301 Chapter 14 Edition 15

Long-Term Liabilities

14

Bonds

Payable

Basic Characteristics of Debt Stated amount (principal or par) Interest rate(s)

Fixed Variable

Interest payment dates Maturity date(s) [Principal payment

date(s)] Term--single maturity date Serial--multiple maturity dates

Bonds Payable

Key terms Par (principal/face value) of the bond Stated/face interest rate--determines

periodic cash interest payments Market/effective interest rate--rate of return

required by the market Maturity date and interest period

Bonds Payable Bonds can be issued at:

par--face interest rate = market interest rate discount--face interest rate < market interest

rate premium--face interest rate > market interest

rate Amortization of premium or discount

Straight line method Effective interest method

Straight-line Amortization

Not GAAP if it yields results which are materially different from the effective interest method.

Yields a constant dollar amount of interest even though the carrying value of the debt is changing.

Effective Interest Method

Yields a constant rate of interest on a changing carrying value of the debt.

Computation of Interest Expense

When bonds are issued at a discount Interest paid + discount amortized

When bonds are issued at a premium Interest paid - premium amortized

Issuance of Bonds & Interest Transactions (Exercise 3, Part 1) 1/1/14 Cash 200,000 Bonds Payable

200,000

7/1/14 Interest Expense 4,500 Cash 4,500 ($200,000 X 9% X 3/12) Quarterly interest

12/31/14 Interest Expense 4,500 Interest Payable 4,500 (Year end adjusting journal entry)

Issuing Bonds at a Discount Brief Exercise 3

Cash (98%x$300,000) 294,000 Discount on Bond Payable 6,000

Bond Payable 300,000

Interest Expense 15,600 Cash 15,000Discount on Bond Payable 600 ($6,000/10 = 600)

Issuing Bonds at a Discount Brief Exercise 3

Interest Expense 15,600Interest Payable

15,000 Discount on Bond Payable 600 ($6,000/10 = $600)

Issuing Bonds at a PremiumExercise 4

1/1/14 Cash (600,000 X 102%) 612,000 Bonds Payable 600,000 Premium on Bond Payable 12,000

7/1/14 Interest Expense 29,700 Premium on Bond Payable 300 Cash 30,000 ($12,000/40 = $300) (600,000 X 10% X6/12)

12/31/14 Interest Expense 29,700 Premium on Bond Payable 300 Interest Payable 30,000

Aumont Company

Exercise 14 - 10Issuance of Bonds at a

Premium--Effective Interest Method

Determination of Proceeds

Interest Paid: Par value X Face rateInterest Paid: $500,000 X 12% = $60,000

n = 5 i = 10% (market)

Principal: $500,000 X .62092 = $ 310,460 Interest: $ 60,000 X 3.79079 = 227,447 PROCEEDS $

537,907

Issuance of the Bonds

1/1/14Cash 537,907

Premium--B/P 37,907 Bond Payable 500,000

Carrying value of the debt at 1/1/14 is $537,907

Amortization of Bond Premium

Interest expense: Carrying Value of Debt X Market Interest Rate $537,907 X .10 = $ 53,791

December 31, 2014Interest Expense 53,791

Premium--BP 6,209 Cash 60,000

Balance Sheet Presentation at 12/31/14

Long Term Liabilities:Bonds Payable $ 500,000

Premium 31,698Carrying Value $ 531,698


Interest expense: Carrying Value of Debt X Market Interest Rate$ 531,698 X .10 = $ 53,170 (rounded)





Premium 24,868Carrying Value $

524,868


Interest expense: Carrying Value of Debt X Market Interest Rate$524,868 X .10 = $ 52,487 (rounded)





Premium 17,355Carrying Value $

517,355

Bond Issue Costs

Reported as a deferred charge, which is a long-term asset

The issue costs are amortized over the term (life) of the bonds straight-line approach is generally used

Can not be expensed unless the amount is deemed to lack materiality

Bond Issue Costs: BE 10

January 1, 2014 Unamortized Bond Issue Costs 160,000

Cash160,000

December 31, 2014 Interest Expense 16,000

Unamortized Bond Issue Costs 16,000 ($160,000 X 1/10)

Long-Term Debt: Disclosures Required principal payments in each of

the next five years Restrictive debt covenants Collateral, if any Interest paid (3 years) Capitalized interest (3 years) Available sources of cash

Lines of credit Approved sale of debt securities

Special Characteristics of Debt Callable debt

at the option of the issuer at a predetermined price prior to its maturity date

Convertible debt exchange for stock at the option of the investor at a predetermined rate

Extinguishment of DebtPrior to Maturity

An ordinary gain or loss is reported in the income statement in the period of the early extinguishment (redemption).

Ordinary gain/loss = Reacquisition cost - Carrying value at the date of extinguishment (redemption)

Early Extinguishment: BE 11 Reacquisition cost: $500,000 X 99% = $495,000 Carrying Value: Bond Payable

$500,000 Premium--BP 15,000Unamort. Issue Cost (5,250) 509,750 Gain on Redemption $ 14,750

Bonds Payable 500,000 Premium on Bond Payable 15,000

Unamortized Issue Costs 5,250 Cash495,000 Gain on Redemption of Bonds 14,750

Long-term Notes Payable

In substance the same as bonds Valuation: Present value of the

future cash flows Types of notes

interest bearing at market rate interest bearing at a rate below market non-interest bearing

Non-interest bearing noteExercise 16

January 1, 2014

Land 200,000 Discount on Note Payable 137,012

Notes Payable 337,012

December 31, 2014

Interest Expense 22,000 Discount on Note Payable 22,000 ($200,000 X 11%)

Interest Bearing Note at a Rate Below Market: Exercise 16

Determination of the Present Value of the Note (Equipment acquisition cost) n = 8 i = 11%1. Principal ($250,000 X .43393) $ 108,4822. Interest ($15,000 X 5.14612) 77,192 Present value of the note $ 185,674

Interest Paid: $250,000 X 6% = $15,000January 1, 2014

Equipment 185,674 Discount on Note Payable 64,326 Notes

Payable 250,000

Interest Bearing Note at a Rate Below Market: Exercise 16

Interest Expense: $185,674 X 11% = $20,424Interest Paid: $250,000 X 6% = $15,000

December 31, 2014

Interest Expense 20,424 Discount on Note Payable 5,424 Cash 15,000

End of Chapter 14

301 Chapter 14 Edition 15

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