10
7/e
PowerPoint Author: Catherine Lumbattis
COPYRIGHT © 2011 South-Western/Cengage Learning
Long-TermLiabilities
Balance Sheet ClassificationsCurrent liabilities:
Long-term liabilities:
Due within one year of the balance sheet date
Due beyond one year
LO1
Long-Term LiabilitiesBonds payableNotes payableLeasesDeferred taxes
Bonds
Long-term borrowing arrangement Interest paid at stated rate and timesPrincipal repaid at maturity date
Investor Borrower
LO2
Bond Features
Collateralized backed by
specific assets in event of default
Term: entire principal
due on a specific single date
Debentures backed only by
general creditworthiness
of issue
Serial: principal repaid in
installments over time
Bond Features
Convertible into common stock
Callable / Redeemable may be retired before maturity date
Bonds Sold at Face Value
Cash 10,000 Bonds Payable 10,000
To record the issuance of bonds at face value.
Face value of bonds = Sales price
Bond Interest Rates Face rate of interest the rate specified on the bond certificate also called: stated rate coupon rate nominal rate contract rate
Market rate of interest the rate that investors could
obtain by investing in other bonds similar to the issuing firm’s bonds
also called:
effective rate yield
LO3
Two sets of cash flows
PV = ?
Calculating Bond Prices
$$
(2) Principal due at maturity
PV = ? $$$$$
(1) Interest payments made each period
etc. $$ $$ $$
Determining Bond Prices
On 1/1/10, Discount Firm issues: $10,000, 8% bonds Due December 31, 2011 Interest payable annually Market rate of interest = 10%
Calculate the issue price of the bonds.
Example:
PV = ?
Calculating Bond Prices
$800
(1) Interest payments (4 payments @ $800)
2010 2011 2012 2013
$800
$800
Interest is always paid at rate stated on bonds ($10,000 @ 8%)
$800
Calculating Bond Prices
(2) Principal of $10,000 due at end of 2013
2013
PV = ? $10,000
(1) Interest payments (4 payments @ $800)
PV = ?
2010 2011 2012 2013
$800
$800
$800
$800
Present value:Interest payments: $800 × 3.170 = $2,536
(PV; n = 4; i = 10%)
Principal payment: $10,000 × 0.683 = 6,830
(PV; n = 4; i = 10%)Bond issue price: $9,366
Example of Price Calculation
…butdiscount
@ market rate
Compute interestpayment at stated
rate (i.e., 8%)...
Recording Bond DiscountsCash 9,366Discount on Bonds Payable 634
Bonds Payable 10,000To record the issuance of bonds payable.
Assets = Liabilities + Owners’ Equity+9,366 = –634
+10,000 LO4
Balance Sheet Presentation of Bond Discount
Long-term liabilities:Bonds payable $10,000Less: Discount on bonds payable 634
$ 9,366
Determining Bond PricesAssume Premium Firm sells the same $10,000, 8% bonds when the market rate on similar bonds is 6%.
Present value:Interest payments: $800 × 3.465 = $ 2,772
(PV; n = 4; i = 6%)
Principal payment: $10,000 × 0.792 = 7,920
(PV; n = 4; i = 6%)Bond issue price: $10,692
Example of Price Calculation
…butdiscount
@ market rate
Compute interestpayment at stated
rate (i.e., 8%)...
Recording Bond PremiumsCash 10,692
Bonds Payable 10,000Premium on Bonds Payable 692
To record the issuance of bonds payable.
Assets = Liabilities + Owners’ Equity +10,692 = +10,000
+ 692
Balance Sheet Presentation of Bond Premium
Long-term liabilities:Bonds payable $10,000Plus: Premium on bonds payable 692
$10,692
Interest Rates and Bond Prices
Above face value (at a premium)
At face value
Below face value (at a discount)
= MARKET RATE
BONDS ISSUED: IF STATED RATE:
> MARKET RATE
< MARKET RATE
Amortization of Bond Premiums and Discounts
Transferring an amount from the discount or premium account to interest expense over the life of the bond using the effective interest method
Discountincreasesinterestexpense
Premiumreducesinterestexpense
LO5
Amortization Schedule: Discount
Cash Interest Discount CarryingDate Interest Expense Amortized Value 1/ 1/10 — — — $ 9,36612/31/10 $800 $937 $137 9,50312/31/11 800 950 150 9,65312/31/12 800 965 165 9,81812/31/13 800 982 182 10,000
(rounded)
Amortization Schedule: Premium
Cash Interest Discount CarryingDate Interest Expense Amortized Value1/1/10 — — — $10,69212/31/10 $800 $642 $158 10,53412/31/11 800 632 168 10,36612/31/12 800 622 178 10,18812/31/13 800 612 188 10,000
(rounded)
Redemption of BondsReasons for early redemption:
• Excess cash• Changing interest rates
Gain = Carrying Value – Redemption Price Loss = Redemption Price – Carrying Value
LO6
LeasesContractual arrangementGrants right to use asset in exchange
for paymentsForm of financing
Lessee Lessor
LO7
Operating LeasesRecord as rent (lease) expense
each periodDisclose future lease obligations
in financial statement notes
OFFICESPACE
FOR LEASE
Capital Lease Record as asset and corresponding liability
(as if purchased through borrowings)
Depreciate asset over lease term
Separate payments into principal and interest components using the effective interest method
Criteria for Lease Capitalization
Transfers ownership of property
Contains a bargain-purchase option
Term is >75% of property’s life
Present value of payments is >90% of property’s fair market value
Lease meets one or more:
IFRS and LeasesIn U.S., if any of the previous criteria are
present, the lease is considered a capital lease
IFRS considers these criteria as “guidelines” rather than rigid rules
Because of these differences , there is much more flexibility with international standards.
Debt-to-Equity Ratio
Total LiabilitiesTotal Stockholders’ Equity
How much have creditors contributed as compared to
owners?
LO 8
Times Interest Earned Ratio
Income Before Interest and TaxInterest Expense
Will they be able to pay the
interest on their debt?
Debt Service Coverage Ratio
Cash Flow from Operations Before Interest and Tax
Interest and Principal Payments
Will they be able to repay the principal
on their loan?
Long-Term Liabilities on the Statement of Cash Flows
Operating Activities Net income xxx Increase in current liability + Decrease in current liability – Investing Activities Financing Activities Increase in long-term liability + Decrease in long-term liability –
LO 9
AppendixAccounting Tools:
Other Liabilities
Deferred Tax Used to reconcile the differences between
the accounting for book purposes and for tax purposes
Should reflect temporary differences but not permanent differences
LO 10
Permanent difference –
affects the tax records but not the accounting records, or vice versa
Temporary difference –
affects both book and tax records but not in the same period
Deferred Income Taxes
SalesDepreciation ExpenseTaxable Income× Tax RateTax Payable to IRS
Book Tax$6,000 $6,000 2,500 4,000 3,500 2,000 40% 40%$1,400 $ 800
$ 600Difference recorded
as deferred tax
Deferred Income Taxes
Income tax Book Tax$1,400 $ 800
Tax Expense 1,400 Tax Payable 800 Deferred Tax 600To record income tax for the year.
$ 600
End of Chapter 10