Chapter 12 13

Chapter 12Chapter 12

Debt FinancingDebt Financing

Debt Financing : LiabilitiesThe obligation of a particular entity to transfer assets or provide services.

– Must be the result of past transactions or events.

– Probable transfer of assets (or services) must be in the future.

Classification of Liabilities

• Current Liabilities- Paid within one year or the operating cycle, whichever is longer.

• Noncurrent Liabilities- Not paid within one year or the operating cycle, whichever is longer.

Accounting for Short-Term Debt

• Short-Term obligations are due within one year or an operating cycle.

• Account Payable - the amount due for the purchase of merchandise.

• Notes Payable - a formal written promise to pay a sum of money in the future, also known as a promissory note.

Short-Term Obligations Expected to be Refinanced

• A short-term obligation that is expected to be refinanced on a long-term basis should not be reported as a current liability

1. Management must intend to refinance the obligation on a

long-term basis.

2. Management must demonstrate an ability to

refinance the obligation.

Review : From P3-40 b. Classification

Bank notes payable include two separate notes payable to First Interstate. (Today is 12/31/2013)

(1) A $30,000, 8% note issued March 1, 2011, payable on demand. Interest is payable every six months.

(2) A 1-year, $50,000, 11.5% note issued January 2, 2013. On December 30,2013, Sierra negotiated a written agreement with First Interstate Bank to replace the note with a 2-year, $50,000, 10%, note to be issued January 2, 2014.

Review of Time Value : Corporate Bond Example

Exercise) The company issued new corporate bonds on 1/1/12, with face value $1,000 due in 3 years. The bond pays 10% stated interest rate at the end of each year. Market interest rate is 8%. What is the market value of the bonds ?  

Analysis : The cash receipt from the bond  

1/1/12 12/31/12 12/31/13 12/31/14 : Assume 8% interest-----------|------------------|-----------------|-----------------|-----------------------------------

today $ 100 $ 100 $ 100 : stated interest (10%) $1,000 : principal

Value of the bond

= PV of 3 payments of $100 + PV of $1,000 at 12/31/14 at 8% market interest rate

Corporate Bonds

BOND PAYABLEBOND PAYABLE

Face Value $1,000Face Value $1,000 Interest 6%

12/31 each year12/31 each year

Maturity Date 12/31/08Maturity Date 12/31/08Bond Date 1/1/06Bond Date 1/1/06

1. 1. Face value (maturity or par value)Face value (maturity or par value)2. 2. Maturity DateMaturity Date3. 3. Stated Interest RateStated Interest Rate 4.4. Interest Payment DatesInterest Payment Dates5. Bond Date5. Bond Date

Other Factors:Other Factors:6. Market Interest Rate6. Market Interest Rate7. Issue Date7. Issue Date

BOND PAYABLEBOND PAYABLE

Face Value $1,000Face Value $1,000 Interest 10%

12/31 each year12/31 each year

Maturity Date 12/31/14Maturity Date 12/31/14Bond Date 1/1/12Bond Date 1/1/12

Table : Present Value of 1

Periods 6% 8% 9% 10% 12%1 0.94340 0.92593 0.91743 0.90909 0.892862 0.89000 0.85734 0.84168 0.82645 0.797193 0.83962 0.79383 0.77218 0.75132 0.711784 0.79209 0.73503 0.70843 0.68301 0.635525 0.74726 0.68058 0.64993 0.62092 0.567436 0.70496 0.63017 0.59627 0.56447 0.506637 0.66506 0.58349 0.54703 0.51316 0.452358 0.62741 0.54027 0.50187 0.46651 0.403889 0.59190 0.50025 0.46043 0.42410 0.36061

10 0.55839 0.46319 0.42241 0.38554 0.32197

(Textbook page TVM-24)

Table : Present Value of an Ordinary Annuity of 1

Periods 6% 8% 9% 10% 12%1 0.94340 0.92593 0.91743 0.90909 0.892862 1.83339 1.78326 1.75911 1.73554 1.690053 2.67301 2.57710 2.53130 2.48685 2.401834 3.46511 3.31213 3.23972 3.16986 3.037355 4.21236 3.99271 3.88965 3.79079 3.604786 4.91732 4.62288 4.48592 4.35526 4.111417 5.58238 5.20637 5.03295 4.86842 4.563768 6.20979 5.74664 5.53482 5.33493 4.967649 6.80169 6.24689 5.99525 5.75902 5.32825

10 7.36009 6.71008 6.41766 6.14457 5.65022

(Textbook page TVM-26)

Review : Determining the Selling Price

Stated interest rate is The bonds sells:

Above market rateAt a premium

(Cash received is greater than face amount)

Equal to market rateAt par value

(Cash received is equal to face amount)

Below market rateAt a discount

(Cash received is less than face amount)

Stated interest rate is The bonds sells:

Above market rateAt a premium

(Cash received is greater than face amount)

Equal to market rateAt par value

(Cash received is equal to face amount)

Below market rateAt a discount

(Cash received is less than face amount)

E 12-26 Market Values of Bond Issues What is the market value of each of the following bond

issues? (Round to the nearest dollar)(a) 10% bonds of $1,000,000 sold on bond issue date;

10-year life; interest payable semi-annually; effective rate, 12%.

(b) 9% bonds of $200,000 sold on bond issue date; 5-year life; interest payable semiannually; effective rate, 8%.

(c) 8% bonds of $150,000 sold 30 months after bond issue date; 15-year life; interest payable semiannually; effective rate, 10%.

Back to the first Corporate Bond Example

Exercise) The company issued new corporate bonds on 1/1/12, with face value $1,000 due in 3 years. The bond pays 10% stated interest rate at the end of each year. Market interest rate is 8%. What is the market value of the bonds ?  

Analysis : The cash receipt from the bond  

1/1/12 12/31/12 12/31/13 12/31/14 : Assume 8% interest-----------|------------------|-----------------|-----------------|-----------------------------------

today $ 100 $ 100 $ 100 : stated interest (10%) $1,000 : principal

Value of the bond

= PV of 3 payments of $100 + PV of $1,000 at 12/31/14 at 8% market interest rate

Straight-Line Method

The discount or The discount or premium is premium is allocated allocated

equallyequally to each to each period over the period over the outstanding life outstanding life

of the bond.of the bond.

ConsideredConsideredpractical when practical when the discount the discount or premium or premium amount is amount is

smallsmall..

ConsideredConsideredpractical when practical when the discount the discount or premium or premium amount is amount is

smallsmall..

Straight-Line Method

In our last example, straight-lineIn our last example, straight-linepremium amortization would be:premium amortization would be:

$51.54 $51.54 ÷ 3 = $17.18 every year.÷ 3 = $17.18 every year.

In our last example, straight-lineIn our last example, straight-linepremium amortization would be:premium amortization would be:

$51.54 $51.54 ÷ 3 = $17.18 every year.÷ 3 = $17.18 every year.

Effective Interest Method

The interest The interest expense is expense is recorded at recorded at

effective interest effective interest rate, and then rate, and then

discount or discount or premium is premium is

adjustedadjusted

More accurateMore accuratemethod when method when the discount the discount or premium or premium amount is amount is material.material.

More accurateMore accuratemethod when method when the discount the discount or premium or premium amount is amount is material.material.

E 12-30 Amortization of Bond Premium or Discount

On January 1, 2012, Terrel Company sold $100,000 of 10-year, 8% bonds at 93.5, an effective rate of 9%. Interest is to be paid on July 1 and December 31. Compute the amount of premium or discount amortization in 2012 and 2013 using (1) the straight-line method and (2) the effective-interest method. Make the journal entries to record the amortization when the effective-interest method is used.

E12-24 Accounting for Mortgages On January 1, 2013, Lily Company purchased a building for

$2,000,000. The company made a 25% down payment and took out a mortgage payable over 30 years with monthly payments of $11,006.47. The first payment is due February 1, 2013. The mortgage interest rate is 8%.

1. Determine how much of the first two mortgage payments would be applied to interest expense and how much would be applied to reducing the principal. (Note : The 8% interest rate is compounded monthly.)

2. Make the journal entry necessary to record the first mortgage payment on February 1, 2013.

Interest on Long Term PayableAt January 1, 2012, the Marlow Consulting Inc.

purchases furniture and paid in exchange a promissory note with a face value of $100,000, a due date of December 31, 2013, and a stated interest rate of 11%, with interest payable at the end of each year. The fair value of furniture is $101,736, and the note is considered to have an appropriate imputed market rate of interest of 10%. The company adopts the effective interest method to recognize interest expenses.

QUESTIONS : Journal entries at (1) January 1, 2012, (2) December 31, 2012 and (3) December 31, 2013.

From Old Exam

End of Chapter 12

Chapter 13Shareholders’ Equity

The Nature of Shareholders’Equity

Assets – Liabilities = Shareholders’ Equity

Net Assets(Residual Interest)

Sources of Shareholders’ Equity

Stockholders’ Equity

Paid-in Capital

Retained Earnings

Amounts earnedby corporation

Amounts investedby shareholders

Common Stock

• Common Stock - when a corporation is formed, the single class of stock is typically issued.

• Owners of common stock have these basic rights:

1. To vote in the election of directors and in the determination of certain corporate policies.

2. Preemptive right- to maintain one’s proportional interest in the corporation through purchase of additional common stock if and when it is issued.

Par or Stated Value

• Par Value – Amount written on the face of the stock. In general, it has no economic implication.

• Today, most stocks have a nominal par value (for example $1.00) or no par value.

Capital Stock

Par value stock• Designated dollar

amount per share stated in the corporate charter.

• Par value has no relationship to market value.

No-par stock• Dollar amount per share

not designated in corporate charter.

• Corporations can assign a stated value per share

(treated as if par value for accounting purpose).

Issuance of Capital Stock

• The issuance of stock for cash is recorded by a debit to Cash and a credit to Capital Stock for the par value.

• When the amount of cash received for the stock is more than the par value, the excess is recorded as a credit to additional paid-in capital or paid in capital in excess of par.

Capital Stock Issued for Cash

Stocks with par value :

Goode Corporation issued 4,000 shares of $1 par common stock on April 1, 2012, for

$45,000 cash.

With no par value:

Goode Corporation issued 4,000 shares of no par common stock without a stated value on April 1, 2012, for

$45,000 cash.

Capital Stock Issued for Consideration Other than Cash

AC Company issues 200 shares of $0.50 par value common stock in return for land. The company’s stock is currently selling

for $50 per share.

Record Non-cash Assets or Issued Common Shares at fair market value…

E 13-24 Common Stock Verdero Company is authorized to issue 100,000 shares of $2 par value common stock. Verdero has the following transactions:

(a) Issued 20,000 shares at $30 per share; received cash.

(b) Issued 250 shares to attorneys for services in securing the corporate charter and for preliminary legal costs of organizing the corporation. The value of the services was $9,000.

(c) Issued 300 shares, valued objectively at $10,000, to the employees instead of them cash wages.

E 13-24 Continued

(d) Issued 12,500 shares of stock in exchange for a building valued at $295,000 and land valued at $80,000. (The building was originally acquired by the investor for $250,000 and has $100,000 of accumulated depreciation; the land was originally acquired for $30,000.)

(e) Received cash for 6,500 shares of stock sold at $38 per share.

(f) Issued 4,000 shares at $45 per share; received cash.

Preferred Stock

Dividend andliquidation

preference over common stock.

Dividend andliquidation

preference over common stock.

Generally does nothave voting rights.

Generally does nothave voting rights.

Usually has apar or stated value.

Usually has apar or stated value.

May be convertible,callable, and/or

redeemable.

May be convertible,callable, and/or

redeemable.

Preferred Stock

• Priority in receiving dividends

• Rights given up by preferred stockholders :

1. Voting- most PS are not allowed to vote for the board of directors.

2. Sharing in success- Cash dividends received by PS are usually fixed in amount. If the firm does extremely well, their dividend amount is not adjusted.

Types of Preferred Stock

CumulativeHas the right to receive accumulated dividends before any dividends may be paid to common stockholders.

Non-Cumulative

Has no right to “passed”dividends.

Preferred Stock DividendsCumulative

Unpaid dividends must be paid in full before any distributions to common stock.

Dividends in arrears (dividends carry-forwarded) are not liabilities, but the per share and aggregate amounts must be

disclosed.

E 13-26 Preferred StockAnderson Company paid dividends at the end of each year as follows: 2011, $150,000; 2012, $240,000; and 2013, $560,000. Determine the amount of dividends per share paid on common and preferred stock for each year, assuming independent capital structures as follows;

(a) 300,000 shares of no-par common; 10,000 shares of 100 par, 9% noncumulative preferred. (b) 250,000 shares of no-par common; 20,000 shares of $100 par, 9% noncumulative preferred. (c) 250,000 shares of no-par common; 20,000 shares of $100 par, 9% cumulative preferred (d) 250,000 shares of $1 par common; 30,000 shares of $100 par, 9% cumulative preferred

Treasury Stock

• Stock issued by a corporation but subsequently reacquired by the corporation and held for possible future reissuance or retirement.

• Reported as a contra-equity account, not as an asset.

• Never creates a gain or loss on reacquisition, reissuance, or retirement.

• May decrease Retained Earnings, but cannot increase it.

Treasury Stock

Usually does not have:– Voting rights.

– Dividend rights.

– Preemptive rights.

– Liquidation rights.

Reduces both assets andstockholders’ equity.

Accounting for Treasury Stock

(one-transaction concept)

(rarely used : NOT covered in the class)

Treasury Stock ; Example

March 10 Issued 10,000, $1 par value shares at $15 per share

March 10 Issued 10,000, $1 par value shares at $15 per share

March 25 Reacquired 1,000 shares at $40 per share.

March 25 Reacquired 1,000 shares at $40 per share.

April 13 Reissued 700 shares at $45 per share.April 13 Reissued 700 shares at $45 per share.

April 25 Retired remaining 300 shares of treasury stock.April 25 Retired remaining 300 shares of treasury stock.

E 13-29 Treasury StocksThe stockholders’ equity of Thomas Company as of December 31, 2012, was as follows:

Common stock, $1 par, authorized 275,000 shares; 240,000 shares issued and outstanding ....$ 240,000

Paid-in capital in excess of par……………… 3,840,000Retained earnings ……………………………….900,000

On June 1, 2013, Thomas reacquired 15,000 shares of its common stock at $16. The following transactions occurred in 2013 with regard to these shares.

July 1 Sold 5,000 shares at $20. Aug. 1 Sold 7,000 shares at $14. Sept. 1 Retired 1,000 shares.

Accounting for Dividends

• Declaration date- The date the corporation’s board of directors formally declares a dividend will be paid.

• Date of record- The date on which stockholders of record are identified as those who will receive a dividend.

• Date of payment- The date when the dividend is actually distributed to stockholders.

Cash Dividends

ABC Corporation declares a $100,000 dividend; the following journal entries should be made:

Declaration Date

Retained Earnings 100,000

Dividends Payable100,000

Payment Date

Dividends Payable 100,000

Cash100,000

E 13-46 Stockholders’ Equity Kenny Co. began operations on January 1, 2012, by issuing at $15 per share one-half of the 950,000 shares of $1 par value common stock that had been authorized for sale. In addition, Kenny has 500,000 shares of $5 par value, 6% preferred shares authorized. During 2012, Kenny had $1,025,000 of net income and declared $237,500 of dividends. During 2013, Kenny had the following transactions:

Jan. 10 Issued an additional 100,000 shares of common stock for $l7 per share.

Apr. 1 Issued 150,000 shares of the preferred stock for $8 per share.

E 13-46 Stockholders’ Equity July 19 Authorized the purchase of a custom-

made machine to be delivered in January 2014. Kenny restricted $295,000 of retained earnings for the purchase of

the machine.

Oct. 23 Sold an additional 50,000 shares of the preferred stock for $9 per share.

Dec. 3l Reported $1,215,000 of net income and declared a dividend of $635,000 to stockholders of record on January 15,

2014, to be paid on February I, 2014.