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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 Chapter 14 LONG-TERM LIABILITIES McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
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MGMT-026 Chapter 14 Slides - Kids in Prison Program · The accounting for issuances of bonds, market pricing, and retirement of both bonds and notes is similar. ... MGMT-026 Chapter

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Page 1: MGMT-026 Chapter 14 Slides - Kids in Prison Program · The accounting for issuances of bonds, market pricing, and retirement of both bonds and notes is similar. ... MGMT-026 Chapter

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

Chapter 14

LONG-TERM LIABILITIES

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

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BOND FINANCING

Bonds do not affect owner control.

Interest on bonds is tax deductible.

Bonds can increase return on equity.

Advantages

Bonds require payment of both

periodic interest and par value at maturity.

Bonds can decrease return on equity.

Disadvantages

A1

FINANCIAL LEVERAGE IF IT EANRS MORE THAN IT PAYS ON B. INTEREST

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BOND TRADING A1

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.

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BOND ISSUING PROCEDURES A1

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Bond Certificate

Bond Selling Price

Corporation Investors

BOND ISSUANCES P1

Transaction on the Bond Issue Date

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Bond Interest Payments

Corporation Investors

Bond Issue Date

Bond Interest Payments

Interest Payment = Bond Par Value × Stated Interest Rate x Time

BOND ISSUANCES

Transactions during the bond life

P1

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Bond Face Value

Corporation Investors

BOND ISSUANCES

Transaction on the Maturity Date

P1

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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)

P1

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$800,000 × 9% × ½ year = $36,000

ISSUING BONDS AT PAR

On June 30, 2011, the issuer of the bond pays the first semiannual interest payment of $36,000.

P1

This entry is made every six months until the bonds mature.

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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.

P1

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BOND DISCOUNT OR PREMIUM P1

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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)

ISSUING BONDS AT A DISCOUNT

} Bond will sell at a discount.

P2

ISSUE AT DISCOUNT IF MARKET RATE HIGHER THAN CONTRACT RATE ISSUE PRICE LESS THAN CONTRACT VALUE

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On Dec. 31, 2011, Fila should record the bond issue.

ISSUING BONDS AT A DISCOUNT

Par value $ 100,000 Cash proceeds 96,454 Discount $ 3,546 *$100,000 x 96.454%

Contra-Liability Account

P2

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Long-term Liabilities: Bonds Payable 100,000 Less: Discount on Bonds Payable 3,546 96,454

Partial Balance Sheet as of Dec. 31, 2011

Maturity Value

Carrying Value

ISSUING BONDS AT A DISCOUNT

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)

P2

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$3,546 ÷ 4 periods = $887 (rounded)

$100,000 × 8% × ½ = $4,000

Fila will make the following entry every six months to record the cash interest payment and

the amortization of the discount.

AMORTIZING A BOND DISCOUNT P2

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Straight-Line Amortization TableInterest Interest Discount Unamortized Carrying

Date Payment Expense Amortization* Discount Value12/31/2011 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 P2

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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% Interest Dates: 6/30 and 12/31 Bond Date: Dec. 31, 2011 Maturity Date: Dec. 31, 2013 (2 years)

ISSUING BONDS AT A PREMIUM

} Bond will sell at a premium.

P3

ISSUE AT PTEMIOUM IF MARKET RATE LOWER THAN CONTRACT RATE ISSUE PRICE MORE THAN CONTRACT VALUE

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ISSUING BONDS AT A PREMIUM

Par value $ 100,000 Cash proceeds 103,546 * Premium $ 3,546 *$100,000 x 103.546%

Adjunct-Liability Account

On Dec. 31, 2011, Adidas will record the bond issue as:

P3

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ISSUING BONDS AT A PREMIUM

Long-term Liabilities: Bonds Payable 100,000 Plus: Premum on Bonds Payable 3,546 103,546

Partial Balance Sheet as of Dec. 31, 2011

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)

P3

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AMORTIZING A BOND PREMIUM

$3,546 ÷ 4 periods = $887 (rounded)

$100,000 × 12% × ½ = $6,000

Adidas will make the following entry every six months to record the cash interest payment and

the amortization of the discount.

P3

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Straight-Line Amortization TableInterest Interest Premium Unamortized Carrying

Date Payment Expense Amortization* Premium Value12/31/2011 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.

AMORTIZING A BOND PREMIUM P3

CARRYING VALUE =PAR VALUE +UNAMORTIZED PREMIUM

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BOND PRICING P2

Cash Outflows related to Interest Payments

Cash Outflows for par value at end of Bond life

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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)

ISSUING BONDS AT A DISCOUNT P2

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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

P2

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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.

P4

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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.

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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

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Note Maturity Date

Note Payable

Cash

Company Lender

Note Date

When is the repayment of the principal and interest going to be made?

LONG-TERM NOTES PAYABLE C1

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Note Maturity Date

Company Lender

Note Date

Single Payment of Principal plus

Interest

Single Payment of Principal plus Interest

LONG-TERM NOTES PAYABLE C1

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Note Maturity Date

Company Lender

Note Date

Regular Payments of Principal plus Interest

Payments either can be equal principal payments plus interest

or equal payments.

Regular Payments of Principal plus Interest

LONG-TERM NOTES PAYABLE C1

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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.

Computation Table Table Value

Present Value Payment

Principal divided by PV factor

PV of Annuity of $1 (B.3) 4.6229 60,000 12,979

Compute the periodic payment by dividing the face amount of the note by the present value factor.

C1

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INSTALLMENT NOTES WITH EQUAL PAYMENTS

C1

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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.

P5

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MORTGAGE NOTES AND BONDS A legal agreement that helps protect the

lender if the borrower fails to make the required payments.

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.

C1

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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.

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Secured and Unsecured

Term and Serial

Registered and Bearer

Convertible and Callable

FEATURES OF BONDS AND NOTES A2

Term bonds are scheduled for maturity on one specified date. Serial bonds mature at more than one date.

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This ratio helps investors determine the risk of investing in a company by dividing its total liabilities by total equity.

DEBT-TO-EQUITY RATIO

Debt-to-

Equity Ratio

Total Liabilities

Total Equity =

A3

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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

C2

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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

10 8.5302 8.1109 7.7217

APPENDIX 14A: PRESENT VALUES OF BONDS AND NOTES

$100,000 × 8% × ½ = $4,000

Semiannual Interest Annuity

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

$4,000 × 3.5460 = $14,184

C2

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APPENDIX 14B: EFFECTIVE INTEREST AMORTIZATION

Effective Interest Amortization ScheduleInterest Interest Discount Unamortized Carrying

Date Payment Expense Amortization* Discount Value12/31/2011 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

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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 First Interest

date 6/30 $1,500 accrued $3,000 earned

Bondholder pays $1,500 to issuer

Issuer pays $4,500 to bondholder

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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.

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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.

C4

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END OF CHAPTER 14