1. Chapter 15-1 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition

2. Chapter 15-2 Long-Term Liabilities Obligations that are expected to be paid after one year Include bonds, long-term notes, and lease obligations Long-Term Liabilities

3. Chapter 15-3 Bonds are: Bond Basics LO 1 Explain why bonds are issued.

4. Chapter 15-4 To obtain large amounts of long-term capital, management usually must decide whether to issue bonds or to use equity financing (common stock). Three advantages over common stock: Bond Basics LO 1 Explain why bonds are issued.

5. Chapter 15-5 Two disadvantages over common stock: Bond Basics LO 1 Explain why bonds are issued.

6. Chapter 15-6 Effects on earnings per share—stocks vs. bonds. Bond Basics LO 1 Explain why bonds are issued. Illustration 15-2

7. Chapter 15-7 Types of Bonds Secured and Unsecured (debenture) bonds. Term and Serial bonds. Registered (“Joe Smith”) and Bearer (or coupon) bonds. Convertible and Callable bonds. Bond Basics LO 1 Explain why bonds are issued.

8. Chapter 15-8 Types of Bonds: Term and Serial Bonds 3) Term bonds – 4) Serial bonds -

9. Chapter 15-9 Types of Bonds Convertible and Callable Convertible Callable

10. Chapter 15-10 Issuing Procedures Bond contract known as a bond indenture. 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). Paper certificate, typically a $1,000 face value. Interest payments usually made semiannually. Generally issued when the amount of capital needed is too large for one lender to supply. Bond Basics LO 1 Explain why bonds are issued.

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

12. Chapter 15-12 $800,000,000,000 average daily trading volume in the U.S. Bonds traded on national securities exchanges and OTC. Newspapers & financial press publish bond prices and trading activity daily. Bond Basics - Bond Basics - Bond Trading LO 1 Explain why bonds are issued. Read as: Outstanding 5.125%, $1,000 bonds that mature in 2011. Currently yield a 5.747% return. On this day, $33,965,000 of these bonds were traded. Closing price was 96.595% of face value, or $965.95.

13. Chapter 15-13 Market value is a function of the three factors that determine present value: Bond Basics - Bond Basics - Determining the Market Value of Bonds LO 1 Explain why bonds are issued. The features of a bond (callable, convertible, etc) affect the market rate of the bond.

14. Chapter 15-14 The Accounting… LO 2 Prepare the entries for the issuance of bonds and interest expense. A corporation only makes journal entries when it issues or buys back bonds, and when bondholders convert bonds into common stock. Transactions between a bondholder and other investors are not journalized by the issuing corporation. After the bond is sold – the issuing company does not journalize any further sales between investors…. why?

15. Chapter 15-15 Illustration: On January 1, 2010, San Marcos HS issues $100,000, three-year, 8% bonds at 100 (100% of face value). Interest is paid annually each Dec. 31. Issuing Bonds at Face Value LO 2 Prepare the entries for the issuance of bonds and interest expense. Jan. 1 Dec. 31

16. Chapter 15-16 The Real World Issuing bonds at a $ amount different from face value is quite common. (Meaning… a $1,000 bond does not always sell for $1,000.) http://www.old-stocks-bonds.com/gm-214384a.jpg Why?

17. Chapter 15-17 6% 8% 10% Premium Face Value Discount Assume Contractual (Face) Rate of 8% Accounting for Bond Issues LO 2 Prepare the entries for the issuance of bonds and interest expense. $1,000 Face Value Bonds Sold At… Market Interest

18. Chapter 15-18 If the market rate is 10%, will this bond sell at a premium or discount? What will it sell for in $?

19. Chapter 15-19 Illustration: On January 1, 2010, San Marcos HS issues $100,000, three-year, 8% bonds for $95,027 (95.027% of face value). Issuing Bonds at a Discount LO 2 Prepare the entries for the issuance of bonds and interest expense. Jan. 1

20. Chapter 15-20 Statement Presentation Issuing Bonds at a Discount LO 2 Prepare the entries for the issuance of bonds and interest expense.

21. Chapter 15-21 Illustration: On January 1, 2010, San Marcos HS issues $100,000, three-year, 8% bonds for $105,346 (105.346% of face value). Issuing Bonds at a Premium LO 2 Prepare the entries for the issuance of bonds and interest expense. Jan. 1

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

23. Chapter 15-23 Redeeming Bonds at Maturity Accounting for Bond Retirements LO 3 Describe the entries when bonds are redeemed or converted. How does San Marcos HS records the redemption of its bonds at maturity. What is the entry.

24. Chapter 15-24 E15-6 Nocioni Company issued $1,000,000 of bonds on January 1, 2010. Instructions: Prepare the journal entry to record the conversion of the bonds into 30,000 shares of $10 par value common stock. Assume the bonds were issued at par. Accounting for Bond Retirements LO 3 Describe the entries when bonds are redeemed or converted.

25. Chapter 15-25 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 LO 4 Describe the accounting for long-term notes payable.

26. Chapter 15-26 Exercise: On December 31, 2008 Tucki Co. receives $240,000 when it issues a $240,000, 10%, mortgage note payable to the Bank to construct a building. The terms provide for semiannual installment payments of $16,000 on June 30 and December 31. Prepare the journal entries to record the mortgage loan and the first installment payment. Accounting for Other Long-Term Liabilities Dec. 31 Jun. 30 * ($240,000 x 10% x 6/12 = $12,000) LO 4 Describe the accounting for long-term notes payable. *

27. Chapter 15-27 Lease Liabilities - A lease is a contract between a lessor (owner of the property) and a lessee (renter of the property). Accounting for Other Long-Term Liabilities Illustration 15-13

28. Chapter 15-28 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. The issue of how to report leases is the case of substance versus form. A lease that transfers substantially all of the benefits and risks of property ownership should be capitalized. (i.e. leasing for years vs. leasing for a month) Accounting for Other Long-Term Liabilities LO 5 Contrast the accounting for operating and capital leases.

29. Chapter 15-29 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 >= 75% of the estimated economic life of the leased property. 4. The present value of the minimum lease payments >= 90% of the fair value of the leased property. Accounting for Other Long-Term Liabilities LO 5 Contrast the accounting for operating and capital leases.

30. Chapter 15-30 Exercise: On January 1, 2010, Burke Corporation signed a 5-year noncancelable lease for a machine. The machine has an estimated useful life of 6 years and the present value of the lease payments is $36,144, 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 on January 1, 2010. LO 5 Contrast the accounting for operating and capital leases. Accounting for Other Long-Term Liabilities

31. Chapter 15-31 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 Lease term 5 yrs. Economic life6 yrs. 83.3% PV and FMV are the same. Capital Lease? LO 5 Contrast the accounting for operating and capital leases. Accounting for Other Long-Term Liabilities

32. Chapter 15-32 Exercise: (b) Prepare the journal entry to record the lease on January 1, 2010. Jan. 1 LO 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.