NETA POWERPOINT PRESENTATIONS TO ACCOMPANY VOLUME 2 Accounting Second Canadian Edition BY WARREN/REEVE/DUCHAC/ELWORTHY/KRISTJANSON/TOBER Adapted by Sheila.

NETA POWERPOINT PRESENTATIONS TO ACCOMPANY VOLUME 2 Accounting Second Canadian Edition BY WARREN/REEVE/DUCHAC/ELWORTHY/KRISTJANSON/TOBER Adapted by Sheila Elworthy and Tana Kristjanson Copyright © 2014 by Nelson Education Ltd.1

After studying this chapter, you should be able to: 1.Describe the characteristics and terminology of bonds payable, and the potential impact of borrowing on earnings per share. 2.Journalize entries for bonds payable. Long-Term Liabilities: Bonds and Notes Copyright © 2014 by Nelson Education Ltd.3

After studying this chapter, you should be able to: 3.Describe and illustrate the accounting for installment notes. 4.Describe and illustrate the reporting and analysis of long- term liabilities. Long-Term Liabilities: Bonds and Notes Copyright © 2014 by Nelson Education Ltd.4

Bond The corporation borrows money from the bondholder. Over the life of the bond, the corporation will pay interest for the use of the money. At the end of the bond’s life, the face amount must be repaid to the bondholder. Copyright © 2014 by Nelson Education Ltd.7

Bond Characteristics and Terminology Usually, the face value of each bond, called the principal, is $1,000 or a multiple of $1,000. Interest on bonds may be payable annually, semiannually, or quarterly. Most pay interest semiannually. Copyright © 2014 by Nelson Education Ltd.10

Bond Characteristics and Terminology The price of a bond is quoted as a percentage of the bond’s face value. For example, a $1,000 bond quoted at 98 could be purchased or sold for $980 ($1,000 × 0.98). Likewise, a bond quoted at 109 could be purchased or sold for $1,090 ($1,000 × 1.09). Copyright © 2014 by Nelson Education Ltd.11

Bond Characteristics and Terminology When all bonds of an issue mature at the same time, they are called term bonds. If the maturity dates are spread over several dates, they are called serial bonds. Bonds that may be exchanged for other securities are called convertible bonds. Copyright © 2014 by Nelson Education Ltd.12

Bond Characteristics and Terminology Bonds that a corporation reserves the right to redeem before their maturity are called callable bonds. Bonds that the purchaser may redeem before maturity are called redeemable bonds. Bonds issued on the basis of general credit of the corporation are debenture bonds. Copyright © 2014 by Nelson Education Ltd.13

Financing Corporations Corporations finance their operations using the following: Debt such as purchasing on account or issuing bonds or notes payable. Equity such as issuing common shares and, in some cases, preferred shares. Debt and equity combined. Copyright © 2014 by Nelson Education Ltd.14

Advantages of Issuing Bonds No impact on ownership—bondholders have no ownership of the corporation. Tax-deductible interest—interest paid on bonds is tax-deductible, whereas dividends are paid out of after-tax income. Positive impact on earnings per share— issuing bonds can result in an increase to earnings per share. Copyright © 2014 by Nelson Education Ltd.15

Highland Corporation is considering the following plans to issue debt and equity: Plan 1: Sell 40,000 common shares at $100 each. Plan 2: Issue $4,000,000 5% bonds Plan 3: Sell 20,000 common shares and issue $2,000,000 5% bonds Copyright © 2014 by Nelson Education Ltd.16

Earnings per share (EPS) measure the income earned by each common share. It is computed as follows: Copyright © 2014 by Nelson Education Ltd.17 Earnings per share = Net Income – Preferred Dividends Weighted Average Number of Common Shares Outstanding

Data for Highland Corporation: Earnings before interest and taxes are $1,000,000. The tax rate is 30%. Highland Corporation has 100,000 outstanding common shares. Copyright © 2014 by Nelson Education Ltd.18

Disadvantages of Issuing Bonds Mandatory interest payments—a corporation must make interest payments whereas a corporation is not obligated to pay dividends. Copyright © 2014 by Nelson Education Ltd.20

Disadvantages of Issuing Bonds Mandatory principal repayment— at maturity the principal amount of the bond must be repaid whereas the amount received for shares is not repaid. Negative impact on earnings per share—issuing bonds can result in a decrease to earnings per share. Copyright © 2014 by Nelson Education Ltd.21

EXAMPLE EXERCISE 14-1 Financing with Bonds versus Shares Greenfield Co. is planning a new business, which is expected to generate $750,000 income before interest and income taxes. Greenfield is considering the following alternative plans for financing its expansion: Copyright © 2014 by Nelson Education Ltd.23

EXAMPLE EXERCISE 14-1 Financing with Bonds versus Shares Determine the earnings per share under the two alternative financing plans, assuming an income tax rate of 30%. Copyright © 2014 by Nelson Education Ltd.24

Proceeds from Issuing Bonds 1.The principal amount or face value of the bonds, which is the amount due at the maturity date. 2.The interest rate on the bonds. 3.The market rate of interest. Copyright © 2014 by Nelson Education Ltd.27

Proceeds from Issuing Bonds The market or effective rate of interest is the rate determined by transactions between buyers and sellers of similar bonds. The market rate of interest is affected by a variety of factors, including investors’ expectations of current and future economic conditions. Copyright © 2014 by Nelson Education Ltd.29

Proceeds from Issuing Bonds Copyright © 2014 by Nelson Education Ltd.30 Often a bond’s stated rate of interest differs from the market rate of interest. The market or effective rate of interest is the rate determined by transactions between buyers and sellers of similar bonds. The interest rate to be paid on the face value of the bond is called the stated rate, contract rate, or coupon rate.

Bonds Issued at Face Value On January 1, 2014, Muskoka Communications Inc. issued for cash $100,000 of 6%, five-year bonds; interest payable semiannually. The market rate of interest is 6%. Copyright © 2014 by Nelson Education Ltd.35

EXAMPLE EXERCISE 14-2 Issuing Bonds at Face Value On July 1, when the market rate of interest was 4%, a company issued a $3,000,000, 4%, 10-year bond that pays semiannual interest on December 31 and June 30, receiving cash of $3,000,000. Journalize the entries to record (a) the issuance of the bonds and (b) the first interest payment. Copyright © 2014 by Nelson Education Ltd.39

Bonds Issued between Interest Dates If bonds are sold between interest dates, the amount of interest earned to date is calculated and added to the selling price. Copyright © 2014 by Nelson Education Ltd.41

Assume that the Muskoka Communications Ltd. bonds in the prior example were sold on March 1, 2014 at par value. The bondholder will receive an interest payment of $3,000 for six months on June 30, even though they will have owned the bonds for only four months. Copyright © 2014 by Nelson Education Ltd.42

EXAMPLE EXERCISE 14-3 Bonds Issued between Interest Dates On May 1, a company issued at face value a $1,200,000, 3%, five-year bond that pays semiannual interest on March 31 and September 30. Journalize (a) the sale of the bond and (b) the interest payment on September 30. Copyright © 2014 by Nelson Education Ltd.46

Bonds Issued at a Discount On January 1, 2014, New Brunswick Distribution Ltd. issued $100,000, 6% (paid semiannually on June 30 and December 31), five-year bonds when the market rate was 7%. Copyright © 2014 by Nelson Education Ltd.48

On January 1, 2014, the firm issued $100,000 bonds for $95,842 (a discount of $4,158). Copyright © 2014 by Nelson Education Ltd.49 The discount may be viewed as the amount required by investors to accept a contract rate of interest below the market rate.

EXAMPLE EXERCISE 14-4 Issuing Bonds at a Discount On the first day of the fiscal year, a company issues a $1,000,000, 6%, five-year bond that pays semiannual interest of $30,000 ($1,000,000 × 6% × ½), receiving cash of $936,420. Journalize the entry to record the issuance of the bonds. Copyright © 2014 by Nelson Education Ltd.51

Amortizing a Bond Discount The two methods of computing amortization of a bond discount are as follows: 1.Straight-line method 2.Effective interest method (Required for IFRS) Both methods amortize the same total amount of discount over the life of the bonds. Copyright © 2014 by Nelson Education Ltd.53

Straight-Line Amortization May be used by businesses that report according to ASPE. Provides for a constant amount of amortization each period. To illustrate, amortization of the preceding bond discount is computed on the next slide. Copyright © 2014 by Nelson Education Ltd.54

Straight-Line Amortization Discount on bonds payable... $4,158.00 Term of bonds.............. 5 years Semiannual amortization..... $415.80 Copyright © 2014 by Nelson Education Ltd.55 ($4,158/10 periods)

Straight-Line Amortization On June 30, 2014 (and each subsequent interest payment date), six-months’ interest is paid and the bond discount is amortized ($4,158/10). Copyright © 2014 by Nelson Education Ltd.56

Straight-Line Amortization The effect of the discount amortization is to increase the interest expense from $3000.00 to $3,415.80, which effectively raises the bond rate of interest from 6% to a rate of interest that approximates the market rate of 7%. Copyright © 2014 by Nelson Education Ltd.58

EXAMPLE EXERCISE 14-5 Discount Amortization—Straight-Line Method Using the bond from Example Exercise 14-4, journalize the first interest payment and the amortization of the related bond discount, using the straight-line method for discount amortization. Copyright © 2014 by Nelson Education Ltd.60

Effective Interest Method Provides for a constant rate of interest over the life of the bonds. Better reflection of reality as the interest rate stays constant: conceptually superior results to the straight-line method. Required for companies reporting under IFRS. Copyright © 2014 by Nelson Education Ltd.62

Amortization of Discount by Effective Interest Method New Brunswick Distribution Ltd. bonds issued at a discount have the following data: Copyright © 2014 by Nelson Education Ltd.63 Face value of 6%, 5-year bonds, interest compounded semiannually $100,000 Present value of bonds at effective (market) rate of interest of 7% 95,842 Discount on bonds payable 4,158

EXAMPLE EXERCISE 14-6 Discount Amortization—Effective Interest Method A company issued a $2,000,000, 4%, five-year bond that pays semiannual interest of $40,000 ($2,000,000 × 4% × 1/2), receiving cash of $1,912,479, for an effective interest rate of 5%. Journalize the first interest payment. Copyright © 2014 by Nelson Education Ltd.66

Adjusting Entry for Interest Expense When the interest payment dates of bonds differ from the company’s fiscal year-end, an adjusting entry is needed. Using the same New Brunswick Distribution Ltd. example, the December 31, 2014, payment would be recorded as follows: Copyright © 2014 by Nelson Education Ltd.68

Adjusting Entry for Interest Expense If the company’s fiscal year-end was August 31, 2014, interest expense needs to be recorded for the two months from the last interest payment. Copyright © 2014 by Nelson Education Ltd.70

Bonds Issued at a Premium On January 1, 2014, Newfoundland Transportation Ltd. issued $100,000, 6% (paid semiannually on June 30 and December 31), five-year bonds when the market rate was 5%. Copyright © 2014 by Nelson Education Ltd.72

On January 1, 2014, the firm issued $100,000 bonds for $104,376 (a premium of $4,376). Copyright © 2014 by Nelson Education Ltd.73 The premium may be viewed as the extra amount investors are willing to pay for bonds that have higher rate of interest than the market rate.

EXAMPLE EXERCISE 14-7 Issuing Bonds at a Premium A company issued a $2,000,000, 6%, five-year bond that pays semiannual interest of $60,000 ($2,000,000 × 6% × 1/2), receiving cash of $2,087,521. Journalize the bond issuance. Copyright © 2014 by Nelson Education Ltd.75

Straight-Line Method of Amortization Premium on bonds payable.. $4,376 Term of bonds............. 5 years Semiannual amortization..... $437.60 Copyright © 2014 by Nelson Education Ltd.79 ($4,376/10 periods)

Premium Amortization The effect of the premium amortization is to decrease the interest expense from $3000.00 to $2,562.40, which effectively reduces the bond rate of interest from 6% to a rate of interest that approximates the market rate of 5%. Copyright © 2014 by Nelson Education Ltd.82

EXAMPLE EXERCISE 14-8 Premium Amortization—Straight-Line Method Using the bond from Example Exercise 14-7, journalize the first interest payment and the amortization of the related bond premium, using the straight-line method of amortization. Copyright © 2014 by Nelson Education Ltd.83

Amortization of Premium by Effective Interest Method Newfoundland Transportation Ltd. bonds issued at a discount has the following data: Present value of bonds at effective (market) rate of interest of 5%$104,376 Face value of 6%, semiannual, 5-year bonds: 100,000 Premium on bonds payable$ 4,376 Copyright © 2014 by Nelson Education Ltd.85

EXAMPLE EXERCISE 14-9 Premium Amortization—Effective Interest Method A company issued a $2,000,000, 6%, five-year bond that pays semiannual interest of $60,000 ($2,000,000 × 6% × ½), receiving cash of $2,087,521, for an effective interest rate of 5%. Journalize the first interest payment and premium amortization, using the effective interest method. Copyright © 2014 by Nelson Education Ltd.87

Bond Redemption A corporation may call or redeem bonds before they mature. Callable bonds can be redeemed by the issuing corporation within the period of time and the price stated in the bond indenture. Normally, the call price is above the face value. Copyright © 2014 by Nelson Education Ltd.89

On June 30, a corporation has a bond issue of $100,000 outstanding on which there is an unamortized premium of $4,000. The corporation purchases one-fourth of the bonds for $24,000. Copyright © 2014 by Nelson Education Ltd.90 Gains and losses on the redemption of bonds are normally reported as Other Income (Loss).

EXAMPLE EXERCISE 14-10 Redemption of Bonds Payable A $500,000 bond with an unamortized discount of $40,000 is redeemed for $475,000. Journalize the redemption of the bonds. Copyright © 2014 by Nelson Education Ltd.92

Installment Notes Unlike bonds, a note payment consists of payment of a portion of the amount initially borrowed (the principal) and payment of interest on the outstanding balance. At the end of the note’s term, the principle will have been repaid in full. Copyright © 2014 by Nelson Education Ltd.96

The entry to record the final payment on December 31, 2017, is as follows: Copyright © 2014 by Nelson Education Ltd.101 After the entry is posted, the balance in Notes Payable related to this note is zero.

EXAMPLE EXERCISE 14-11 Journalizing Installment Notes On the first day of the fiscal year, a company issues a $30,000, 10%, five-year installment note that has annual payments of $7,914. a.Journalize the entry to record the issuance of the installment note. b.Journalize the first annual note payment, which consists of both interest and principal repayment. Copyright © 2014 by Nelson Education Ltd.102

Reporting Long-Term Liabilities The reporting of long-term liabilities is the same under both IFRS and ASPE accounting standards. Any portion due within one year is reported as a current liability. A description of bonds or notes should be reported on the face of the financial statements or in the accompanying notes. Copyright © 2014 by Nelson Education Ltd.105

EXAMPLE EXERCISE 14-12 Times Interest Earned Harris Industries reported the following on the company’s income statement in 2015 and 2014: a.Determine the times interest earned for 2015 and 2014. Round to one decimal place. b.Is the times interest earned improving or declining? Copyright © 2014 by Nelson Education Ltd.109

FOLLOW MY EXAMPLE 14-12 Times Interest Earned b.The times interest earned has increased from 5.0 in 2014 to 6.0 in 2015. Thus, the debtholders have improved confidence in the company’s ability to make its interest payments. For Practice: PE 14-12 Copyright © 2014 by Nelson Education Ltd.111

NETA POWERPOINT PRESENTATIONS TO ACCOMPANY VOLUME 2 Accounting Second Canadian Edition BY WARREN/REEVE/DUCHAC/ELWORTHY/KRISTJANSON/TOBER Adapted by Sheila.

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NETA POWERPOINT PRESENTATIONS TO ACCOMPANY VOLUME 2 Accounting Second Canadian Edition BY WARREN/REEVE/DUCHAC/ELWORTHY/KRISTJANSON/TOBER Adapted by Sheila.

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Presentation on theme: "NETA POWERPOINT PRESENTATIONS TO ACCOMPANY VOLUME 2 Accounting Second Canadian Edition BY WARREN/REEVE/DUCHAC/ELWORTHY/KRISTJANSON/TOBER Adapted by Sheila."— Presentation transcript:

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