1. Long-Term Liabilities
Chapter 14

2. Long-Term Debit: General
Long-term debt consists of probable future sacrifices.
It has various covenants or restrictions for the protection of both lenders and borrowers.
The indenture agreement incorporates the terms of the issue and restrictions.

3. Issuing Bonds Bonds are the most common type of long-term debt.
A bond indenture is a promise (by the lender to the borrower) to pay:
a sum of money at the designated date, and
periodic interest at a stipulated rate on the face value.

4. Bond Issues: Parties to the Contract
lend cash
Issuer of Bonds
Bondholders
3. Payment of Face Value (maturity)
2. Payment Periodic Interest
1. Bond Certificate

5. Types of bonds:
Secured and unsecured bonds
Term, Serial, and Callable bonds
Convertible, Commodity-Backed, and Deep discount bonds
Commodity-backed bonds
Registered and bearer (coupon) bonds
Income and Revenue bonds

6. Valuation of Bonds payable Discount and premium
The price of a bond issue is determined by:
the present value of the interest payments, and
the present value of the face value,
both discounted at the market (effective) rate of interest at date of issue.
Interest payments by borrower are calculated as:
Face value of bond issue x Stated (face) rate of interest.

7. Valuation of Bonds payable Discount and premium
The interest rate written in the terms of bond indenture is known as the stated, coupon, or nominal rate.
- stated rate is the rate used to determine the amount of cash interest the borrower pays and the investor receives.( usually stated as annual rate).
The face value is the amount of principal the issuer must pay at the maturity date.
The present value of bonds is the value at which it should sell in the marketplace.

8. If the bonds sell for if the bonds sell for
Under which conditions of bonds issuance does a discount on bonds payable arise?
Under which conditions of bonds issuance does a premium on bonds payable arise?
The difference between the face value and the present value of the bonds is either:
Discount or Premium
If the bonds sell for if the bonds sell for
less than face value more than face value

9. Present value of the principle: $100,000 × .59345 (table 6-2) $59,345
Example:
ServiceMaster issues $100,000 in bonds, due in 5 years with 9 percent interest payable annually at year-end. At the time of issue, the market rate for such bonds is 11 percent.
(The market rate is the rate investors demand for loaning funds)
Present value of the principle:
$100,000 × (table 6-2) $59,345
Present value of the interest payment:
$9,000 × (table6-4) $33,263,10
Present value (selling price) of the bonds $92,608,10

10. Year 1 Year 2 Year 3 Year 4 Year 5
$9,000
Interest
$100,000
face value
Redemption at maturity ==>
Interest = $100,000 x 9% per year stated rate

11. Bond issued at par on interest date
When bonds are issued on an interest payment date at face value, no interest has occurred and no premium or discount exists.
Example:
If 10-yearterm bonds with a par value of $800,000 dated in Jan1, 2004, and bearing interest at an annual rate of 10 percent payable semi-annually on Jan1 and July 1, are issued on Jan 1 at par.

12. The entry on the books of the issuing corporation would be:
Cash ,000
Bonds Payable 800,000
The entry to record the first semi-annual interest payment
of 40,000 (800,000 × 10% × ½)on July 1, 2004, would be:
Bond interest expense 40,000
Cash ,000
The entry to record accrued expense at Dec 31, 2004 (year-end) would be:
Bond interest payable 40,000

13. Bonds issued at discount or Premium on interest date
1- Discount ( a discount is amortized either by the straight line method or the effective interest method.)
From the previous example, assume that $800,000 of bonds were issued on Jan 1, 2004 at 97% of par, he issuance would be recorded as follows:
Cash (800,000 × .97) 776,000
Discount on bonds payable 24,000
Bonds payable 800,000

14. The discount is amortized and charged to interest expense over the period of time that the bonds are outstanding.
Under the straight-line method, the amount amortized each year is a constant amount.
The discount is 24,000, so the amount amortized to interest expense each year is 2,400 (24,000 / 10 years)
Total Discount or Premium
Total Number of Periods
The amortization is recorded as follows:
Bonds interest expense 2,400
Discount on bonds payable ,400

15. At the end of the first year:
The unamortized balance in discount on bonds payable is:
24,000 – 2,400 = 21,600
(The balance of the discount is subtracted from the bonds payable in he balance sheet)
Assume that the bonds were sold in Oct 2004, so there are three months of accrued interest must be recorded on Dec 31.

16. 2- Premium ( a premium is amortized either by the straight line method or the effective interest method.)
From the previous example, assume that the bonds are sold in Jan1, 2004 at 103%, so the entry will be:
Cash (800,000 × 1.3) ,000
Premium on bonds payable 24,000
Bonds payable ,000
At the end of the year, the entry to amortized the premium will be
Premium on bonds payable 2,400
Bond interest expense 2,400
Bond interest is increased by amortization of discount and decreased by amortization of premium.
Any premium or discount must be amortized over the life to maturity date because early redemption (call of bond) is not a certainty.

17. Bonds Issued Between Interest Dates
When the bonds are issued on other than the interest payment dates, buyers of the bonds will pay the seller the interest accrued from the last interest payment date on the date of issue.
The purchasers will receive the full 6-months’ interest payment n the next semiannual interest payment date.
Example:
If 10-year bonds of a par value of $800,000, dated Jan 1, 2004, and bearing interest at an annual rate of 10 percent payable semiannually on Jan 1 and July 1, are issued on March 1, 2004 at par plus accrued interest.

18. The entry on the books of the issuing corporation is:
Cash ,333
Bonds Payable ,000
Bond interest expense (800,000 × .10 × 2/12 ) ,333
On July 1, 2004, the company will make the following entry:
Bond interest expense 40,000
Cash ,000
The interest expense account will have a debit balance of $26,667 which represent the proper amount of interest expense (800,000 × .10 × 4/12)

19. Bonds payable 800,000 Premium on bonds payable (800,000× 2%) 16,000
Example:
From the previous example, assume that the 10% bonds were issued at the entry on March 1 will be as follows:
Cash (800,000 × 1.02) + (800,000 × .10× 2/12) 829,333
Bonds payable , Premium on bonds payable (800,000× 2%) ,000
Bond interest expense ,333
The premium would be amortized from the date of sale, which is March1,2004, not the date from of the bonds, which is Jan1, 2004

20. Effective Interest Method
The effective interest method is also called the present value amortization which is the preferred procedure for amortization of discount or premium.
1- Bond interest expense is computed first by multiplying the carrying value( which is book value) of the bonds at the beginning of the period by the effective interest rate.
2- The bond discount or premium amortization is then determined by comparing the bond interest expense with the interest to be paid.

21. - = Bond interest expense Bonds interest paid Carrying value=
Amortization amount
Bonds interest paid
Face amount × Stated
of bonds interest
rate
Bond interest expense
Carrying value
Of bonds × effective interest
Beginning rate
of period

22. Bonds Issued at Discount
Example:
Evermaster Corporation issued $100,000 of 8% term bonds on Jan 1,2004, due on Jan 1,2009, with interest payable each July 1 and Jan 1 . Because the investors required an effective interest rate of 10%, they paid $92,278 for the $100,000 of bonds, creating a $7,722 discount.
The $7,722 discount is computed as follows:
Maturity value of bonds payable ,000
Present value of 100,000 due in 5 years at 10%, interest payable
Semiannually (100,000 × ) ,391
Present value of 4,000 interest payable semi-annually for 5 years
At 10% annually (4,000 × ) ,887
Proceeds from sale of bonds ,278
Discount on bonds payable ,722

23. Schedule of bond discount amortization
Date Cash paid Interest Discount Carrying amount
Expense amortized of bonds
1/1/ ,278
7/1/ ,000 a ,614b c ,892d
1/1/ , , ,537
7/1/ , , ,214
1/1/ , , ,925
7/1/ , , ,671
1/1/ , , ,454
7/1/ , , ,277
1/1/ , , ,141
7/1/ , , ,048
1/1/ , , ,000
40, , ,722
A: 4,000 = 100,000 × 8% × 6/ B: 4,614 = 92,278 × 10% × 6/12
C: 614 = 4,614 – 4, D: 92,892 = 92,

24. The entry to record the issuance of the bonds at discount
on Jan 1, 2004 is:
Cash 92,278
Discount on Bonds payable ,722
Bonds Payable 100,000
The entry to record the first interest payment in July 1,2004 and amortization of the discount is:
Bond Interest Expense 4,614
Discount on Bonds Payable
Cash ,000
The entry to record the interest expense accrued at Dec 31,2004 and amortization of the discount is:
Bond Interest Expense 4,645
Bond Interest Payable 4,000
Discount on Bonds Payable

25. Bonds Issued at Premium
Example
From the previous example, assume that the investors were willing to accept an effective interest rate of 6% on the bond issue, and they would have paid $108,530 or premium of $8,530.
Maturity value of bonds payable ,000
Present value of 100,000 due in 5 years at 6%, interest payable
Semi-annually (100,000 × ) ,409
Present value of 4,000 interest payable semi-annually for 5 years
At 6% annually (4,000 × ) ,121
Proceeds from sale of bonds ,530
Premium on bonds payable 8,530

26. Schedule of bond premium amortization
Date Cash paid Interest Premium Carrying amount
Expense amortized of bonds
1/1/ ,530
7/1/ ,000 a ,256b c ,786d
1/1/ , , ,020
7/1/ , , ,231
1/1/ , , ,418
7/1/ , , ,580
1/1/ , , ,717
7/1/ , , ,829
1/1/ , , ,914
7/1/ , , ,971
1/1/ , , ,000
40, , ,530
A: 4,000 = 100,000 × 8% × 6/ B: 3,256 = 108,530 × 6% × 6/12
C: 744 = 4,000 – 3, D: 107,786 = 108,

27. The entry to record the issuance of bonds at premium on Jan 1, 2004, is:
Cash ,530
Premium on bonds Payable ,530
Bonds Payable ,000
The entry to record the first interest payment on July 1,2004 and amortization of the premium is:
Bond interest expense 3,256
Premium on bonds payable
Cash ,000

28. Accruing Interest
In the previous examples, the two interest payment dates coincided with the financial reporting dates. However, if the financial statements are reported at the end of Feb, the premium or discount will be reported by the appropriate number of months to get the proper interest expense.

29. Interest accrual (4,000 × 2/6) 1,333.33
Premium amortized (744 × 2/6)
Interest expense 1,085.33
The entry to record this accrual is:
Bond Interest Expense 1,085.33
Premium on Bonds Payable
Bond Interest Payable ,333.33

30. Long-Term Notes Payable
The difference between current notes payable and long-term notes payable.
Note issued at face value
Cash ,000
Notes Payable ,000
Notes not issued at face value
Zero-Interest-Bearing Notes
Interest-Bearing Notes

31. Exercises
On Dec 2004, Gulf Software issued $1.0 million, 10%, 10 year bonds at face value. Interest is payable semiannually on Jan 1 and July1
A- Journalize the issuance of the bonds on Jan , 2005.
B- Prepare the journal entries for interest expense in 2005.

32. (to record issuance of bonds) B- July 1 Bond Interest Expense 50,000
A- Jan 1
Cash 1,000,000
Bonds Payable ,000,000
(to record issuance of bonds)
B- July 1
Bond Interest Expense 50,000
Cash 50,000
(to record payment of semiannual interest, 1000,000 × 10%× 6/12)
Dec 31
Bond Interest Payable 50,000
( to record accrual of semi-annual interest)

33. BE14-2
The Goofy company issued $200,000 of 10% bonds on Jan 1, The bonds are due Jan 1, 2010, with interest payable each July 1 and Jan 1. The bonds are issued at face value. Prepare Goofy’s journal entries for (a) the Jan issuance, (b) the July 1 interest payment, and (c) the Dec 31 adjustment entry.
A- Jan 1
Cash ,000
Bonds Payable ,000
(to record issuance of bonds)
B- July 1
Bond Interest Expense 10,000
Cash 10,000
(to record payment of semiannual interest, 200,000 × 10%× 6/12)
C- Dec 31
Bond Interest Payable 10,000
( to record accrual of semi-annual interest)

34. BE14-3
Assume the bonds in BE14-2 were issued at 98%. Prepare the journal entries for (a) the Jan issuance, (b) the July 1 and (c) the Dec 31 adjustment entry. Assume the Goofy company records straight-line amortization annually on Dec 31.
A- Cash (200,000 × .98) 196,000
Discount on bonds payable ,000
Bonds payable 200,000
B- The discount is 4,000, so the amount amortized to interest expense each year is 800 ( 4,000 / 5 years) because it’s semi-annually, it will be $400
July entry is:
Bond interest expense 10,000
Discount on bonds payable
Cash ,600
C- Dec 31
Bonds interest expense 10,000
Bond interest payable 9,600
The July and Dec entries will be the same in all five years

35. Although Discount on Bonds Payable has a debit balance, it is not an asset. Rather, it is a contra account. This account is deducted from bonds payable on the balance sheet.
Goofy Company
Balance Sheet
Long-term Liabilities
Bonds Payable ,000
Less: Discount on bonds Payable ,200
Note: the balance of the discount is deducted from the bonds payable, so at the end of the year the balance of the discount will be 3,200. so this amount will be subtracted from the bonds payable in the balance sheet.

36. Discount on Bonds Payable
Jan1, ,000
July 1,
Dec 31,
Bal. Jan ,200
July 1,
Dec 31,
Bal. Jan ,400
July 1,
Dec 31,
Bal. Jan ,600
July 1,
Dec 31,
Bal. Jan
July 1,
Dec 31,

37. Balance Sheet
At Dec 31, 2005
Long-term Liabilities ,000
Less: Discount on bonds Payable ,200
196,800
Balance Sheet
At Dec 31, 2006
Long-term Liabilities ,000
Less: Discount on bonds Payable ,400
197,600
Balance Sheet
At Dec 31, 2007
Long-term Liabilities ,000
Less: Discount on bonds Payable ,600
198,400
Balance Sheet
At Dec 31, 2008
Long-term Liabilities ,000
Less: Discount on bonds Payable
198,200
Balance Sheet
At Dec 31, 2009
Long-term Liabilities ,000
Note:
If there is redemption of the bonds in 2009, the account will be closed by making bonds payable debit and cash credit.

38. BE14-4
Assume the bonds in BE14-2 were issued at 103%. Prepare the journal entries for (a) the Jan issuance, (b) the July 1 and (c) the Dec 31 adjustment entry. Assume the Goofy company records straight-line amortization annually on Dec 31.
A- Cash (200,000 × 103%) 206,000
Premium on bonds payable ,000
Bonds payable ,000 B-
July entry is:
Bond interest expense 9,400
Premium on bonds payable
Cash ,000
C- Dec 31
Bonds interest expense ,400
Premium on bonds payable
Bond interest payable 10,000

39. Premium on bonds payable is added to bonds payable on the balance sheet.
Goofy Company
Balance Sheet
Long-term Liabilities
Bonds Payable ,000
Add: Premium on bonds Payable ,800
Note: the balance of the premium is added to the bonds payable, so at the end of the year the balance of the premium will be 4,800. so this amount will be added on the bonds payable in the balance sheet.

40. Balance Sheet
At Dec 31, 2005
Long-term Liabilities ,000
Add: Premium on bonds Payable ,800
204,800
Balance Sheet
At Dec 31, 2006
Long-term Liabilities ,000
Add: Premium on bonds Payable ,600
203,600
Balance Sheet
At Dec 31, 2007
Long-term Liabilities ,000
Add: Premium on bonds Payable ,400
202,400
Balance Sheet
At Dec 31, 2008
Long-term Liabilities ,000
Add: Premium on bonds Payable ,200
201,200
Note:
If there is redemption of the bonds in 2009, the account will be closed by making bonds payable debit and cash credit.
Balance Sheet
At Dec 31, 2009
Long-term Liabilities ,000

41. Premium on Bonds Payable
July 1,
Dec 31,
Jan1, ,000
July 1,
Dec 31,
Bal. Jan ,800
July 1,
Dec 31,
Bal. Jan ,600
July 1,
Dec 31,
Bal. Jan ,400
July 1,
Dec 31,
Bal. Jan ,200

42. Exercise: Garden, Inc issued $100,000 of 10%, 5-year bonds on Jan 1, 2001, with interest payable each July 1 and Jan 1. Bonds were sold for $92,639, and an effective-interest rate of 12%. (a) prepare bond discount amortization schedule. (b) journal entries for Jan issuance and July 1 interest payment and Dec 31 adjusting entry.
Maturity value of bonds payable ,000
Present value of 100,000 due in 5 years at 12%, interest payable
Semi-annually (100,000 × ) ,839
Present value of 5,000 interest payable semi-annually for 5 years
At 12% annually (5,000 × ) ,800
Proceeds from sale of bonds ,239
Discount on bonds payable ,361

43. Schedule of bond discount amortization
Date Cash paid Interest Discount Carrying amount Expense amortized of bonds
1/1/ ,639
7/1/ ,000 a ,558b c ,197d
1/1/ , , ,789
7/1/ , , ,416
1/1/ , , ,081
7/1/ , , ,786
1/1/ , , ,533
7/1/ , , ,325
1/1/ , , ,165
7/1/ , , ,055
1/1/ , , ,000
50, , ,361
A: 5,000 = 100,000 × 10% × 6/ B: 5,558 = 92,639 × 12% × 6/12
C: 558 = 5,558 – 5, D: 93,197 = 92,

44. Discount on Bonds Payable 592
Jan 1, 2001
Cash (200,000 × .98) ,639
Discount on bonds payable ,361
Bonds payable ,000
July 1, 2001
Bond Interest Expense 5,585
Discount on Bonds Payable
Cash ,000
Dec 31, 2001
Bond Interest Expense 5,592
Bond Interest Payable 5,000
Discount on Bonds Payable

45. Homework
Ortiz, Inc issues $100,000 of 10%, 5-year bonds on Jan 1, 2004, with interest payable each July 1 and Jan 1. The bonds sell for $108,111, and an effective-interest rate of 8%. (a) prepare bond premium amortization schedule. (b) journal entries for Jan issuance and July 1 interest payment and Dec 31 adjusting entry.