Chapter 14 LONG-TERM LIABILITIES 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 McGraw-Hill/Irwin Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
14-2 A1 BOND FINANCING Advantages Bonds do not affect owner control. Interest on bonds is tax deductible. Bonds can increase return on equity. Disadvantages Bonds require payment of both periodic interest and par value at maturity. Bonds can decrease return on equity. FINANCIAL LEVERAGE IF IT EANRS MORE THAN IT PAYS ON B. INTEREST
14-3 A1 BOND TRADING 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.
14-4 A1 BOND ISSUING PROCEDURES
14-5 P1 BOND ISSUANCES Transaction on the Bond Issue Date Corporation Investors Bond Selling Price Bond Certificate
14-6 P1 BOND ISSUANCES Transactions during the bond life Bond Interest Payments Corporation Bond Interest Payments Investors Bond Issue Date Interest Payment = Bond Par Value Stated Interest Rate x Time
14-7 P1 BOND ISSUANCES Transaction on the Maturity Date Corporation Investors Bond Face Value
14-8 P1 ISSUING BONDS AT PAR 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)
14-9 P1 ISSUING BONDS AT PAR On June 30, 2011, the issuer of the bond pays the first semiannual interest payment of $36,000. $800,000 9% ½ year = $36,000 This entry is made every six months until the bonds mature.
14-10 P1 ISSUING BONDS AT PAR On December 31, 2030, the bonds mature and the issuer of the bond pays face value of $800,000 to the bondholders.
14-11 P1 BOND DISCOUNT OR PREMIUM
14-12 P2 ISSUING BONDS AT A DISCOUNT Fila issues bonds with the following provisions: Par Value: $100,000 Issue Price: 96.454% of par value Stated Interest Rate: 8% Market Interest Rate: 10% Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years) } Bond will sell at a discount. ISSUE AT DISCOUNT IF MARKET RATE HIGHER THAN CONTRACT RATE ISSUE PRICE LESS THAN CONTRACT VALUE
14-13 P2 ISSUING BONDS AT A DISCOUNT On Dec. 31, 2011, Fila should record the bond issue. Par value $ 100,000 Cash proceeds 96,454 Discount $ 3,546 *$100,000 x 96.454% Contra-Liability Account
14-14 P2 ISSUING BONDS AT A DISCOUNT Partial Balance Sheet as of Dec. 31, 2011 Long-term Liabilities: Bonds Payable 100,000 Less: Discount on Bonds Payable 3,546 96,454 Maturity Value Carrying Value 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)
14-15 P2 AMORTIZING A BOND DISCOUNT Fila will make the following entry every six months to record the cash interest payment and the amortization of the discount. $3,546 4 periods = $887 (rounded) $100,000 8% ½ = $4,000
14-16 P2 Straight-Line Amortization Table Interest Interest Discount Unamortized Carrying Date Payment Expense Amortization* Discount Value 12/31/2011 $ 3,546 $ 96,454 6/30/2012 $ 4,000 $ 4,887 $ 887 2,659 97,341 12/31/2012 4,000 4,887 887 1,772 98,228 6/30/2013 4,000 4,887 887 885 99,115 12/31/2013 4,000 4,885 885-100,000 $ 16,000 $ 19,546 $ 3,546 * Rounded. AMORTIZING A BOND DISCOUNT
14-17 P3 ISSUING BONDS AT A PREMIUM Adidas issues bonds with the following provisions: Par Value: $100,000 Issue Price: 103.546% of par value Stated Interest Rate: 12% Market Interest Rate: 10% } Bond will sell at a premium. Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years) ISSUE AT PTEMIOUM IF MARKET RATE LOWER THAN CONTRACT RATE ISSUE PRICE MORE THAN CONTRACT VALUE
14-18 P3 ISSUING BONDS AT A PREMIUM On Dec. 31, 2011, Adidas will record the bond issue as: Par value $ 100,000 Cash proceeds 103,546 * Premium $ 3,546 *$100,000 x 103.546% Adjunct-Liability Account
14-19 P3 ISSUING BONDS AT A PREMIUM Partial Balance Sheet as of Dec. 31, 2011 Long-term Liabilities: Bonds Payable 100,000 Plus: Premum on Bonds Payable 3,546 103,546 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)
14-20 P3 AMORTIZING A BOND PREMIUM Adidas will make the following entry every six months to record the cash interest payment and the amortization of the discount. $3,546 4 periods = $887 (rounded) $100,000 12% ½ = $6,000
14-21 P3 AMORTIZING A BOND PREMIUM Straight-Line Amortization Table Interest Interest Premium Unamortized Carrying Date Payment Expense Amortization* Premium Value 12/31/2011 $ 3,546 $ 103,546 6/30/2012 $ 6,000 $ 5,113 $ 887 2,659 102,659 12/31/2012 6,000 5,113 887 1,772 101,772 6/30/2013 6,000 5,113 887 885 100,885 12/31/2013 6,000 5,115 885-100,000 $ 24,000 $ 20,454 $ 3,546 * Rounded. CARRYING VALUE =PAR VALUE +UNAMORTIZED PREMIUM
14-22 P2 BOND PRICING Cash Outflows related to Interest Payments Cash Outflows for par value at end of Bond life
14-23 P2 ISSUING BONDS AT A DISCOUNT Fila issues bonds with the following provisions: Par Value: $100,000 Issue Price:? Stated Interest Rate: 8% Market Interest Rate: 10% Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years)
14-24 P2 PRESENT VALUE OF A DISCOUNT BOND 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
14-25 P4 BOND RETIREMENT 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.
14-26 P4 BOND RETIREMENT 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.
14-27 P4 BOND RETIREMENT 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
14-28 C1 LONG-TERM NOTES PAYABLE Cash Company Note Payable Lender When is the repayment of the principal and interest going to be made? Note Date Note Maturity Date
14-29 C1 LONG-TERM NOTES PAYABLE Single Payment of Principal plus Interest Company Lender Single Payment of Principal plus Interest Note Date Note Maturity Date
14-30 C1 LONG-TERM NOTES PAYABLE Company Regular Payments of Principal plus Interest Lender Regular Payments of Principal plus Interest Note Date Payments either can be equal principal payments plus interest or equal payments. Note Maturity Date
14-31 C1 INSTALLMENT NOTES 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. Computation Principal divided by PV factor Table Value Present Value Table PV of Payment Annuity of $1 (B.3) 4.6229 60,000 12,979
14-32 C1 INSTALLMENT NOTES WITH EQUAL PAYMENTS
14-33 P5 INSTALLMENT NOTES WITH EQUAL PAYMENTS 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.
C1 MORTGAGE NOTES AND BONDS A legal agreement that helps protect the lender if the borrower fails to make the required payments. 14-34 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.
14-35 GLOBAL VIEW 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.
14-36 A2 FEATURES OF BONDS AND NOTES Secured and Unsecured Convertible and Callable Term and Serial Registered and Bearer Term bonds are scheduled for maturity on one specified date. Serial bonds mature at more than one date.
14-37 A3 DEBT-TO-EQUITY RATIO Debt-to- Equity Ratio = Total Liabilities Total Equity This ratio helps investors determine the risk of investing in a company by dividing its total liabilities by total equity.
14-38 C2 Present Value of $1 Rate Periods 3% 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 APPENDIX 14A: PRESENT VALUES OF BONDS AND NOTES 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
14-39 C2 APPENDIX 14A: PRESENT VALUES OF BONDS AND NOTES Semiannual Interest Annuity $100,000 8% ½ = $4,000 $4,000 3.5460 = $14,184 Present Value of Annuity of $1 Rate Periods 3% 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 Present Amount PV Factor Value Principal $ 100,000 0.8227 $ 82,270 Interest 8,000 3.5460 14,184 Issue price of debt $ 96,454 10 8.5302 8.1109 7.7217
14-40 APPENDIX 14B: EFFECTIVE INTEREST AMORTIZATION Effective Interest Amortization Schedule Interest Interest Discount Unamortized Carrying Date Payment Expense Amortization* Discount Value 12/31/2011 $ 3,546 $ 96,454 6/30/2012 $ 4,000 $ 4,823 $ 823 2,723 97,277 12/31/2012 4,000 4,864 864 1,859 98,141 6/30/2013 4,000 4,907 907 952 99,048 12/31/2013 4,000 4,952 952 0 100,000 $ 16,000 $ 19,546 $ 3,546 * Rounded. $96,454 5% = $4,823 $100,000 - $2,723 = $97,277
14-41 C3 APPENDIX14C: ISSUING BONDS BETWEEN INTEREST DATES 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 $1,500 accrued $3,000 earned Bondholder pays $1,500 to issuer First Interest date 6/30 Issuer pays $4,500 to bondholder
14-42 C4 APPENDIX 14D: LEASES AND PENSIONS 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. 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.
14-43 C4 APPENDIX 14D: LEASES AND PENSIONS 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.
END OF CHAPTER 14 14-44