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					Long-Term Liabilities

      Chapter 14
   Long-Term Debit: General
Long-term debt consists of probable future
sacrifices.

It has various covenants or restrictions for the
protection of both lenders and borrowers.

The indenture agreement incorporates the
terms of the issue and restrictions.
              Issuing Bonds
Bonds are the most common type of long-term
   debt.

A bond indenture is a promise (by the lender to
    the borrower) to pay:
   1. a sum of money at the designated date, and
   2. periodic interest at a stipulated rate on the
      face value.
Bond Issues: Parties to the Contract

   Issuer of Bonds        lend cash
                                           Bondholders

                     1. Bond Certificate


            2. Payment Periodic Interest

         3. Payment of Face Value (maturity)
Types of bonds:

Secured and unsecured bonds
Term, Serial, and Callable bonds
Convertible, Commodity-Backed, and
 Deep discount bonds
Commodity-backed bonds
Registered and bearer (coupon) bonds
Income and Revenue bonds
        Valuation of Bonds payable
         Discount and premium
The price of a bond issue is determined by:
 the present value of the interest payments, and
 the present value of the face value,
 both discounted at the market (effective) rate of
  interest at date of issue.
  Interest payments by borrower are
  calculated as:
  Face value of bond issue x Stated (face) rate of
  interest.
         Valuation of Bonds payable
          Discount and premium
 The interest rate written in the terms of bond indenture is known as
  the stated, coupon, or nominal rate.
  - stated rate is the rate used to determine the amount of cash
  interest the borrower pays and the investor receives.( usually stated
  as annual rate).

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

 The present value of bonds is the value at which it should sell in the
  marketplace.
Under which conditions of bonds issuance does a discount on bonds
  payable arise?
Under which conditions of bonds issuance does a premium on bonds
  payable arise?


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



     Discount             or              Premium

If the bonds sell for                 if the bonds sell for
less than face value                  more than face value
Example:
ServiceMaster issues $100,000 in bonds, due in 5 years
  with 9 percent interest payable annually at year-end. At
  the time of issue, the market rate for such bonds is 11
  percent.
   (The market rate is the rate investors demand for loaning funds)

Present value of the principle:
   $100,000 × .59345 (table 6-2)            $59,345
Present value of the interest payment:
    $9,000 × 3.69590 (table6-4)           $33,263,10
Present value (selling price) of the bonds $92,608,10
       Year 1      Year 2       Year 3       Year 4        Year 5


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



                                                         $100,000
                   Redemption at maturity ==>
                                                        face value
                Interest = $100,000 x 9% per year stated rate
• Bond issued at par on interest date

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

Example:
If 10-yearterm bonds with a par value of $800,000 dated in
    Jan1, 2004, and bearing interest at an annual rate of 10
    percent payable semi-annually on Jan1 and July 1, are
    issued on Jan 1 at par.
The entry on the books of the issuing corporation would be:
       Cash                         800,000
               Bonds Payable                       800,000

The entry to record the first semi-annual interest payment
of 40,000 (800,000 × 10% × ½)on July 1, 2004, would be:
       Bond interest expense                  40,000
             Cash                                       40,000
The entry to record accrued expense at Dec 31, 2004 (year-end)
  would be:
       Bond interest expense                  40,000
             Bond interest payable                     40,000
• Bonds issued at discount or Premium on interest
  date

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


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

  Cash (800,000 × .97)      776,000
  Discount on bonds payable 24,000
            Bonds payable                                             800,000
• The discount is amortized and charged to interest expense over the
  period of time that the bonds are outstanding.

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

• The discount is 24,000, so the amount amortized to interest expense
  each year is 2,400 (24,000 / 10 years)
           Total Discount or Premium
            Total Number of Periods

• The amortization is recorded as follows:
      Bonds interest expense                   2,400
              Discount on bonds payable                     2,400
• At the end of the first year:
The unamortized balance in discount on bonds payable is:
       24,000 – 2,400 = 21,600
   (The balance of the discount is subtracted from the
  bonds payable in he balance sheet)

• Assume that the bonds were sold in Oct 2004, so there
  are three months of accrued interest must be recorded
  on Dec 31.
2- Premium           ( a premium is amortized either by the straight line method or the
                     effective interest method.)
 From the previous example, assume that the bonds are sold in
  Jan1, 2004 at 103%, so the entry will be:
      Cash (800,000 × 1.3)                   824,000
              Premium on bonds payable               24,000
              Bonds payable                        800,000


 At the end of the year, the entry to amortized the premium will be
        Premium on bonds payable               2,400
                           Bond interest expense              2,400

 Bond interest is increased by amortization of discount and decreased by
  amortization of premium.

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

 When the bonds are issued on other than the interest
    payment dates, buyers of the bonds will pay the seller the
    interest accrued from the last interest payment date on the
    date of issue.
 The purchasers will receive the full 6-months’ interest
    payment n the next semiannual interest payment date.
Example:
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
    semiannually on Jan 1 and July 1, are issued on March 1,
    2004 at par plus accrued interest.
 The entry on the books of the issuing corporation is:
Cash                                813,333
      Bonds Payable                                 800,000
      Bond interest expense (800,000 × .10 × 2/12 )   13,333


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

  Bond interest expense              40,000
     Cash                                          40,000

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

From the previous example, assume that the 10% bonds were
   issued at 102. the entry on March 1 will be as follows:
  Cash   (800,000 × 1.02) + (800,000 × .10× 2/12)   829,333
          Bonds payable                                   800,000
          Premium on bonds payable (800,000× 2%)              16,000

         Bond interest expense                                13,333

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

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

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

2- The bond discount or premium amortization is then determined by
   comparing the bond interest expense with the interest to be paid.
  Bond interest expense
                                        Bonds interest paid
Carrying value
  Of bonds × effective interest
                                  -   Face amount ×   Stated     =   Amortization
                                                                       amount
 Beginning           rate             of bonds        interest
  of period                                            rate
Bonds Issued at Discount
Example:
Evermaster Corporation issued $100,000 of 8% term bonds on
  Jan 1,2004, due on Jan 1,2009, with interest payable each
  July 1 and Jan 1 . Because the investors required an
  effective interest rate of 10%, they paid $92,278 for the
  $100,000 of bonds, creating a $7,722 discount.
The $7,722 discount is computed as follows:
Maturity value of bonds payable                                              100,000
Present value of 100,000 due in 5 years at 10%, interest payable
Semiannually (100,000 × .61391)                                     61,391
Present value of 4,000 interest payable semi-annually for 5 years
At 10% annually (4,000 × 7.72173)                                   30,887
Proceeds from sale of bonds                                                  92,278
Discount on bonds payable                                                     7,722
                     Schedule of bond discount amortization
Date       Cash paid       Interest              Discount        Carrying amount
                          Expense                amortized             of bonds
1/1/04                                                                  92,278
7/1/04        4,000 a         4,614b                  614c               92,892d
1/1/05        4,000           4,645                   645               93,537
7/1/05        4,000           4,677                   677               94,214
1/1/06        4,000           4,711                   711               94,925
7/1/06        4,000           4,746                   746               95,671
1/1/07        4,000           4,783                   783               96,454
7/1/07        4,000           4,823                   823               97,277
1/1/08        4,000           4,864                   864               98,141
7/1/08        4,000           4,907                   907               99,048
1/1/09        4,000            4,952                  952               100,000
             40,000           47,722                 7,722
A: 4,000 = 100,000 × 8%× 6/12        B: 4,614 = 92,278 × 10%× 6/12
C: 614 = 4,614 – 4,000               D: 92,892 = 92,278 + 614
 The entry to record the issuance of the bonds at discount
  on Jan 1, 2004 is:
  Cash                                     92,278
  Discount on Bonds payable                 7,722
                Bonds Payable                     100,000
 The entry to record the first interest payment in July 1,2004 and
  amortization of the discount is:
  Bond Interest Expense                           4,614
       Discount on Bonds Payable                            614
       Cash                                                4,000
 The entry to record the interest expense accrued at Dec 31,2004
  and amortization of the discount is:
  Bond Interest Expense                           4,645
       Bond Interest Payable                               4,000
       Discount on Bonds Payable                             645
Bonds Issued at Premium

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


Maturity value of bonds payable                                          100,000
Present value of 100,000 due in 5 years at 6%, interest payable
Semi-annually (100,000 × .74409)                                    74,409
Present value of 4,000 interest payable semi-annually for 5 years
At 6% annually (4,000 × 8.53020)                                    34,121
Proceeds from sale of bonds                                               108,530
Premium on bonds payable                                                    8,530
                     Schedule of bond premium amortization
Date       Cash paid       Interest             Premium          Carrying amount
                          Expense              amortized              of bonds
1/1/04                                                                 108,530
7/1/04        4,000 a         3,256b                  744c              107,786d
1/1/05        4,000           3,234                   766               107,020
7/1/05        4,000           3,211                   789               106,231
1/1/06        4,000           3,187                   813               105,418
7/1/06        4,000           3,162                   838               104,580
1/1/07        4,000           3,137                   863               103,717
7/1/07        4,000           3,112                   888               102,829
1/1/08        4,000           3,085                   915               101,914
7/1/08        4,000           3,057                   943               100,971
1/1/09        4,000            3,029                  971              100,000
             40,000           31,471                 8,530
A: 4,000 = 100,000 × 8%× 6/12        B: 3,256 = 108,530 × 6%× 6/12
C: 744 = 4,000 – 3,256               D: 107,786 = 108,530 - 744
The entry to record the issuance of bonds at premium on
  Jan 1, 2004, is:

Cash                                      108,530
       Premium on bonds Payable                     8,530
       Bonds Payable                              100,000


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

Bond interest expense                     3,256
Premium on bonds payable                    744
       Cash                                       4,000
Accruing Interest

In the previous examples, the two interest payment dates
   coincided with the financial reporting dates. However, if
   the financial statements are reported at the end of Feb,
   the premium or discount will be reported by the
   appropriate number of months to get the proper interest
   expense.
Interest accrual (4,000 × 2/6)         1,333.33
Premium amortized (744 × 2/6)              284
Interest expense                       1,085.33

The entry to record this accrual is:

Bond Interest Expense                  1,085.33
Premium on Bonds Payable                   248
         Bond Interest Payable                    1,333.33
Long-Term Notes Payable

 The difference between current notes payable and long-term
  notes payable.
 Note issued at face value

Cash                                10,000
       Notes Payable                         10,000

 Notes not issued at face value
      Zero-Interest-Bearing Notes
      Interest-Bearing Notes
                       Exercises

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

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

B- Prepare the journal entries for interest expense in 2005.
A- Jan 1
        Cash                                      1,000,000
               Bonds Payable                               1,000,000
             (to record issuance of bonds)


B- July 1
        Bond Interest Expense                  50,000
                  Cash                                    50,000
          (to record payment of semiannual interest, 1000,000 × 10%× 6/12)

Dec 31
         Bond Interest Expense         50,000
                 Bond Interest Payable        50,000
                    ( to record accrual of semi-annual interest)
BE14-2
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
  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
  payment, and (c) the Dec 31 adjustment entry.
A- Jan 1
            Cash                                    200,000
                  Bonds Payable                                 200,000
             (to record issuance of bonds)
B- July 1
            Bond Interest Expense                  10,000
                      Cash                                   10,000
             (to record payment of semiannual interest, 200,000 × 10%× 6/12)

C- Dec 31
            Bond Interest Expense                    10,000
                      Bond Interest Payable                     10,000
                       ( to record accrual of semi-annual interest)
BE14-3
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.
   Assume the Goofy company records straight-line amortization annually on
   Dec 31.
A- Cash (200,000 × .98)                               196,000
    Discount on bonds payable                           4,000
                     Bonds payable                              200,000
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 $400
July entry is:
           Bond interest expense                                10,000
               Discount on bonds payable                                400
                Cash                                                    9,600
C- Dec 31
Bonds interest expense                                          10,000
               Discount on bonds payable                                400
                Bond interest payable                                   9,600
 The July and Dec entries will be the same in all five years
Although Discount on Bonds Payable has a debit balance,
   it is not an asset. Rather, it is a contra account. This
   account is deducted from bonds payable on the
   balance sheet.



                        Goofy Company
                        Balance Sheet
             Long-term Liabilities
                Bonds Payable                     200,000
             Less: Discount on bonds Payable        3,200
             Note: the balance of the discount is deducted
             from the bonds payable, so at the end of the
             year the balance of the discount will be 3,200.
             so this amount will be subtracted from the
             bonds payable in the balance sheet.
                   Discount on Bonds Payable


Jan1, 2005              4,000    July 1, 2005   400
                                 Dec 31, 2005   400
Bal. Jan 1. 2006         3,200   July 1, 2006   400
                                 Dec 31, 2006   400
Bal. Jan 1. 2007         2,400   July 1, 2007   400
                                 Dec 31, 2007   400
Bal. Jan 1. 2008         1,600   July 1, 2008   400
                                 Dec 31, 2008   400
Bal. Jan 1. 2009           800   July 1, 2009   400
                                 Dec 31, 2009   400
           Balance Sheet                                            Balance Sheet
           At Dec 31, 2005                                          At Dec 31, 2006
Long-term Liabilities              200,000
                                                       Long-term Liabilities               200,000
Less: Discount on bonds Payable      3,200
                                                       Less: Discount on bonds Payable       2,400
                                  196,800
                                                                                           197,600




           Balance Sheet                                              Balance Sheet
           At Dec 31, 2007                                            At Dec 31, 2008
Long-term Liabilities             200,000                Long-term Liabilities               200,000
Less: Discount on bonds Payable    1,600                 Less: Discount on bonds Payable        800
                                  198,400                                                    198,200




                  Balance Sheet                             Note:
                  At Dec 31, 2009                           If there is redemption of the bonds
 Long-term Liabilities                       200,000        in 2009, the account will be closed
                                                            by making bonds payable debit
                                                            and cash credit.
BE14-4
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.
   Assume the Goofy company records straight-line amortization annually on
   Dec 31.
A- Cash (200,000 × 103%)                        206,000
                     Premium on bonds payable                      6,000
                     Bonds payable                                 200,000
B-
July entry is:
           Bond interest expense                          9,400
           Premium on bonds payable                         600
                     Cash                                          10,000
C- Dec 31
Bonds interest expense                                     9,400
Premium on bonds payable                                     600
                     Bond interest payable                         10,000
Premium on bonds payable is added to bonds payable on
  the balance sheet.



                               Goofy Company
                               Balance Sheet

       Long-term Liabilities
          Bonds Payable                    200,000
       Add: Premium on bonds Payable          4,800
       Note: 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
       4,800. so this amount will be added on the bonds payable in the
       balance sheet.
               Balance Sheet                                   Balance Sheet
               At Dec 31, 2005                                 At Dec 31, 2006
  Long-term Liabilities             200,000
  Add: Premium on bonds Payable       4,800   Long-term Liabilities               200,000
                                    204,800   Add: Premium on bonds Payable         3,600
                                                                                  203,600




               Balance Sheet                                      Balance Sheet
               At Dec 31, 2007                                    At Dec 31, 2008
 Long-term Liabilities            200,000         Long-term Liabilities               200,000
 Add: Premium on bonds Payable      2,400         Add: Premium on bonds Payable         1,200
                                  202,400                                             201,200




               Balance Sheet                        Note:
               At Dec 31, 2009                      If there is redemption of the
Long-term Liabilities             200,000
                                                    bonds in 2009, the account will
                                                    be closed by making bonds
                                                    payable debit and cash credit.
               Premium on Bonds Payable

July 1, 2005      600      Jan1, 2005         6,000
Dec 31, 2005      600
July 1, 2006      600      Bal. Jan 1. 2006   4,800
Dec 31, 2006      600

July 1, 2007      600      Bal. Jan 1. 2007   3,600
Dec 31, 2007      600

July 1, 2008      600      Bal. Jan 1. 2008   2,400
Dec 31, 2008      600
July 1, 2009      600      Bal. Jan 1. 2009   1,200
Dec 31, 2009      600
Exercise: Garden, Inc issued $100,000 of 10%, 5-year
  bonds on Jan 1, 2001, with interest payable each July 1
  and Jan 1. Bonds were sold for $92,639, and an
  effective-interest rate of 12%. (a) prepare bond discount
  amortization schedule. (b) journal entries for Jan
  issuance and July 1 interest payment and Dec 31
  adjusting entry.
Maturity value of bonds payable                                               100,000
Present value of 100,000 due in 5 years at 12%, interest payable
Semi-annually (100,000 × .55839)                                    55,839
Present value of 5,000 interest payable semi-annually for 5 years
At 12% annually (5,000 × 7.36009)                                    36,800
Proceeds from sale of bonds                                                   92,239
Discount on bonds payable                                                     7,361
                     Schedule of bond discount amortization
Date       Cash paid         Interest             Discount           Carrying
amount                      Expense              amortized           of bonds
1/1/01                                                                 92,639
7/1/01        5,000 a         5,558b                558c                93,197d
1/1/02        5,000           5,592                  592               93,789
7/1/02        5,000           5,627                  627               94,416
1/1/03        5,000           5,665                  665               95,081
7/1/03        5,000           5,705                  705               95,786
1/1/04        5,000           5,747                  747               96,533
7/1/04        5,000           5,792                  792               97,325
1/1/05        5,000           5,840                  840               98,165
7/1/05        5,000           5,890                  890               99,055
1/1/06        5,000            5,945                 945               100,000
             50,000           57,361                7,361
A: 5,000 = 100,000 × 10%× 6/12       B: 5,558 = 92,639 × 12%× 6/12
C: 558 = 5,558 – 5,000               D: 93,197 = 92,639 + 558
 Jan 1, 2001
Cash (200,000 × .98)                   92,639
Discount on bonds payable               7,361
                 Bonds payable                  100,000

 July 1, 2001
Bond Interest Expense                5,585
         Discount on Bonds Payable                  558
         Cash                                     5,000

 Dec 31, 2001
Bond Interest Expense                5,592
        Bond Interest Payable                     5,000
        Discount on Bonds Payable                   592
                      Homework

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

				
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