1. Study Objectives Long term Liabilities Quiz
Accounting for Bonds (TFCs)
Accounting for Bonds / TFCs with serial maturity
Lease Accounting
Presentation & Analysis for Long Term Liabilities
Discussion of Assignments
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)

2. Study Objectives Quiz shall be from annual report of Searle
Refer annual report of Searle (refer year 2010)
………………………
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)

3. Accounting Principles, Ninth Edition
Chapter 15
Long-Term Liabilities
Accounting Principles, Ninth Edition

4. Bond Basics
Bonds (‘Term Finance Certificates’ as local statute labels) are a form of long term interest-bearing debt.
Three advantages over common stock:
Stockholder control is not affected.
Tax savings result.
Earnings per share may be higher without any new investment by the owners.
SO 1 Explain why bonds are issued.

5. Bond Basics
Assume Global Limited has 100,000 (par value $25) shares issued and outstanding with existing following income statement
Operating Income $ 500,000 Interest Expense - Pre Tax Income ,000 Income Tax (30%) (150,000) Net After Tax Income 350,000 EPS $
Assume further that Global finds a business opportunity with same ROI (20%) requiring & 5.0 million investment and promising further $ 1.0 million operating income
SO 1 Explain why bonds are issued.

6. Bond Basics Effects on earnings per share—stocks vs. bonds.
Illustration 15-2
1. When this benefit will be reversed?
2. One of the ill affect of interest
SO 1 Explain why bonds are issued.

7. Bond Basics
Question
The major disadvantages resulting from the use of bonds are:
that interest is not tax deductible and the principal must be repaid.
that the principal is tax deductible and interest must be paid.
that neither interest nor principal is tax deductible.
that interest must be paid and principal repaid.
SO 1 Explain why bonds are issued.

8. Bond Basics Types of Bonds Secured and Unsecured (debenture) bonds.
Term and Serial bonds.
Registered and Bearer (or coupon) bonds.
Convertible and Callable bonds.
SO 1 Explain why bonds are issued.

9. Bond Basics Important Terms Face Value, Maturity Value and Issue Price
Nominal / Contractual Interest Rate
Bond Term
Interest Payment Dates
Market Rate of Interest
Effective Rate of Interest
Market Price of Bonds
Call Price
Conversion Ratio
SO 1 Explain why bonds are issued.

10. Check these terms for bonds
Bond Basics
Issuing Procedures
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) in case of term bonds.
Paper certificate, typically PKR5000 face value.
Interest payments usually made semiannually or quarterly.
Generally issued when the amount of capital needed is too large for one lender to supply. - Private placement - Public placement
Check these terms for bonds
SO 1 Explain why bonds are issued.

11. Bond Basics Issuer of Bonds Maturity Date Contractual Interest Rate
Illustration 15-3
Maturity
Date
Contractual
Interest
Rate
Face or
Par Value
SO 1 Explain why bonds are issued.

12. Bond Basics Determining the Market Value of Bonds
Market value is a function of the three factors that determine present value:
the dollar amounts to be received against principal and interests
the length of time until the amounts are received, and
the market rate of interest.
The features of a bond (callable, convertible, and so on) affect the market rate of the bond.
SO 1 Explain why bonds are issued.

13. Bond Basics Determining the Market Value of Bonds
Market Value = PV (Maturity Value) at market interest rate for maturity period [FV(1+i) ] PV (interest payments) at market interest
rate for maturity period [R{1-(1+i) }/i] -n -n
SO 1 Explain why bonds are issued.

14. Accounting for Bond Issues
Assume Contractual Rate of 8%
Market Interest
Bonds Sold At 6%
Premium 8%
Face Value
10%
Discount
SO 2 Prepare the entries for the issuance of bonds and interest expense.

15. Accounting for Bond Issues
Question
The rate of interest investors demand for loaning funds to a corporation is the:
contractual interest rate.
face value rate.
market interest rate.
stated interest rate.
SO 2 Prepare the entries for the issuance of bonds and interest expense.

16. Accounting for Bond Issues
Question
Karson Inc. issues 10-year bonds with a maturity value of $200,000. If the bonds are issued at a premium, this indicates that:
the contractual interest rate exceeds the market interest rate.
the market interest rate exceeds the contractual interest rate.
the contractual interest rate and the market interest rate are the same.
no relationship exists between the two rates.
SO 2 Prepare the entries for the issuance of bonds and interest expense.

17. Issuing Bonds at Face Value
Illustration: On January 1, 2010, Candlestick
Corporation issues $100,000, five-year, 10% bonds at 100 (100% of face value). The entry to record the sale is:
Jan. 1 Cash 100,000
Bonds payable 100,000
SO 2 Prepare the entries for the issuance of bonds and interest expense.

18. Issuing Bonds at Face Value
Illustration: On January 1, 2010, 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, 2010, assume no previous accrual (assuming no period closure on any month before).
July 1 Bond interest expense 5,000
Cash 5,000
SO 2 Prepare the entries for the issuance of bonds and interest expense.

19. Issuing Bonds at Face Value
Illustration: On January 1, 2010, 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, 2010, assume no previous accrual.
Dec. 31 Bond interest expense 5,000
Bond interest payable 5,000
Jan, 1 Bond interest payable 5,000
Cash / Bank 5,000
SO 2 Prepare the entries for the issuance of bonds and interest expense.

20. Issuing Bonds at Face Value
Illustration: On January 1, 2010, 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.
Calculate total cost of debt
Total amount received against bonds is $100000
Total amount repaid is $ $5000 x = $150000
Total cost of borrowing = $50000
SO 2 Prepare the entries for the issuance of bonds and interest expense.

21. Issuing Bonds at a Discount
Illustration: On January 1, 2010, 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. 1 Cash 92,639
Discount on bonds payable 7,361
Bond payable 100,000
Nature of ‘Discount’ account: ?
Mrs. Bonds Payable, remains with bonds payable in balance sheet all the time, but reduces its value
It’s valuation account for the liability ‘bonds payable’
SO 2 Prepare the entries for the issuance of bonds and interest expense.

22. Issuing Bonds at a Discount
Statement Presentation
Illustration 15-6
SO 2 Prepare the entries for the issuance of bonds and interest expense.

23. Issuing Bonds at a Discount
Illustration: On January 1, 2010, 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.
Total amount received against bonds is $92639
Total amount to repay is $ $5000 x = $150000
Total cost of borrowing = $57,361
SO 2 Prepare the entries for the issuance of bonds and interest expense.

24. Issuing Bonds at a Discount
Total Cost of Borrowing
Illustration 15-7
Illustration 15-8
SO 2 Prepare the entries for the issuance of bonds and interest expense.

25. Issuing Bonds at a Discount
Question
Discount on Bonds Payable:
has a credit balance.
is a contra account.
is added to bonds payable on the balance sheet.
increases over the term of the bonds.
SO 2 Prepare the entries for the issuance of bonds and interest expense.

26. Issuing Bonds at a Premium
Illustration: On January 1, 2010, 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. 1 Cash 108,111
Bonds payable 100,000
Premium on bond payable 8,111
Nature of ‘Premium’ account: ? Mrs. Bonds payable, this time enhancing the value of bonds in balance sheet
It’s valuation account for the liability ‘bonds payable’
SO 2 Prepare the entries for the issuance of bonds and interest expense.

27. Issuing Bonds at a Premium
Statement Presentation
Illustration 15-9
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.
SO 2 Prepare the entries for the issuance of bonds and interest expense.

28. Issuing Bonds at a Premium
Total Cost of Borrowing
Illustration 15-10
Illustration 15-11
SO 2 Prepare the entries for the issuance of bonds and interest expense.

29. Full Accounting for bonds issued at discount
Nina Gera issued 100, Rs.5000, 9%, two years bonds on 1st January 2008 at 95. Interest is payable semiannually on 1st July and 1st January each.
The point to note regarding accounting for periodic interest expense is that expense will be recorded for 1- periodic interest due or paid; and 2- amortization of bonds discount Note: discount has debit balance and by the time bonds will mature, it should have been wiped off
Received Rs.475,000 Repaid Rs.500,000 so Rs.25,000 discount is also part of the overall cost of debt

30. Full Accounting for bonds issued at discount
Nina Gera issued 100, Rs.5000, 9%, two years bonds on 1st January 2008 at 95. Interest is payable semiannually on 1st July and 1st January each.
Make the entries for - recording bonds issue on 1st Jan interest payment on 1st July 2008 and entry for discount amortization (wipe off) - interest adjusting entry on 31st December 2008 and discount amortization - interest payment on 1st January 2009

31. Full Accounting for bonds issued at discount
Nina Gera issued 100, Rs.5000, 9%, two years bonds on 1st January 2008 at 95. Interest is payable semiannually on 1st July and 1st January each.
Repeat remaining entries for the next year (1st January 2009 onwards) and the entry for the maturity on 1st January 2010

32. Full Accounting for bonds issued at discount
Nina Gera issued 100, Rs.5000, 9%, two years bonds on 1st January 2008 at 108. Interest is payable semiannually on 1st July and 1st January each.
Make all necessary journal entries for the bonds life period

33. Full Accounting for bonds issued at discount
Bonds interest expense in the income statement is higher than the nominal face value interest in case of issue of bonds at ? Discount ? ? Premium ?
Why (link with market rate of interest being the underlying cause of issue at discount or premium)
Part or all of this might go ‘over your heads’: Don’t worry, read the chapter and most of the things will get either clearer or ….

34. Straight-Line Amortization
Appendix 15C
Amortizing Bond Discount
Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2010, 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 15C-2
SO 9 Apply the straight-line method of amortizing bond discount and bond premium.

35. Straight-Line Amortization
Amortizing Bond Discount
Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2010, 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, 2010, to record the interest payment and amortization of discount is as follows:
July 1
Interest Expense ,736
Discount on Bonds Payable
Cash 5,000
SO 9 Apply the straight-line method of amortizing bond discount and bond premium.

36. Accounting for Bond Retirements
Redeeming Bonds at Maturity
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
Cash 100,000
SO 3 Describe the entries when bonds are redeemed or converted.

37. Accounting for Bond Retirements
Redeeming Bonds before Maturity - Calling
When a company retires bonds before maturity, it is necessary to:
eliminate the carrying value of the bonds at the redemption date;
record the cash paid; and
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 3 Describe the entries when bonds are redeemed or converted.

38. Accounting for Bond Retirements
Question
When bonds are redeemed before maturity, the gain or loss on redemption is the difference between the cash paid and the:
carrying value of the bonds.
face value of the bonds.
original selling price of the bonds.
maturity value of the bonds.
SO 3 Describe the entries when bonds are redeemed or converted.

39. Accounting for Bond Retirements
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, 2014):
Bonds payable 100,000
Premium on bonds payable 1,623
Loss on redemption 1,377
Cash 103,000
SO 3 Describe the entries when bonds are redeemed or converted.

40. Accounting for Bond Retirements
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 3 Describe the entries when bonds are redeemed or converted.

41. Accounting for Bond Retirements
Illustration: 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. Saunders makes the following entry to record the conversion:
Bonds payable 100,000
Common stock (2,000 x $10) 20,000
Paid-in capital in excess of par 80,000
SO 3 Describe the entries when bonds are redeemed or converted.

42. Accounting for Bond Retirements
Question
When bonds are converted into common stock:
a gain or loss is recognized.
the carrying value of the bonds is transferred to paid-in capital accounts.
the market price of the stock is considered in the entry.
the market price of the bonds is transferred to paid-in capital.
SO 3 Describe the entries when bonds are redeemed or converted.

43. Accounting for Other Long-Term Liabilities (Serial Bonds)
Long-Term Notes Payable / Serial Bonds
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
interest on the unpaid balance of the loan and
a reduction of loan principal.
Companies initially record mortgage notes payable at face value recording the discount or premium as necessary.
SO 4 Describe the accounting for long-term notes payable.

44. Accounting for Other Long-Term Liabilities
Illustration: Porter Technology Inc. issues a $500,000, 12%, 20-year mortgage note on December 31, The terms provide for semiannual installment payments of $33,231 (not including real estate taxes and insurance). The installment payment schedule for the first two years is as follows.
Illustration 15-12
SO 4 Describe the accounting for long-term notes payable.

45. Accounting for Other Long-Term Liabilities
Illustration: Porter Technology Inc. issues a $500,000, 12%, 20-year mortgage note on December 31, The terms provide for semiannual installment payments of $33,231 (not including real estate taxes and insurance). The installment payment schedule for the first two years is as follows.
Dec. 31 Cash 500,000
Mortgage notes payable 500,000
Jun. 30 Interest expense 30,000
Mortgage notes payable 3,231
Cash 33,231
SO 4 Describe the accounting for long-term notes payable.

46. Accounting for Other Long-Term Liabilities
Question
Each payment on a mortgage note payable consists of:
interest on the original balance of the loan.
reduction of loan principal only.
interest on the original balance of the loan and reduction of loan principal.
interest on the unpaid balance of the loan and reduction of loan principal.
SO 4 Describe the accounting for long-term notes payable.

48. Lease Accounting Lease Liabilities
A lease is a contractual arrangement between a lessor (owner of the property) and a lessee (renter of the property).
Illustration 15-13
SO 5 Contrast the accounting for operating and capital leases.

49. Lease Accounting
The issue of how to report leases is the case of substance versus form. Although technically legal title may not pass, the benefits and rsisks from the use of the property do.
Capital Lease:
A lease that transfers substantially all of the risks and rewards of property ownership, should be capitalized (i.e. regarded as purchase of property on credit)
SO 5 Contrast the accounting for operating and capital leases.

50. Lease Accounting Capital / Finance Lease
One or more of four criteria must be met:
Transfers ownership to the lessee.
Contains a bargain purchase option.
Lease term is equal to or greater than 75 percent of the estimated economic life of the leased property.
The present value of the minimum lease payments (excluding certain items) equals or exceeds 90 percent of the fair value of the leased property.
A lease which is not a Finance Lease is an Operating Lease which is a sort of usual rental of property concerned
SO 5 Contrast the accounting for operating and capital leases.

51. Accounting for Other Long-Term Liabilities
Operating Lease
Capital Lease / Finance Lease
At Inception
No entry
At periodic payments
Rent expense xxx
Cash xxx
At lease inception
Leased equipment xxx
Lease liability xxx
At periodic payments
Lease Liability xxx
Interest Exp. xxx
Cash xxx
SO 5 Contrast the accounting for operating and capital leases.

52. Accounting for Other Long-Term Liabilities
Exercise: Gonzalez Company decides to lease new equipment. The lease period is four years; the economic life of the leased equipment is estimated to be five 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.
Instructions:
(a) What type of lease is this? Explain.
(b) Prepare the journal entry to record the lease.
SO 5 Contrast the accounting for operating and capital leases.

53. Accounting for Other Long-Term Liabilities
Exercise: (a) What type of lease is this? Explain.
Capitalization Criteria:
Transfer of ownership
Bargain purchase option
Lease term => 75% of economic life of leased property
Present value of minimum lease payments => 90% of FMV of property
Capital Lease? NO NO
Lease term 4 yrs.
Economic life 5 yrs.
YES 80%
YES - PV and FMV
are the same.
SO 5 Contrast the accounting for operating and capital leases.

54. Accounting for Other Long-Term Liabilities
Exercise: (b) Prepare the journal entry to record the lease.
Leased asset - equipment 190,000
Lease liability 190,000
The portion of the lease liability expected to be paid in the next year is a current liability. The remainder is classified as a long-term liability.
SO 5 Contrast the accounting for operating and capital leases.

55. Accounting for Other Long-Term Liabilities
Question
The lessee must record a lease as an asset if the lease:
transfers ownership of the property to the lessor.
contains any purchase option.
term is 75% or more of the useful life of the leased property.
payments equal or exceed 90% of the fair market value of the leased property.
SO 5 Contrast the accounting for operating and capital leases.

56. Presentation Statement Analysis and Presentation
Illustration 15-14
SO 6 Identify the methods for the presentation and analysis of long-term liabilities.

57. Statement Analysis and Presentation
Analysis of Long-Term Debt
Two ratios that provide information about debt-paying ability and long-run solvency are:
Total debt 1.
Debt to total assets =
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.
SO 6 Identify the methods for the presentation and analysis of long-term liabilities.

58. Income before income taxes and interest expense
Statement Analysis and Presentation
Analysis of Long-Term Debt
Two ratios that provide information about debt-paying ability and long-run solvency are:
Income before income taxes and interest expense
Times interest earned 2. =
Interest expense
Indicates the company’s ability to meet interest payments as they come due.
SO 6 Identify the methods for the presentation and analysis of long-term liabilities.

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