Chapter 15 Part 2 Long Term Liabilities Redeeming Bonds at Maturity Accounting for Bond Retirements SO 3 Describe the entries when bonds are redeemed.

Chapter 15Part 2

Long Term Liabilities

Redeeming Bonds at Maturity

Accounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond RetirementsAccounting for Bond Retirements

SO 3 Describe the entries when bonds are redeemed or SO 3 Describe the entries when bonds are redeemed or converted.converted.

Assuming that the company pays and records separately the interest for the last interest period, Candlestick records the redemption of its bonds at maturity as follows:

Bond payable 100,000

Cash 100,000

Redeeming Bonds before Maturity

When a company retires bonds before maturity, it is necessary to:

1. eliminate the carrying value of the bonds at the redemption date;

2. record the cash paid; and

3. recognize the gain or loss on redemption.

The carrying value of the bonds is the face value of the bonds less unamortized bond discount or plus unamortized bond premium at the redemption date.




When bonds are redeemed before maturity, the gain or loss on redemption is the difference between the cash paid and the:

a. carrying value of the bonds.

b. face value of the bonds.

c. original selling price of the bonds.

d. maturity value of the bonds.

QuestionQuestion


Illustration: Assume Candlestick, Inc. has sold its bonds at a premium. At the end of the eighth period, Candlestick retires these bonds at 103 after paying the semiannual interest. The carrying value of the bonds at the redemption date is $101,623. Candlestick makes the following entry to record the redemption at the end of the eighth interest period (January 1, 2014):

Bonds payable 100,000

Premium on bonds payable 1,623

Loss on redemption 1,377

Cash 103,000



Converting Bonds into Common Stock

Until conversion, the bondholder receives interest on the bond.

For the issuer, the bonds sell at a higher price and pay a lower rate of interest than comparable debt securities without the conversion option.

Upon conversion, the company transfers the carrying value of the bonds to paid-in capital accounts. No gain or loss is recognized.



Illustration: Assume that on July 1 Saunders Associates converts $100,000 bonds sold at face value into 2,000 shares of $10 par value common stock. Both the bonds and the common stock have a market value of $130,000. Saunders makes the following entry to record the conversion:

Bonds payable 100,000

Common stock (2,000 x $10) 20,000

Paid-in capital in excess of par 80,000



When bonds are converted into common stock:

a. a gain or loss is recognized.

b. the carrying value of the bonds is transferred to paid-in capital accounts.

c. the market price of the stock is considered in the entry.

d. the market price of the bonds is transferred to paid-in capital.

QuestionQuestion



Long-Term Notes Payable

May be secured by a mortgage that pledges title to specific assets as security for a loan

Typically, the terms require the borrower to make installment payments over the term of the loan. Each payment consists of

1. interest on the unpaid balance of the loan and

2. a reduction of loan principal.

Companies initially record mortgage notes payable at face value.

Accounting for Other Long-Term LiabilitiesAccounting for Other Long-Term LiabilitiesAccounting for Other Long-Term LiabilitiesAccounting for Other Long-Term Liabilities

SO 4 Describe the accounting for long-term notes payable.

Illustration: Porter Technology Inc. issues a $500,000, 12%, 20-year mortgage note on December 31, 2010. The terms provide for semiannual installment payments of $33,231 (not including real estate taxes and insurance). The installment payment schedule for the first two years is as follows.



Illustration 15-12



Dec. 31 Cash 500,000Mortgage notes payable 500,000

Jun. 30 Interest expense 30,000Mortgage notes payable 3,231

Cash 33,231

Each payment on a mortgage note payable consists of:

a. interest on the original balance of the loan.

b. reduction of loan principal only.

c. interest on the original balance of the loan and reduction of loan principal.

d. interest on the unpaid balance of the loan and reduction of loan principal.

QuestionQuestion



Lease LiabilitiesA lease is a contractual arrangement between a lessor (owner of the property) and a lessee (renter of the property).


SO 5 Contrast the accounting for operating and capital leases.

Illustration 15-13

Operating LeaseOperating Lease Capital LeaseCapital Lease

Journal Entry:Journal Entry:

Rent expenseRent expense xxx xxx

CashCash xxx xxx

Journal Entry:Journal Entry:

Leased equipment xxxLeased equipment xxx

Lease liability Lease liability xxxxxx

The issue of how to report leases is the case of The issue of how to report leases is the case of substance versus form. Although technically legal title may not pass, the . Although technically legal title may not pass, the benefits from the use of the property do.benefits from the use of the property do.

Statement of Financial Accounting Standard No. 13, Statement of Financial Accounting Standard No. 13, “Accounting for Leases,” 1976“Accounting for Leases,” 1976

A lease that transfers substantially all of the benefits and risks A lease that transfers substantially all of the benefits and risks of property ownership should be capitalized (only of property ownership should be capitalized (only noncancellable leases may be capitalized).noncancellable leases may be capitalized).



To capitalize a lease, one or more of four criteria must be met:

1. Transfers ownership to the lessee.

2. Contains a bargain purchase option.

3. Lease term is equal to or greater than 75 percent of the estimated economic life of the leased property.

4. The present value of the minimum lease payments (excluding executory costs) equals or exceeds 90 percent of the fair value of the leased property.



Exercise: Gonzalez Company decides to lease new equipment. The lease period is four years; the economic life of the leased equipment is estimated to be five years. The present value of the lease payments is $190,000, whichis equal to the fair market value of the equipment. There is no transfer of ownership during the lease term, nor is there any bargain purchase option.Instructions:

(a) What type of lease is this? Explain.

(b) Prepare the journal entry to record the lease.



Exercise: (a) What type of lease is this? Explain.

Capitalization Criteria:

1. Transfer of ownership

2. Bargain purchase option

3. Lease term => 75% of economic life of leased property

4. Present value of minimum lease payments => 90% of FMV of property

NONO

NONO

Lease term

4 yrs.Economic life

5 yrs. YES

80%

YES - PV and FMV are the same.

Capital Lease?



Exercise: (b) Prepare the journal entry to record the lease.



The portion of the lease liability expected to be paid in The portion of the lease liability expected to be paid in the next year is a current liability. The remainder is the next year is a current liability. The remainder is classified as a long-term liability.classified as a long-term liability.

Leased asset - equipment 190,000

Lease liability 190,000

The lessee must record a lease as an asset if the lease:

a. transfers ownership of the property to the lessor.

b. contains any purchase option.

c. term is 75% or more of the useful life of the leased property.

d. payments equal or exceed 90% of the fair market value of the leased property.

QuestionQuestion



Presentation

SO 6 Identify the methods for the presentation and analysis of long-term liabilities.

Statement Analysis and PresentationStatement Analysis and PresentationStatement Analysis and PresentationStatement Analysis and Presentation

Illustration 15-14

Analysis of Long-Term DebtTwo ratios that provide information about debt-paying ability and long-run solvency are:

Total debt

Total assets

Debt to total assets

=

The higher the percentage of debt to total assets, the greater the risk that the company may be unable to meet its maturing obligations.

1.1.



Analysis of Long-Term DebtTwo ratios that provide information about debt-paying ability and long-run solvency are:

Income before income taxes and interest expense

Interest expense

Times interest earned

=

Indicates the company’s ability to meet interest payments as they come due.

2.2.



Chapter 15 Part 2 Long Term Liabilities Redeeming Bonds at Maturity Accounting for Bond Retirements SO 3 Describe the entries when bonds are redeemed.

Documents

redeeming bonds

bonds payable1

bond retirements

maturity value

bond payable

face value

market value

maturity accounting