Spiceland | Thomas | Herrmann Financial Accounting Long-Term Liabilities Chapter 9 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

9-2 Learning Objectives Explain financing alternatives Identify the characteristics of bonds Determine the price of a bond issue Account for the issuance of bonds Record the retirement of bonds Identify other major long-term liabilities Make financial decisions using long-term liability ratios Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Part A Overview of Long-Term Debt Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-3

Learning Objective 1 Explain financing alternatives Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-4

9-5 Financing Alternatives Capital structure: mixture of liabilities and stockholders’ equity a business uses Debt financing: borrowing money Equity financing: obtaining additional investment from stockholders Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Learning Objective 2 Identify the characteristics of bonds Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-6

9-7 What Are Bonds? Formal debt instrument Usually issued to many lenders Borrower repays the principal or face amount, at a specified maturity date Pay interest over the life of the bond Private placement: selling debt securities directly to a single investor Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

9-8 Characteristics of Bonds Secured bonds Unsecured bonds Term bonds Serial bonds Callable bonds Convertible bonds Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Illustration 9.1—Summary of Bond Characteristics Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-9

Illustration 9.2—Timeline of a Bond Issue Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-10

Part B Pricing a Bond Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-11

Learning Objective 3 Determine the price of a bond issue Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-12

Illustration 9.3—Pricing Bonds Issued at Face Amount Using a Financial Calculator Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-13

9-14 Illustration 9.4—Pricing Bonds Issued at Face Amount Using Excel Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Illustration 9.5—Pricing Bonds Issued at Face Amount Using Present Value Tables Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-15

Illustration 9.6—Pricing Bonds Issued at a Discount Using a Financial Calculator Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-16

Illustration 9.9—Pricing Bonds Issued at a Premium Using a Financial Calculator Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-17

Illustration 9.12—Stated Rate, Market Rate, and the Bond Issue Price Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-18

Part C Recording Bonds Payable Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-19

Learning Objective 4 Account for the issuance of bonds Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-20

9-21 Recording Bonds Payable—Issued at Face Value Bonds issue for exactly $100,000, assuming a 7% market interest rate First semiannual interest payment: Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Recording Bonds Payable—Issued at Discount Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-22

Illustration 9.13—Amortization Schedule for Bonds Issued at a Discount Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-23

Recording Bonds Payable—Issued at Premium Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-24

Illustration 9.14—Amortization Schedule for Bonds Issued at a Premium Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-25

Illustration 9.15—Changes in Carrying Value over Time Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-26

Learning Objective 5 Record the retirement of bonds Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-27

9-28 Recording Bond Retirements— At Maturity Retired: buy back of bonds from the investors Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

9-29 Recording Bond Retirements— Before Maturity Early extinguishment of debt: retirement of debt before its scheduled maturity Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Part D Other Long-Term Liabilities Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-30

Learning Objective 6 Identify other major long-term liabilities Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-31

9-32 Installment Notes Requires installment payments Installment payment: payment includes interest and outstanding balance Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Illustration 9.16—Amortization Schedule for an Installment Note Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-33

9-34 Recording Installment Payments of Note For first two months Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

9-35 Leases Contractual arrangement between lessor (owner) and lessee (user) to provide the right to use an asset for a specified period of time Types: Operating leases: lessor owns the asset, and the lessee simply uses the asset temporarily Capital leases: lessee buys an asset and borrows the money through a lease to pay for the asset Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Learning Objective 7 Make financial decisions using long-term liability ratios Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-36

9-37 Debt Analysis Business decisions include risk Failure to properly consider risk could prove costly Long-term debt management is crucial Measuring a company’s risk: Debt to equity ratio Times interest earned ratio Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

9-38 Debt to Equity Ratio Measure of financial leverage Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

9-39 Times Interest Earned Ratio Compares interest expense with income available to pay those charges Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

End of Chapter 9 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 9-40