Chapter 15 Part 2 Long Term Liabilities

Redeeming Bonds at Maturity Accounting for Bond Retirements SO 3 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

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. Accounting for Bond Retirements SO 3 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

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 payable1,623 Loss on redemption1,377 Cash103,000 Accounting for Bond Retirements SO 3 Describe the entries when bonds are redeemed or converted.

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

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 par80,000 Accounting for Bond Retirements SO 3 Describe the entries when bonds are redeemed or converted.

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

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. Accounting for Other Long-Term Liabilities SO 4 Describe the accounting for long-term notes payable.

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. Accounting for Other Long-Term Liabilities SO 4 Describe the accounting for long-term notes payable. Illustration 15-12

Accounting for Other Long-Term Liabilities SO 4 Describe the accounting for long-term notes payable. 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. journal entry is for the note and the first interest payment is Dec. 31Cash 500,000 Mortgage notes payable500,000 Jun. 30Interest expense30,000 Mortgage notes payable3,231 Cash33,231

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 Accounting for Other Long-Term Liabilities SO 4 Describe the accounting for long-term notes payable.

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

Operating Lease Capital Lease Journal Entry: Rent expense xxx Rent expense xxx Cash xxx Cash xxx Journal Entry: Leased equipment xxx Leased equipment xxx Lease liability xxx Lease liability xxx The issue of how to report leases is the case of. Although technically legal title may not pass, the benefits from the use of the property do. The issue of how to report leases is the case of substance versus form. Although technically legal title may not pass, the benefits from the use of the property do. Statement of Financial Accounting Standard No. 13, “Accounting for Leases,” 1976 A lease that transfers substantially all of the benefits and risks of property ownership should be capitalized (only noncancellable leases may be capitalized). Accounting for Other Long-Term Liabilities SO 5 Contrast the accounting for operating and capital leases.

To capitalize a lease, one or more of four criteria must be met: 1. Transfers ownership to the lessee. 2. Contains a bargain purchase option. 3. Lease term is equal to or greater than 75 percent of the estimated economic life of the leased property. 4. The present value of the minimum lease payments (excluding executory costs) equals or exceeds 90 percent of the fair value of the leased property. Accounting for Other Long-Term Liabilities SO 5 Contrast the accounting for operating and capital leases.

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. Accounting for Other Long-Term Liabilities

Exercise: (a) What type of lease is this? Explain. Capitalization Criteria: 1. Transfer of ownership 2. Bargain purchase option 3. Lease term => 75% of economic life of leased property 4. Present value of minimum lease payments => 90% of FMV of property NO NO Lease term 4 yrs. Economic life5 yrs. YES 80% YES - PV and FMV are the same. Capital Lease? SO 5 Contrast the accounting for operating and capital leases. Accounting for Other Long-Term Liabilities

Exercise: (b) Prepare the journal entry to record the lease. SO 5 Contrast the accounting for operating and capital leases. Accounting for Other Long-Term Liabilities 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. Leased asset - equipment 190,000 Lease liability190,000

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

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

Analysis of Long-Term Debt 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 6 Identify the methods for the presentation and analysis of long-term liabilities. 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 Interest expense Times interest earned = Indicates the company’s ability to meet interest payments as they come due. 2. SO 6 Identify the methods for the presentation and analysis of long-term liabilities. Statement Analysis and Presentation