Long-Term Debt Financing Long-Term Debt Financing C H A P T E R 11

Learning Objective 1 Use present value concepts to measure long-term liabilities.

Define Long-Term Liabilities

Accounting for Long-Term Liabilities Measurement and recording of long-term liabilities are based on the time value of money concept. If money can earn 10% per year, $100 to be received 1 year from now is approximately equal to $90.91 received today. Present value of $1 is the value today of $1 to be received or paid in the future, given a specific interest rate.

Present and Future Value Tables Present Value Table Locate the number of periods in the left column and the interest rate in the row at the top of the table. This intersection is the factor representing the present value of $1. Discounting—present value amount is the amount that could be paid today to satisfy the obligation. Future Value Table Locate the number of periods in the left column and the interest rate in the row at the top of the table. This intersection is the factor representing the future value of $1. Compounding—the frequency with which interest is added to the principal.

Present value of $100 paid in 5 years discounted at 10 percent. PV = $62.09 Today1234Future $100 Discount at 10% Present Value $90.90$82.64

Future value of $100 today compounded for 5 years at 10 percent. FV = $ Today1234Future $100 Future Value Compound at 10% $110$121

Value Table — Future Value Joan invested $2,000 for 3 years at 12 percent, compounded annually. Using the table below, what is the future value of the $2,000? Periods 6% 8% 10% 12%

Joan invested $2,000 for 3 years at 12 percent, compounded semiannually. Using the table below, what is the future value of the $2,000? Periods 6% 8% 10% 12% Value Table — Future Value

Computing the Interest Rate Provide the Appropriate Formula. Interest rate per compounding period = Number of interest periods =

Define Annuities Annuity Present Value of an Annuity

Value Tables — Annuity Joan is paid $8,000 a year for 8 years at 10 percent interest per year. Using the table below, what is the present value of the annuity? Periods 6% 8% 10% 12%

Learning Objective 2 Account for long- term liabilities, including notes payable and mortgages payable.

Time Line of Business Issues ChooseIssue Pay AmortizeRetire Note Payable Mortgage Payable Bond + –

Example: Interest- Bearing Notes On January 1, 2004, Silver Eagle Co. borrowed $20,000 for 3 years at 12 percent interest. The interest is payable on December 31 of each year. What entries are necessary for 2004?

Example: Interest- Bearing Notes What entry is needed when Silver Eagle Co. repays the loan on December 31, 2005?

What is a Mortgage Payable?

Example: Mortgages Payable On January 1, 2006, Blue Bird Corp. borrowed $500,000 to acquire a new building. The building was signed as collateral for the 30-year, 7 percent loan. Payments of $3, are to be made monthly. What are the January 2006 entries?

A mortgage amortization schedule shows the breakdown between interest and principal for each payment over the life of a mortgage. Monthly Principal Interest Mortgage Month Payment Paid Paid Balance 1 3, , , , , , , , , , , , , , , , , , Mortgages Payable

Learning Objective 3 Account for capital lease obligations and understand the significance of operating leases being excluded from the balance sheet.

Lease Obligations Match the Following Terms The party that is granted the right to use property under the terms of a lease The owner of property that is rented (leased) to another party. 3.A simple short-term rental agreement A leasing transaction that is recorded as a purchase by the lessee. 5.A contract that specifies the terms under which the owner of an asset agrees to transfer the right to use the asset to another party. Lessor Operating Lease Lease Lessee Capital Lease

Classifying Leases If the lease is cancelable or does not meet any of the four requirements, is it an operating lease? Transfer of Ownership? Bargain Purchase Option? Term  75% of Useful Life? PV Payment  90% of FMV? Capital Lease Operating Lease

Example: Lease Obligations On January 1, 2006, The Cockatoo Company leased a computer. The lease requires annual payments of $5,000 for 8 years. The applicable interest rate is 12 percent. How is the lease recorded? What is the December 31, 2006 entry for interest expense?

Learning Objective 4 Account for bonds, including the original issuance, the payment of interest, and the retirement of bonds.

Bond Unsecured Bonds (Debentures) Secured Bonds Coupon (Bearer) Bonds Define These Types of Bonds

1.Bonds that mature in one lump sum on a specified future date. 2.Bonds that mature in a series of installments at specified future dates. 3.Bonds for which the issuer reserves the right to pay the obligation before its maturity date. 4.Bonds that can be traded for, or converted to, other securities after a specified period of time. 5.The names and addresses of the bondholders are kept on file by the issuing company. Types of Bonds Matching Serial Bonds Convertible Bonds Term Bonds Callable Bonds Registered Bonds

Zero-Coupon Bonds Junk Bonds Discuss These Types of Bonds

A contract between a bond issuer and a bond purchaser that specifies the terms of a bond. The amount that will be paid on a bond at the maturity date. The date at which a bond principal or face amount becomes payable. Characteristics of Bonds Match Correctly. Principal (face value or market value) Bond Indenture Bond Maturity Date A contract between a bond issuer and a bond purchaser that specifies the terms of a bond. The amount that will be paid on a bond at the maturity date. The date at which a bond principal or face amount becomes payable.

Price should equal: Market rate (effective rate or yield rate) of interest Stated rate of interest How Do You Determine Issuance Price?

Determining Issuance Price Correctly Define Each Term Face Value Bond Discount Bond Premium

Bond Stated Interest Rate 10% Market RateBond Sold at Characteristics of Bonds Complete the Chart 8%10% 12%

Falcon Company agreed to issue 5-year, $500,000 bonds and pay 10 percent interest, compounded semiannually. Assume the effective and stated rates are equal. Calculate the issue price. Example: Bond Issued at Face Value 1.Semiannual interest payments Present value of interest annuity 2.Maturity value of bonds Present value of bonds 3.Issuance price of bonds

Falcon Company agreed to issue 5-year, $500,000 bonds and pay 10 percent interest, compounded semiannually. Assume the effective rate is 12 percent. Calculate the issue price of the bonds. Example: Bond Issued at a Discount 1.Semiannual interest payments Present value of interest annuity 2.Maturity value of bonds Present value of bonds 3.Issuance price of bonds

Falcon Company agreed to issue 5-year, $500,000 bonds and pay 10 percent interest, compounded semiannually. Assume the effective rate is 8 percent. Calculate the issue price of the bonds. Example: Bond Issued at a Premium 1.Semiannual interest payments Present value of interest annuity 2.Maturity value of bonds Present value of bonds 3.Issuance price of bonds

Example: Accounting for Bonds Payable On January 1, 2006, Falcon Company agreed to issue 5-year, $500,000 bonds and pay 10 percent interest, compounded semiannually. Assume the effective rate is 10 percent. What entry is needed to record the liability?

Example: Accounting for Bonds Payable On January 1, 2006, Falcon Company agreed to issue 5-year, $500,000 bonds and pay 10 percent interest, compounded semiannually. Assume the effective rate is 10 percent. What entry is needed to record the first interest payment?

Example: Bond Retirements at Maturity On January 1, 2006, Falcon Company agreed to issue 5-year, $500,000 bonds and pay 10 percent interest, compounded semiannually. Assume the effective rate is 10 percent. What entry is needed to record the retirement of the bond on January 1, 2011?

Example: Bond Retirements Before Maturity The Great Owl Company issued $200,000, 14 percent bonds, which are now selling for 107 and are callable at 110. The bonds were issued at face value. If the company decides to call the bonds, what entry is needed?

Learning Objective 5 Use debt-related ratios to determine the degree of a company’s financial leverage and its ability to repay loans

Define Debt Ratio

Define Debt-to-Equity Ratio

Times Interest Earned Ratio

Expanded Material Learning Objective 6 Amortize bond discounts and bond premiums using either the straight-line method or the effective-interest method.

Define the Two Bond Premium/Discount Amortization Methods Straight-line Method Effective-interest Method Which method is preferred by GAAP?

On January 1, 2006, The Ostrich Company agreed to issue 10-year, $200,000 bonds and pay 10 percent interest, compounded semiannually. The company received $196,000 for the bonds. Make the entry to record the issuance of the bonds. Example: Bond Issued at a Discount

On January 1, 2006, The Ostrich Company agreed to issue 10-year, $200,000 bonds and pay 10 percent interest, compounded semiannually. Using straight-line amortization, what entry is made for the interest payment on June 30, 2006? Example: Bond Issued at a Discount

On January 1, 2006, The Ostrich Company agreed to issue 10-year, $200,000 bonds and pay 10 percent interest, compounded semiannually. Using straight-line amortization, what adjusting entry is needed on December 31, 2006? Example: Bond Issued at a Discount

On January 1, 2006, The Ostrich Company agreed to issue 10-year, $200,000 bonds and pay 10 percent interest, compounded semiannually. What entry is necessary to retire the debt after 10 years? Example: Bond Issued at a Discount

Example: Bond Issued at a Premium On January 1, 2006, The Parrot Company agreed to issue 10-year, $200,000 bonds and pay 10 percent interest, compounded semiannually. The company received $210,000 for the bonds. Make the entry to record the issuance of the bonds.

Example: Bond Issued at a Premium On January 1, 2006, The Parrot Company agreed to issue 10-year, $200,000 bonds and pay 10 percent interest, compounded semiannually. The company received $210,000 for the bonds. Using straight- line amortization, what entry is made for the interest payment on June 30, 2006?

Example: Bond Issued at a Premium On January 1, 2006, The Parrot Company agreed to issue 10-year, $200,000 bonds and pay 10 percent interest, compounded semiannually. The company received $210,000 for the bonds. Using straight-line amortization, what entry is needed on December 31, 2006?

Example: Bond Issued at a Premium On January 1, 2006, The Parrot Company agreed to issue 10-year, $200,000 bonds and pay 10 percent interest, compounded semiannually. The company received $210,000 for the bonds. What entry is necessary to retire the debt after 10 years?

Effective-Interest Method The Woodpecker Company issued a $1,000, 8 percent bond. The market rate was 7 percent at the time of issuance. Create an effective- interest table. A B C D E ( Premium Amortization #Payment Interest Expense Unamortized Premium Bond Book

Chapter 11 Complete