value Concepts Related to Bond Pricing
Present Value – One Period Discount
Present Value – Two Period Discount

50. Present Value of Face Value

51. Present Value of Interest Payments (Annuities)

52. Present Value of Interest Payments (Annuities)

53. Present Value of a Bond

54. APPENDIX: 16 B Effective-Interest Amortization
An alternative to straight-line amortization.
Both methods result in the same total amount of interest expense over the term of the bonds.
If materially different
the effective-interest method is required under GAAP

55. Computation of amortization-effective-interest method
Bond interest expense
computed by multiplying the carrying value of the bonds at the beginning of the interest period by the effective-interest rate
Bond discount or premium amortization
computed by determining the difference between the bond interest expense and the bond interest paid
(1)
Bond Interest Expense
Carrying value
of Bonds Effective
at Beginning Interest
of Period Rate
(2)
Bond Interest Paid
Face Contractual
Amount Interest
of Bonds Rate
Amortization
Amount x x

56. Illustration 16B-3 Bond discount amortization schedule
Candlestick Inc. issues $100,000 of 10%, 5-year bonds on January 1, 2005 with interest payable each July 1 and January 1. The bonds will sell for $92,639 with an effective interest rate of 12%; Therefore, the bond discount is $7,361 ($100,000 - $92,639). The schedule below facilitates recording of interest expense and discount amortization.
NOTE: TABLE WILL CONTINUE FOR 10 SEMIANNUAL PERIODS
Issue date $7, $92,639
$5, $5, $ , ,197
$5, , , ,789

57. Illustration 16B-4 Bond premium amortization schedule
Candlestick Inc. issues $100,000 of 10%, 5-year bonds on January 1, 2005
with interest payable each July 1 and January 1. The bonds will sell for
$108,111 with an effective interest rate of 8%; therefore, the bond premium
is $8,111 ($108,111-$100,000). The schedule below facilitates recording of
interest expense and premium amortization.
NOTE: TABLE WILL CONTINUE FOR 10 SEMIANNUAL PERIODS
Issue date $8, $108,111
$5, $4, $ $7, ,435
, , , ,73257

58. Appendix 16C Straight-Line Amortization
Matching principle
bond discount allocated systematically to each accounting period that benefits from the use of the cash proceeds
Straight-line method of amortization.
allocates the same amount to interest expense each interest period
The amount is determined as follows:
Number
of Interest
Periods
Bond
Discount
Amortization
Bond
Discount / =

59. Amortizing Bond Discount
In the previous example, the bond discount amortization
is $736 ($7,361 /10 periods). The entry to record the
payment of bond interest and the amortization of bond
discount on the first interest date (July 1, 2005) is:
5, ,000

60. Formula for straight-line method of bond premium amortization
The formula for determining bond premium amortization under the straight-line method is:
Number
of Interest
Periods
Bond
Premium
Amortization
Bond
Premium = /

61. Amortizing Bond Premium
The premium amortization for each interest period
is $811 ($8,111 / 10). The entry to record the
first payment of interest on July 1 is:
4,189
,000

62. Amortizing Bond Premium
At December 31, the adjusting entry is:
4, ,000
Over the term of the bonds, the balance in Premium on Bonds Payable will decrease annually by the same amount until it has a zero balance at maturity date of the bonds.

63. COPYRIGHT
Copyright © 2005 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 consent 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.

64. Time diagram depicting cash flows
$100,000 Principal
$9,000 $9,000 $9,000 $9,000 $9,000 Interest
5 year period
?????????????/
Assume that Kell Company on January 1, 2005, issues $100,000 of
9% bonds, due in 5 years, with interest payable annually at year-end.
The purchaser of the bonds would receive two cash payments: 1) principal of $100,000 to be paid at maturity, and 2) five $9,000 interest payments ($100,000 x 9%) over the term of the bond.

65. Computing the market price of bonds
The market value of a bond is equal to the present
value of all the future cash payments promised by
the bond. The present values of these amounts
are shown below:
Market price of bonds $100,000

66. Amortizing Bond Discount - Entries
At December 31, the adjusting entry is:
5, ,000
Move to the amortization section
Over the term of the bonds, the balance in Discount on Bonds Payable will decrease annually by the same amount until it has a zero balance at maturity. Thus, the carrying value of the bonds at maturity will be equal to the face value.

67. Issuing Bonds between Interest Dates
When bonds are issued between interest payment dates, the issuer requires the investor to pay the market price for the bonds plus accrued interest since the last interest date.
To illustrate, assume that Deer Corporation sells $1,000,000, 9% bonds at face value plus accrued interest on March 1. Interest is payable semiannually on July 1 and January 1. The accrued interest is $15,000 ($1,000,000 x 9% x 2/12). The total
proceeds on the sale of the bonds, therefore, are $1,015,000.
The entry to record the sale is:
1,015, ,000, ,000

68. Issuing Bonds between Interest Dates
At the first interest date, it is necessary to (1) eliminate the bond interest payable balance and (2) recognize interest expense for the 4 months (March 1 - June 30) the bonds have been outstanding. Interest expense is $30,000 ($1,000,000 x 9% x 4/12). The entry on July 1 for the $45,000 interest payment is:
15, ,000
45,000

69. LONG-TERM LIABILITIES
Chapter 16
LONG-TERM LIABILITIES
Copyright © 2005 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 consent 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.