Long-Term Liabilities

Long-Term LiabilitiesLong-Term Liabilities

Chapter 14Chapter 14

Long-Term Debit: Long-Term Debit: General General

Long-term debtLong-term debt consists of probable future consists of probable future sacrifices.sacrifices.

It has various It has various covenantscovenants or or restrictionsrestrictions for the for the protection of both lenders and borrowers.protection of both lenders and borrowers.

The The indenture agreementindenture agreement incorporates the incorporates the terms of the issue and restrictions. terms of the issue and restrictions.

Issuing BondsIssuing Bonds

Bonds are the most common type of long-term Bonds are the most common type of long-term debt.debt.

A A bond indenturebond indenture is a promise (by the lender to is a promise (by the lender to the borrower) to pay:the borrower) to pay:

1.1. a sum of money at the designated date, anda sum of money at the designated date, and

2.2. periodic interest at a stipulated rate on the periodic interest at a stipulated rate on the face value.face value.

Bond Issues: Parties to the Bond Issues: Parties to the ContractContract

Issuer of BondsIssuer of BondsIssuer of BondsIssuer of BondsBondholdersBondholdersBondholdersBondholders

lend cashlend cash

1. Bond Certificate1. Bond Certificate

2. Payment Periodic Interest2. Payment Periodic Interest

3. Payment of Face Value (maturity)3. Payment of Face Value (maturity)

Types of bonds:Types of bonds:

Secured and unsecured bondsSecured and unsecured bondsTerm, Serial, and Callable bondsTerm, Serial, and Callable bondsConvertible, Commodity-Backed, and Convertible, Commodity-Backed, and

Deep discount bondsDeep discount bondsCommodity-backed bondsCommodity-backed bondsRegistered and bearer (coupon) bondsRegistered and bearer (coupon) bonds Income and Revenue bondsIncome and Revenue bonds

Valuation of Bonds payableValuation of Bonds payableDiscount and premiumDiscount and premium

The price of a bond issue is determined by:The price of a bond issue is determined by: the the present value of the interest paymentspresent value of the interest payments, and, and the the present value of the face valuepresent value of the face value,, both discounted at the both discounted at the market (effective) rate of market (effective) rate of

interestinterest at date of issue. at date of issue.

Interest payments by borrower are Interest payments by borrower are calculated as:calculated as:Face value of bond issue x Stated (face) rate of Face value of bond issue x Stated (face) rate of interest.interest.

Valuation of Bonds payableValuation of Bonds payableDiscount and premiumDiscount and premium

The The interest rate writteninterest rate written in the terms of bond indenture is known in the terms of bond indenture is known as the as the stated, coupon, or nominal rate.stated, coupon, or nominal rate.

- stated rate- stated rate is the rate used to determine the amount of cash is the rate used to determine the amount of cash interest the borrower pays and the investor receives.( usually stated interest the borrower pays and the investor receives.( usually stated as annual rate).as annual rate).

The The face valueface value is the amount of principal the issuer must pay at the is the amount of principal the issuer must pay at the maturity date.maturity date.

The The present valuepresent value of bonds is the value at which it should sell in of bonds is the value at which it should sell in the marketplace.the marketplace.

Under which conditions of bonds issuance does a discount on bonds Under which conditions of bonds issuance does a discount on bonds payable arise?payable arise?

Under which conditions of bonds issuance does a premium on bonds Under which conditions of bonds issuance does a premium on bonds payable arise?payable arise?

The difference between the face value and the present value of The difference between the face value and the present value of the bonds is either:the bonds is either:

DiscountDiscount or or PremiumPremium

If the bonds sell for If the bonds sell for if the bonds sell forif the bonds sell for

less than face valueless than face value more than face valuemore than face value

Example:Example:

ServiceMaster issues $100,000 in bonds, due in 5 years ServiceMaster issues $100,000 in bonds, due in 5 years with 9 percent interest payable annually at year-end. At with 9 percent interest payable annually at year-end. At the time of issue, the market rate for such bonds is 11 the time of issue, the market rate for such bonds is 11 percent.percent.

(The (The market ratemarket rate is the rate investors demand for loaning funds) is the rate investors demand for loaning funds)

Present value of the principle:Present value of the principle:

$100,000 $100,000 ×× .59345 (table 6-2) $59,345 .59345 (table 6-2) $59,345

Present value of the interest payment:Present value of the interest payment:

$9,000 $9,000 ×× 3.69590 (table6-4) $33,263,10 3.69590 (table6-4) $33,263,10

Present value (selling price) of the bonds $92,608,10Present value (selling price) of the bonds $92,608,10

Year 1 Year 2 Year 3 Year 4 Year 5

$9,000 $9,000 $9,000 $9,000 $9,000 Interest

$100,000$100,000face valueface valueRedemption at maturity ==>Redemption at maturity ==>

Interest = $100,000 x 9% per year stated rateInterest = $100,000 x 9% per year stated rate

• Bond issued at par on interest dateBond issued at par on interest date

When bonds are issued on an interest payment date at When bonds are issued on an interest payment date at face value, no interest has occurred and no premium or face value, no interest has occurred and no premium or discount exists.discount exists.

Example:Example:

If If 10-yearterm10-yearterm bonds with a bonds with a par value of $800,000par value of $800,000 dated in dated in Jan1, 2004, and bearing interest at an Jan1, 2004, and bearing interest at an annual rate of 10 annual rate of 10 percentpercent payable payable semi-annuallysemi-annually on on Jan1Jan1 and and July July 1, are 1, are issued on Jan 1 at par.issued on Jan 1 at par.

The entry on the books of The entry on the books of the issuingthe issuing corporation would be: corporation would be:

CashCash 800,000800,000

Bonds PayableBonds Payable 800,000800,000

The entry to record The entry to record the first semi-annual interest paymentthe first semi-annual interest payment

of 40,000 (800,000 of 40,000 (800,000 ×× 10% 10% × × ½)on July 1, 2004, would be: ½)on July 1, 2004, would be:

Bond interest expenseBond interest expense 40,00040,000

CashCash 40,000 40,000The entry to record The entry to record accrued expense at Dec 31, 2004accrued expense at Dec 31, 2004 (year-end) (year-end)

would be:would be:


Bond interest payableBond interest payable 40,000 40,000

• Bonds issued at discount or Premium on interest Bonds issued at discount or Premium on interest datedate

1- Discount1- Discount ( a discount is amortized either by the straight line method or the ( a discount is amortized either by the straight line method or the effective interest method.)effective interest method.)

From the previous example, assume that $800,000 of From the previous example, assume that $800,000 of bonds were issued on Jan 1, 2004 at 97% of par, he bonds were issued on Jan 1, 2004 at 97% of par, he issuance would be recorded as follows:issuance would be recorded as follows:

Cash (800,000 Cash (800,000 ×× .97) .97) 776,000776,000Discount on bonds payableDiscount on bonds payable 24,000 24,000

Bonds payableBonds payable 800,000800,000

• The discount is amortized and charged to interest expense over the The discount is amortized and charged to interest expense over the period of time that the bonds are outstanding.period of time that the bonds are outstanding.

• Under the straight-line method, the amount amortized Under the straight-line method, the amount amortized each year is a each year is a constant amount.constant amount.

• The discount is 24,000, so the amount amortized to interest The discount is 24,000, so the amount amortized to interest

expense each year is 2,400 (24,000 / 10 years)expense each year is 2,400 (24,000 / 10 years)

Total Discount or Premium Total Discount or Premium

Total Number of PeriodsTotal Number of Periods

• The amortization is recorded as follows:The amortization is recorded as follows:

Bonds interest expenseBonds interest expense 2,4002,400

Discount on bonds payable Discount on bonds payable 2,400 2,400

• At the end of the first year:At the end of the first year:

The unamortized balance in discount on bonds payable is:The unamortized balance in discount on bonds payable is:

24,000 – 2,400 = 21,60024,000 – 2,400 = 21,600

((The balance of the discount is subtracted from the The balance of the discount is subtracted from the bonds payable in he balance sheet)bonds payable in he balance sheet)

• Assume that the bonds were sold in Oct 2004, so there Assume that the bonds were sold in Oct 2004, so there are are three monthsthree months of accrued interest must be recorded of accrued interest must be recorded on Dec 31.on Dec 31.

2- Premium2- Premium ( a premium is amortized either by the straight line method or the ( a premium is amortized either by the straight line method or the effective interest method.) effective interest method.)

From the previous example, assume that the bonds are sold in From the previous example, assume that the bonds are sold in Jan1, 2004 at 103%, so the entry will be:Jan1, 2004 at 103%, so the entry will be:

Cash (800,000 Cash (800,000 ×× 1.3) 1.3) 824,000824,000Premium on bonds payablePremium on bonds payable 24,00024,000Bonds payableBonds payable 800,000 800,000

At the end of the year, the entry to amortized the premium will beAt the end of the year, the entry to amortized the premium will bePremium on bonds payablePremium on bonds payable 2,400 2,400


Bond interest is Bond interest is increasedincreased by amortization of discount and by amortization of discount and decreaseddecreased by by amortization of premium.amortization of premium.

Any premium or discount must be amortized over the life to maturity date Any premium or discount must be amortized over the life to maturity date because early redemption (call of bond) is not a certainty.because early redemption (call of bond) is not a certainty.

Bonds Issued Between Interest Bonds Issued Between Interest DatesDates

When the bonds are issued on other than the interest When the bonds are issued on other than the interest payment dates, buyers of the bonds will pay the seller the payment dates, buyers of the bonds will pay the seller the interest accruedinterest accrued from the last interest payment date on the from the last interest payment date on the date of issue.date of issue.

The purchasers will receive the full 6-months’ interest The purchasers will receive the full 6-months’ interest payment n the next semiannual interest payment date.payment n the next semiannual interest payment date.

Example:Example:

If 10-year bonds of a par value of $800,000, dated Jan 1, 2004, 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 and bearing interest at an annual rate of 10 percent payable semiannually on Jan 1 and July 1, are issued on March 1, semiannually on Jan 1 and July 1, are issued on March 1, 2004 at par plus accrued interest.2004 at par plus accrued interest.

The entry on the books of the issuing corporation is:The entry on the books of the issuing corporation is:

CashCash 813,333813,333

Bonds PayableBonds Payable 800,000800,000

Bond interest expense Bond interest expense (800,000 (800,000 ×× .10 .10 ×× 2/12 ) 2/12 ) 13,33313,333

On July 1, 2004, the company will make the following entry:On July 1, 2004, the company will make the following entry:


CashCash 40,00040,000

The interest expense account will have a debit balance of The interest expense account will have a debit balance of $26,667 which represent the proper amount of interest $26,667 which represent the proper amount of interest expense expense (800,000 (800,000 ×× .10 .10 ×× 4/12) 4/12)

Example:Example:

From the previous example, assume that the 10% bonds were From the previous example, assume that the 10% bonds were issued at 102. the entry on March 1 will be as follows:issued at 102. the entry on March 1 will be as follows:

CashCash (800,000 (800,000 ×× 1.02) + (800,000 1.02) + (800,000 ×× .10 .10×× 2/12) 2/12) 829,333829,333

Bonds payableBonds payable 800,000800,000 Premium on bonds payable Premium on bonds payable (800,000(800,000×× 2%) 2%) 16,000 16,000

Bond interest expenseBond interest expense 13,333 13,333

The premium would be amortized from the date of sale, which is The premium would be amortized from the date of sale, which is March1,2004, not the date from of the bonds, which is Jan1, 2004March1,2004, not the date from of the bonds, which is Jan1, 2004

Effective Interest MethodEffective Interest Method

The effective interest method is also called the The effective interest method is also called the present value present value amortizationamortization which is the preferred procedure for amortization of which is the preferred procedure for amortization of discount or premium.discount or premium.

1- 1- Bond interest expense is computed first by multiplying the carrying Bond interest expense is computed first by multiplying the carrying value( which is book value) of the bonds at the beginning of the value( which is book value) of the bonds at the beginning of the period by the effective interest rate.period by the effective interest rate.

2-2- The bond discount or premium amortization is then determined by The bond discount or premium amortization is then determined by comparing the bond interest expense with the interest to be paid.comparing the bond interest expense with the interest to be paid.

- =

Bond interest expenseBond interest expense

Carrying valueCarrying value

Of bonds Of bonds ×× effective interest effective interest

Beginning rateBeginning rate

of period of period

Bonds interest paidBonds interest paid

Face amount Face amount ×× Stated Stated

of bonds interest of bonds interest

raterate

Amortization Amortization amountamount

Bonds Issued at DiscountBonds Issued at DiscountExample:Example:Evermaster Corporation issued Evermaster Corporation issued $100,000$100,000 of of 8%8% term bonds on term bonds on

Jan 1,Jan 1,20042004, due on Jan 1,, due on Jan 1,20092009, with interest payable each , with interest payable each July 1 and Jan 1July 1 and Jan 1 . Because the investors required an . Because the investors required an effective interest rate of 10%,effective interest rate of 10%, they paid they paid $92,278$92,278 for the for the $100,000 of bonds, creating a $100,000 of bonds, creating a $7,722 discount$7,722 discount..

The $7,722 discount is computed as follows:The $7,722 discount is computed as follows:Maturity value of bonds payableMaturity value of bonds payable 100,000 100,000

Present value of 100,000 due in 5 years at 10%, interest payablePresent value of 100,000 due in 5 years at 10%, interest payable

Semiannually (100,000 Semiannually (100,000 ×× .61391) .61391) 61,391 61,391

Present value of 4,000 interest payable semi-annually for 5 yearsPresent value of 4,000 interest payable semi-annually for 5 years

At 10% annually (4,000 At 10% annually (4,000 ×× 7.72173) 7.72173) 30,88730,887

Proceeds from sale of bondsProceeds from sale of bonds 92,27892,278

Discount on bonds payableDiscount on bonds payable 7,7227,722

Schedule of bond discount amortizationSchedule of bond discount amortization

Date Cash paid Interest Discount Carrying amountDate Cash paid Interest Discount Carrying amount

Expense amortized of bondsExpense amortized of bonds

1/1/04 92,2781/1/04 92,278

7/1/04 4,000 7/1/04 4,000 aa 4,614 4,614bb 614 614c c 92,892 92,892dd

1/1/05 4,000 4,645 645 93,5371/1/05 4,000 4,645 645 93,537

7/1/05 4,000 4,677 677 94,2147/1/05 4,000 4,677 677 94,214

1/1/06 4,000 4,711 711 94,9251/1/06 4,000 4,711 711 94,925

7/1/06 4,000 4,746 746 95,6717/1/06 4,000 4,746 746 95,671

1/1/07 4,000 4,783 783 96,4541/1/07 4,000 4,783 783 96,454

7/1/07 4,000 4,823 823 97,2777/1/07 4,000 4,823 823 97,277

1/1/08 4,000 4,864 864 98,1411/1/08 4,000 4,864 864 98,141

7/1/08 4,000 4,907 907 99,0487/1/08 4,000 4,907 907 99,048

1/1/09 1/1/09 4,000 4,000 4,9524,952 952 952 100,000 100,000

40,000 47,722 7,72240,000 47,722 7,722

A: 4,000 = 100,000 A: 4,000 = 100,000 ×× 8% 8% × × 6/12 B: 4,614 = 92,278 6/12 B: 4,614 = 92,278 ×× 10% 10% × × 6/12 6/12

C: 614 = 4,614 – 4,000 D: 92,892 = 92,278 + 614C: 614 = 4,614 – 4,000 D: 92,892 = 92,278 + 614

The entry to record the issuance of the bonds at discount The entry to record the issuance of the bonds at discount

on Jan 1, 2004 is:on Jan 1, 2004 is:

CashCash 92,27892,278

Discount on Bonds payableDiscount on Bonds payable 7,722 7,722

Bonds PayableBonds Payable 100,000100,000 The entry to record the first interest payment in July 1,2004 and The entry to record the first interest payment in July 1,2004 and

amortization of the discount is:amortization of the discount is:

Bond Interest ExpenseBond Interest Expense 4,6144,614

Discount on Bonds PayableDiscount on Bonds Payable 614 614

CashCash 4,0004,000 The entry to record the interest expense accrued at Dec 31,2004 The entry to record the interest expense accrued at Dec 31,2004

and amortization of the discount is:and amortization of the discount is:


Bond Interest PayableBond Interest Payable 4,0004,000


Bonds Issued at PremiumBonds Issued at Premium

ExampleExample

From the previous example, assume that the investors were willing to From the previous example, assume that the investors were willing to accept an accept an effective interest rate of 6%effective interest rate of 6% on the bond issue, and they on the bond issue, and they would have paid would have paid $108,530$108,530 or or premium of $8,530premium of $8,530..

Maturity value of bonds payableMaturity value of bonds payable 100,000100,000


Semi-annually (100,000 Semi-annually (100,000 ×× .74409) .74409) 74,409 74,409Present value of 4,000 interest payable semi-annually for 5 yearsPresent value of 4,000 interest payable semi-annually for 5 years

At 6% annually (4,000 At 6% annually (4,000 ×× 8.53020) 8.53020) 34,12134,121Proceeds from sale of bondsProceeds from sale of bonds

108,530108,530 Premium on bonds payablePremium on bonds payable

8,5308,530

Schedule of bond premium amortizationSchedule of bond premium amortization

Date Cash paid Interest Premium Carrying amountDate Cash paid Interest Premium Carrying amount

Expense amortized of bondsExpense amortized of bonds

1/1/04 108,5301/1/04 108,530

7/1/04 4,000 7/1/04 4,000 a a 3,256 3,256bb 744 744cc 107,786 107,786dd

1/1/05 4,000 3,234 766 107,0201/1/05 4,000 3,234 766 107,020

7/1/05 4,000 3,211 789 106,2317/1/05 4,000 3,211 789 106,231

1/1/06 4,000 3,187 813 105,4181/1/06 4,000 3,187 813 105,418

7/1/06 4,000 3,162 838 104,5807/1/06 4,000 3,162 838 104,580

1/1/07 4,000 3,137 863 103,7171/1/07 4,000 3,137 863 103,717

7/1/07 4,000 3,112 888 102,8297/1/07 4,000 3,112 888 102,829

1/1/08 4,000 3,085 915 101,9141/1/08 4,000 3,085 915 101,914

7/1/08 4,000 3,057 943 100,9717/1/08 4,000 3,057 943 100,971

1/1/09 1/1/09 4,000 4,000 3,0293,029 971 971 100,000 100,000

40,000 31,471 8,53040,000 31,471 8,530

A: 4,000 = 100,000 A: 4,000 = 100,000 ×× 8% 8% × × 6/12 B: 3,256 = 108,530 6/12 B: 3,256 = 108,530 ×× 6% 6% × × 6/12 6/12

C: 744 = 4,000 – 3,256 D: 107,786 = 108,530 - 744C: 744 = 4,000 – 3,256 D: 107,786 = 108,530 - 744

The entry to record the issuance of bonds at premium on The entry to record the issuance of bonds at premium on Jan 1, 2004, is:Jan 1, 2004, is:

CashCash 108,530108,530

Premium on bonds PayablePremium on bonds Payable 8,530 8,530

Bonds PayableBonds Payable 100,000 100,000

The entry to record the first interest payment on July The entry to record the first interest payment on July 1,2004 and amortization of the premium is:1,2004 and amortization of the premium is:


Premium on bonds payablePremium on bonds payable 744 744

CashCash 4,0004,000

Accruing InterestAccruing Interest

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

Interest accrual (4,000 Interest accrual (4,000 ×× 2/6) 2/6) 1,333.331,333.33

Premium amortized (744 Premium amortized (744 ×× 2/6) 2/6) 284284

Interest expenseInterest expense 1,085.331,085.33

The entry to record this accrual is:The entry to record this accrual is:

Bond Interest ExpenseBond Interest Expense 1,085.331,085.33

Premium on Bonds PayablePremium on Bonds Payable 248 248

Bond Interest PayableBond Interest Payable 1,333.331,333.33

Long-Term Notes PayableLong-Term Notes Payable

The difference between current notes payable and long-term The difference between current notes payable and long-term notes payable.notes payable.

Note issued at face valueNote issued at face value

Cash Cash 10,00010,000

Notes PayableNotes Payable 10,000 10,000

Notes not issued at face valueNotes not issued at face value

Zero-Interest-Bearing NotesZero-Interest-Bearing Notes

Interest-Bearing NotesInterest-Bearing Notes

ExercisesExercises

On Dec 2004, Gulf Software issued $1.0 million, 10%, 10 On Dec 2004, Gulf Software issued $1.0 million, 10%, 10 year bonds at face value. Interest is payable year bonds at face value. Interest is payable semiannually on Jan 1 and July1semiannually on Jan 1 and July1

A- Journalize the issuance of the bonds on Jan , 2005.A- Journalize the issuance of the bonds on Jan , 2005.

B- Prepare the journal entries for interest expense in 2005.B- Prepare the journal entries for interest expense in 2005.

A- Jan 1A- Jan 1

CashCash 1,000,0001,000,000

Bonds PayableBonds Payable 1,000,000 1,000,000

(to record issuance of bonds)(to record issuance of bonds)

B- July 1B- July 1


CashCash 50,00050,000

((to record payment of semiannual interest, 1000,000 to record payment of semiannual interest, 1000,000 ×× 10% 10%×× 6/12) 6/12)

Dec 31Dec 31


Bond Interest PayableBond Interest Payable 50,00050,000 ( to record accrual of semi-annual interest)( to record accrual of semi-annual interest)

BE14-2BE14-2The Goofy company issued $200,000 of 10% bonds on Jan 1, 2005. The Goofy company issued $200,000 of 10% bonds on Jan 1, 2005.

The bonds are due Jan 1, 2010, with interest payable each July 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 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 journal entries for (a) the Jan issuance, (b) the July 1 interest payment, and (c) the Dec 31 adjustment entry.payment, and (c) the Dec 31 adjustment entry.

A- Jan 1A- Jan 1CashCash 200,000200,000 Bonds PayableBonds Payable 200,000 200,000

(to record issuance of bonds)(to record issuance of bonds)B- B- July 1July 1

Bond Interest ExpenseBond Interest Expense 10,00010,000CashCash 10,00010,000

(to record payment of semiannual interest, 200,000 (to record payment of semiannual interest, 200,000 ×× 10% 10%×× 6/12) 6/12)

C- Dec 31C- Dec 31Bond Interest ExpenseBond Interest Expense 10,00010,000

Bond Interest PayableBond Interest Payable 10,00010,000 ( to record accrual of semi-annual interest)( to record accrual of semi-annual interest)

BE14-3BE14-3Assume the bonds in BE14-2 were issued at 98%. Prepare the journal entries 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. 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 Assume the Goofy company records straight-line amortization annually on Dec 31.Dec 31.

A- A- Cash (200,000 Cash (200,000 ×× .98) .98) 196,000196,000

Discount on bonds payableDiscount on bonds payable 4,000 4,000


B- The discount is 4,000, so the amount amortized to interest expense each year is 800 ( 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 $4004,000 / 5 years) because it’s semi-annually, it will be $400

July entry is: July entry is:


Discount on bonds payable Discount on bonds payable 400400

CashCash 9,6009,600

C- Dec 31C- Dec 31

Bonds interest expenseBonds interest expense 10,00010,000

Discount on bonds payable Discount on bonds payable 400400

Bond interest payableBond interest payable 9,6009,600 The July and Dec entries will be the same in all five yearsThe July and Dec entries will be the same in all five years

Although Discount on Bonds Payable has a debit balance, Although Discount on Bonds Payable has a debit balance, it is not an assetit is not an asset. Rather, it is a contra account. This . Rather, it is a contra account. This account is account is deducted from bonds payable on the deducted from bonds payable on the balance sheet.balance sheet.

Goofy CompanyGoofy Company

Balance SheetBalance Sheet

Long-term LiabilitiesLong-term Liabilities

Bonds Payable 200,000Bonds Payable 200,000

Less: Discount on bonds Payable 3,200Less: Discount on bonds Payable 3,200

NoteNote: the balance of the discount is deducted : the balance of the discount is deducted from the bonds payable, so from the bonds payable, so at the end of the at the end of the year the balance of the discount will be 3,200.year the balance of the discount will be 3,200. so this amount will be subtracted from the so this amount will be subtracted from the bonds payable in the balance sheet.bonds payable in the balance sheet.

Discount on Bonds PayableDiscount on Bonds Payable

Jan1, 2005 4,000Jan1, 2005 4,000 July 1, 2005 400July 1, 2005 400

Dec 31, 2005 400Dec 31, 2005 400

Bal. Jan 1. 2006 Bal. Jan 1. 2006 3,2003,200

July 1, 2006 400July 1, 2006 400

Dec 31, 2006 400Dec 31, 2006 400

Bal. Jan 1. 2007 Bal. Jan 1. 2007 2,4002,400

July 1, 2007 400July 1, 2007 400

Dec 31, 2007 400Dec 31, 2007 400

Bal. Jan 1. 2008 Bal. Jan 1. 2008 1,6001,600

July 1, 2008 400July 1, 2008 400

Dec 31, 2008 400Dec 31, 2008 400

Bal. Jan 1. 2009 Bal. Jan 1. 2009 800800

July 1, 2009 400July 1, 2009 400

Dec 31, 2009 400Dec 31, 2009 400


At Dec 31, 2005At Dec 31, 2005

Long-term Liabilities 200,000Long-term Liabilities 200,000

Less: Discount on bonds Payable Less: Discount on bonds Payable 3,2003,200

196,800196,800


At Dec 31, 2006At Dec 31, 2006


Less: Discount on bonds Payable Less: Discount on bonds Payable 2,4002,400

197,600197,600


At Dec 31, 2008At Dec 31, 2008


Less: Discount on bonds Payable Less: Discount on bonds Payable 800800

198,200198,200


At Dec 31, 2009At Dec 31, 2009



At Dec 31, 2007At Dec 31, 2007


Less: Discount on bonds Payable 1Less: Discount on bonds Payable 1,600,600

198,400198,400

Note:

If there is redemption of the bonds in 2009, the account will be closed by making bonds payable debit and cash credit.

BE14-4BE14-4Assume the bonds in BE14-2 were issued at 103%. Prepare the journal entries 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. 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 Assume the Goofy company records straight-line amortization annually on Dec 31.Dec 31.

A- A- Cash (200,000 Cash (200,000 ×× 103%) 103%) 206,000206,000

Premium on bonds payablePremium on bonds payable 6,0006,000


B- B-

July entry is: July entry is:


Premium on bonds payable Premium on bonds payable 600 600

CashCash 10,00010,000

C- Dec 31C- Dec 31

Bonds interest expenseBonds interest expense 9,400 9,400

Premium on bonds payable Premium on bonds payable 600 600

Bond interest payableBond interest payable 10,00010,000

Premium on bonds payable is added to bonds payable on Premium on bonds payable is added to bonds payable on the balance sheet.the balance sheet.

Goofy CompanyGoofy Company


Long-term LiabilitiesLong-term Liabilities

Bonds Payable 200,000Bonds Payable 200,000

Add: Premium on bonds Payable 4,800Add: Premium on bonds Payable 4,800

NoteNote: the balance of the premium is added to the bonds payable, : 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 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 4,800. so this amount will be added on the bonds payable in the balance sheet.balance sheet.


At Dec 31, 2005At Dec 31, 2005


Add: Premium on bonds Payable Add: Premium on bonds Payable 4,8004,800

204,800204,800


At Dec 31, 2006At Dec 31, 2006



203,600203,600


At Dec 31, 2007At Dec 31, 2007



202,400202,400


At Dec 31, 2008At Dec 31, 2008



201,200201,200


At Dec 31, 2009At Dec 31, 2009


Note:Note:

If there is redemption of the If there is redemption of the bonds in 2009, the account will bonds in 2009, the account will be closed by making bonds be closed by making bonds payable debit and cash credit. payable debit and cash credit.

Premium on Bonds PayablePremium on Bonds Payable

July 1, 2005 600July 1, 2005 600

Dec 31, 2005 600Dec 31, 2005 600

Jan1, 2005 6,000Jan1, 2005 6,000

July 1, 2006 600July 1, 2006 600

Dec 31, 2006 600Dec 31, 2006 600

Bal. Jan 1. 2006 4,800Bal. Jan 1. 2006 4,800

July 1, 2007 600July 1, 2007 600

Dec 31, 2007 600Dec 31, 2007 600

Bal. Jan 1. 2007 3,600Bal. Jan 1. 2007 3,600

July 1, 2008 600July 1, 2008 600

Dec 31, 2008 600Dec 31, 2008 600

Bal. Jan 1. 2008 2,400Bal. Jan 1. 2008 2,400

July 1, 2009 600July 1, 2009 600

Dec 31, 2009 600Dec 31, 2009 600

Bal. Jan 1. 2009 1,200Bal. Jan 1. 2009 1,200

Exercise:Exercise: Garden, Inc issued $100,000 of 10%, 5-year Garden, Inc issued $100,000 of 10%, 5-year bonds on Jan 1, 2001, with interest payable each July 1 bonds on Jan 1, 2001, with interest payable each July 1 and Jan 1. Bonds were sold for and Jan 1. Bonds were sold for $92,639$92,639,, and an and an effective-interest rate of effective-interest rate of 12%.12%. (a) prepare bond discount (a) prepare bond discount amortization schedule. (b) journal entries for Jan amortization schedule. (b) journal entries for Jan issuance and July 1 interest payment and Dec 31 issuance and July 1 interest payment and Dec 31 adjusting entry.adjusting entry.

Maturity value of bonds payableMaturity value of bonds payable 100,000 100,000


Semi-annually (100,000 Semi-annually (100,000 ×× .55839) .55839) 55,839 55,839Present value of 5,000 interest payable semi-annually for 5 yearsPresent value of 5,000 interest payable semi-annually for 5 years

At 12% annually (5,000 At 12% annually (5,000 ×× 7.36009) 7.36009) 36,80036,800Proceeds from sale of bondsProceeds from sale of bonds

92,23992,239

Discount on bonds payableDiscount on bonds payable 7,3617,361

Schedule of bond discount amortizationSchedule of bond discount amortization

Date Cash paid Interest Discount Carrying Date Cash paid Interest Discount Carrying amount Expense amortized of bondsamount Expense amortized of bonds

1/1/01 92,6391/1/01 92,639

7/1/01 5,000 7/1/01 5,000 aa 5,558 5,558bb 558 558c c 93,197 93,197dd

1/1/02 5,000 5,592 592 93,7891/1/02 5,000 5,592 592 93,789

7/1/02 5,000 5,627 627 94,4167/1/02 5,000 5,627 627 94,416

1/1/03 5,000 5,665 665 95,0811/1/03 5,000 5,665 665 95,081

7/1/03 5,000 5,705 705 95,7867/1/03 5,000 5,705 705 95,786

1/1/04 5,000 5,747 747 96,5331/1/04 5,000 5,747 747 96,533

7/1/04 5,000 5,792 792 97,3257/1/04 5,000 5,792 792 97,325

1/1/05 5,000 5,840 840 98,1651/1/05 5,000 5,840 840 98,165

7/1/05 5,000 5,890 890 99,0557/1/05 5,000 5,890 890 99,055

1/1/06 1/1/06 5,000 5,000 5,9455,945 945 945 100,000 100,000

50,000 57,361 7,36150,000 57,361 7,361

A: 5,000 = 100,000 A: 5,000 = 100,000 ×× 10% 10% × × 6/12 B: 5,558 = 92,639 6/12 B: 5,558 = 92,639 ×× 12% 12% × × 6/12 6/12

C: 558 = 5,558 – 5,000 D: 93,197 = 92,639 + 558C: 558 = 5,558 – 5,000 D: 93,197 = 92,639 + 558

Jan 1, 2001Jan 1, 2001

Cash (200,000 Cash (200,000 ×× .98) .98) 92,639 92,639

Discount on bonds payableDiscount on bonds payable 7,361 7,361

Bonds payableBonds payable 100,000 100,000

July 1, 2001July 1, 2001



CashCash 5,0005,000

Dec 31, 2001Dec 31, 2001


Bond Interest PayableBond Interest Payable 5,0005,000


Homework

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

Long-Term Liabilities

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