1. PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Chapter 14 L ONG -T ERM L IABILITIES McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

2. 14 - 2 B OND F INANCING Bonds do not affect owner control. Interest on bonds is tax deductible. Bonds can increase return on equity. Advantages Bonds require payment of both periodic interest and par value at maturity. Bonds can decrease return on equity. Disadvantages A1

3. 14 - 3 B OND T RADING A1 Bonds are securities that can be purchased or sold in the securities markets. They have a market value which is expressed as a percent of their par value. The closing price indicates that the IBM stock is being sold at 119.25% of face value.

4. 14 - 4 B OND I SSUING P ROCEDURES A1

5. 14 - 5 Bond Certificate Bond Certificate Bond Selling Price Corporation Investors B OND I SSUANCES P1 Transaction on the Bond Issue Date

6. 14 - 6 Bond Interest Payments CorporationInvestors Bond Issue Date Bond Interest Payments Interest Payment = Bond Par Value × Stated Interest Rate x Time B OND I SSUANCES Transactions during the bond life P1

7. 14 - 7 Bond Face Value Corporation Investors B OND I SSUANCES Transaction on the Maturity Date P1

8. 14 - 8 I SSUING B ONDS AT P AR On Jan. 1, 2011, a company issued the following bonds: Par Value: $800,000 Stated Interest Rate: 9% Interest Dates: 6/30 and 12/31 Maturity Date = Dec. 31, 2030 (20 years) P1

9. 14 - 9 $800,000 × 9% × ½ year = $36,000 I SSUING B ONDS AT P AR On June 30, 2011, the issuer of the bond pays the first semiannual interest payment of $36,000. P1 This entry is made every six months until the bonds mature.

10. 14 - 10 I SSUING B ONDS AT P AR On December 31, 2030, the bonds mature and the issuer of the bond pays face value of $800,000 to the bondholders. P1

11. 14 - 11 B OND D ISCOUNT OR P REMIUM P1

12. 14 - 12 Fila issues bonds with the following provisions: Fila issues bonds with the following provisions: Par Value: $100,000 Par Value: $100,000 Issue Price: 96.454% of par value Issue Price: 96.454% of par value Stated Interest Rate: 8% Stated Interest Rate: 8% Market Interest Rate: 10% Market Interest Rate: 10% Interest Dates: 6/30 and 12/31 Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years) Maturity Date: Dec. 31, 2013 (2 years) Fila issues bonds with the following provisions: Fila issues bonds with the following provisions: Par Value: $100,000 Par Value: $100,000 Issue Price: 96.454% of par value Issue Price: 96.454% of par value Stated Interest Rate: 8% Stated Interest Rate: 8% Market Interest Rate: 10% Market Interest Rate: 10% Interest Dates: 6/30 and 12/31 Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years) Maturity Date: Dec. 31, 2013 (2 years) I SSUING B ONDS AT A D ISCOUNT } } Bond will sell at a discount. P2

13. 14 - 13 On Dec. 31, 2011, Fila should record the bond issue. I SSUING B ONDS AT A D ISCOUNT Par value $ 100,000 Cash proceeds 96,454 Discount $ 3,546 *$100,000 x 96.454% Contra-LiabilityAccountContra-LiabilityAccount P2

14. 14 - 14 Maturity Value Carrying Value I SSUING B ONDS AT A D ISCOUNT Amortizing a Bond Discount Using the straight-line method, the discount amortization will be $887 (rounded) every six months. $3,546 ÷ 4 periods = $887 (rounded) Amortizing a Bond Discount Using the straight-line method, the discount amortization will be $887 (rounded) every six months. $3,546 ÷ 4 periods = $887 (rounded) P2

15. 14 - 15 $3,546 ÷ 4 periods = $887 (rounded) $100,000 × 8% × ½ = $4,000 $3,546 ÷ 4 periods = $887 (rounded) $100,000 × 8% × ½ = $4,000 Fila will make the following entry every six months to record the cash interest payment and the amortization of the discount. A MORTIZING A B OND D ISCOUNT P2

16. 14 - 16 A MORTIZING A B OND D ISCOUNT P2

17. 14 - 17 Adidas issues bonds with the following provisions: Adidas issues bonds with the following provisions: Par Value: $100,000 Par Value: $100,000 Issue Price: 103.546% of par value Issue Price: 103.546% of par value Stated Interest Rate: 12% Stated Interest Rate: 12% Market Interest Rate: 10% Market Interest Rate: 10% Interest Dates: 6/30 and 12/31 Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years) Maturity Date: Dec. 31, 2013 (2 years) Adidas issues bonds with the following provisions: Adidas issues bonds with the following provisions: Par Value: $100,000 Par Value: $100,000 Issue Price: 103.546% of par value Issue Price: 103.546% of par value Stated Interest Rate: 12% Stated Interest Rate: 12% Market Interest Rate: 10% Market Interest Rate: 10% Interest Dates: 6/30 and 12/31 Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years) Maturity Date: Dec. 31, 2013 (2 years) I SSUING B ONDS AT A P REMIUM } } Bond will sell at a premium. P3

18. 14 - 18 I SSUING B ONDS AT A P REMIUM Par value $ 100,000 Cash proceeds 103,546* Premium $ 3,546 *$100,000 x 103.546% Adjunct-LiabilityAccountAdjunct-LiabilityAccount On Dec. 31, 2011, Adidas will record the bond issue as: P3

19. 14 - 19 I SSUING B ONDS AT A P REMIUM Maturity Value Carrying Value Amortizing a Bond Premium Using the straight-line method, the premium amortization will be $887 (rounded) every six months. $3,546 ÷ 4 periods = $887 (rounded) Amortizing a Bond Premium Using the straight-line method, the premium amortization will be $887 (rounded) every six months. $3,546 ÷ 4 periods = $887 (rounded) P3

20. 14 - 20 A MORTIZING A B OND P REMIUM $3,546 ÷ 4 periods = $887 (rounded) $100,000 × 12% × ½ = $6,000 $3,546 ÷ 4 periods = $887 (rounded) $100,000 × 12% × ½ = $6,000 Adidas will make the following entry every six months to record the cash interest payment and the amortization of the discount. P3

21. 14 - 21 A MORTIZING A B OND P REMIUM P3

22. 14 - 22 B OND P RICING P2 Cash Outflows related to Interest Payments Cash Outflows for par value at end of Bond life

23. 14 - 23 Fila issues bonds with the following provisions: Fila issues bonds with the following provisions: Par Value: $100,000 Par Value: $100,000 Issue Price: ? Issue Price: ? Stated Interest Rate: 8% Stated Interest Rate: 8% Market Interest Rate: 10% Market Interest Rate: 10% Interest Dates: 6/30 and 12/31 Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years) Maturity Date: Dec. 31, 2013 (2 years) Fila issues bonds with the following provisions: Fila issues bonds with the following provisions: Par Value: $100,000 Par Value: $100,000 Issue Price: ? Issue Price: ? Stated Interest Rate: 8% Stated Interest Rate: 8% Market Interest Rate: 10% Market Interest Rate: 10% Interest Dates: 6/30 and 12/31 Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years) Maturity Date: Dec. 31, 2013 (2 years) I SSUING B ONDS AT A D ISCOUNT P2

24. 14 - 24 P RESENT V ALUE OF A D ISCOUNT B OND To calculate Present Value, we need relevant interest rate and number of periods. Semiannual rate = 5% (Market rate 10% ÷ 2) Semiannual periods = 4 (Bond life 2 years × 2) To calculate Present Value, we need relevant interest rate and number of periods. Semiannual rate = 5% (Market rate 10% ÷ 2) Semiannual periods = 4 (Bond life 2 years × 2) $100,000 × 8% × ½ = $4,000 P2

25. 14 - 25 B OND R ETIREMENT Retirement of the Fila bonds at maturity for $100,000 cash. Because any discount or premium will be fully amortized at maturity, the carrying value of the bonds will be equal to par value. P4

26. 14 - 26 B OND R ETIREMENT Retirement of Bonds before Maturity Carrying Value > Retirement Price = Gain Carrying Value < Retirement Price = Loss Assume that $100,000 of callable bonds will be retired on July 1, 2011, after the first interest payment. The bond carrying value is $104,500.The bonds have a call premium of $3,000. P4

27. 14 - 27 B OND R ETIREMENT By Conversion On January 1, $100,000 par value bonds of Converse, with a carrying value of $100,000, are converted to 15,000 shares of $2 par value common stock. 15,000 shares × $2 par value per share P4

28. 14 - 28 Note Maturity Date Note Payable Cash CompanyLender Note Date When is the repayment of the principal and interest going to be made? L ONG -T ERM N OTES P AYABLE C1

29. 14 - 29 Note Maturity Date CompanyLender Note Date Single Payment of Principal plus Interest L ONG -T ERM N OTES P AYABLE C1

30. 14 - 30 Note Maturity Date CompanyLender Note Date Regular Payments of Principal plus Interest Payments either can be equal principal payments plus interest or equal payments. Regular Payments of Principal plus Interest L ONG -T ERM N OTES P AYABLE C1

31. 14 - 31 I NSTALLMENT N OTES On January 1, 2011, Foghog borrows $60,000 from a bank to purchase equipment. It signs an 8% installment note requiring 6 annual payments of principal plus interest. Compute the periodic payment by dividing the face amount of the note by the present value factor. C1

32. 14 - 32 I NSTALLMENT N OTES WITH E QUAL P AYMENTS C1

33. 14 - 33 I NSTALLMENT N OTES WITH E QUAL P AYMENTS Let’s record the first payment made on December 31, 2011 by Foghog to the bank. Refer back to the amortization schedule to make the December 31, 2012 payment on the note. P5

34. 14 - 34 M ORTGAGE N OTES AND B ONDS A legal agreement that helps protect the lender if the borrower fails to make the required payments. Gives the lender the right to be paid out of the cash proceeds from the sale of the borrower’s assets specifically identified in the mortgage contract. A legal agreement that helps protect the lender if the borrower fails to make the required payments. Gives the lender the right to be paid out of the cash proceeds from the sale of the borrower’s assets specifically identified in the mortgage contract. C1

35. 14 - 35 G LOBAL V IEW Accounting for Bonds and Notes The definitions and characteristics of bonds and notes are broadly similar for both U.S. GAAP and IFRS. The accounting for issuances of bonds, market pricing, and retirement of both bonds and notes is similar. Both U.S. GAAP and IFRS also allow companies to account for bonds and notes using fair value. Accounting for Leases and Pensions Both U.S. GAAP and IFRS require companies to distinguish between operating leases and capital leases; with IFRS calling the latter finance leases. The accounting and reporting for leases are broadly similar with the main difference that the criteria for identifying a lease as a capital or finance lease is more general under IFRS. For pensions, the methods of accounting and reporting are similar for both U.S. GAAP and IFRS.

36. 14 - 36 Secured and Unsecured Term and Serial Registered and Bearer Convertible and Callable F EATURES OF B ONDS AND N OTES A2

37. 14 - 37 This ratio helps investors determine the risk of investing in a company by dividing its total liabilities by total equity. D EBT - TO -E QUITY R ATIO Debt-to- Equity Ratio Total Liabilities Total Equity = A3

38. 14 - 38 Present Value of $1 Rate Periods3%4%5% 1 0.9709 0.9615 0.9524 2 0.9426 0.9246 0.9070 3 0.9151 0.8890 0.8638 4 0.8885 0.8548 0.8227 5 0.8626 0.8219 0.7835 6 0.8375 0.7903 0.7462 7 0.8131 0.7599 0.7107 8 0.7894 0.7307 0.6768 9 0.7664 0.7026 0.6446 10 0.7441 0.6756 0.6139 A PPENDIX 14A: P RESENT V ALUES OF B ONDS AND N OTES Face amount = $100,000 Contract rate = 8% Market rate = 10% Interest paid semiannually First, we calculate the present value of the principal repayment in 4 periods (2 years × 2 payments per year, using 5% market rate (10% annual rate ÷ 2 payments per year). $100,000 × 0.8227 = $82,270 C2

39. 14 - 39 Present Value of Annuity of $1 Rate Periods3%4%5% 1 0.9709 0.9615 0.9524 2 1.9135 1.8861 1.8594 3 2.8286 2.7751 2.7232 4 3.7171 3.6299 3.5460 5 4.5797 4.4518 4.3295 6 5.4172 5.2421 5.0757 7 6.2303 6.0021 5.7864 8 7.0197 6.7327 6.4632 9 7.7861 7.4353 7.1078 10 8.5302 8.1109 7.7217 A PPENDIX 14A: P RESENT V ALUES OF B ONDS AND N OTES $100,000 × 8% × ½ = $4,000 Semiannual Interest Annuity Present AmountPV FactorValue Principal $ 100,000 0.8227 $ 82,270 Interest 8,000 3.5460 14,184 Issue price of debt $ 96,454 $4,000 × 3.5460 = $14,184 C2

40. 14 - 40 A PPENDIX 14B: E FFECTIVE I NTEREST A MORTIZATION $96,454 × 5% = $4,823 $100,000 - $2,723 = $97,277

41. 14 - 41 A PPENDIX 14C: I SSUING B ONDS B ETWEEN I NTEREST D ATES Avia sells $100,000 of its 9% bonds at par on March 1, 2011, 60 days after the stated issue date. The interest on Avia bonds is payable semiannual on each June 30 and December 31. Stated Issue date 1/1 Date of sale 3/1 First Interest date 6/30 $1,500 accrued $3,000 earned Bondholder pays $1,500 to issuer Issuer pays $4,500 to bondholder C3

42. 14 - 42 A PPENDIX 14D: L EASES AND P ENSIONS A lease is a contractual agreement between the lessor (asset owner) and the lessee (asset renter or tenant) that grants the lessee the right to use the asset for a period of time in return for cash (rent) payments. rewards Operating Leases Operating leases are short-term (or cancelable) leases in which the lessor retains the risks and rewards of ownership. Examples include most car and apartment rental agreements. Capital Leases Capital leases are long-term (or non-cancelable) leases by which the lessor transfers substantially all risks and rewards of ownership to the lessee. Examples include leases of airplanes and department store buildings. C4

43. 14 - 43 A PPENDIX 14D: L EASES AND P ENSIONS A pension is a contractual agreement between an employer and its employees for the employer to provide benefits (payments) to employees after they retire. Defined Benefit Plans The employer’s contributions vary, depending on assumptions about future pension assets and liabilities. A pension liability is reported when the accumulated benefit obligation is more than the plan assets, a so-called underfunded plan. C4

44. 14 - 44 E ND OF C HAPTER 14