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Page 1: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-1

Page 2: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-2

CHAPTER CHAPTER 1515CHAPTER CHAPTER 1515

LONG-TERM LIABILITIESLONG-TERM LIABILITIES

Accounting Principles, Eighth Edition

Page 3: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-3

1. Explain why bonds are issued.

2. Prepare the entries for the issuance of bonds and interest expense.

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

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

5. Contrast the accounting for operating and capital leases.

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

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

Page 4: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-4

Issuing bonds Issuing bonds at face valueat face value

Discount or Discount or premiumpremium

Issuing bonds Issuing bonds at a discountat a discount

Issuing bonds Issuing bonds at a premiumat a premium

Bonds BasicsBonds BasicsBonds BasicsBonds BasicsAccounting Accounting

for Bond for Bond

IssuesIssues

Accounting Accounting

for Bond for Bond

IssuesIssues

Accounting Accounting

for Bond for Bond

RetirementsRetirements

Accounting Accounting

for Bond for Bond

RetirementsRetirements

Accounting Accounting

for Other for Other

Long-Term Long-Term

LiabilitiesLiabilities

Accounting Accounting

for Other for Other

Long-Term Long-Term

LiabilitiesLiabilities

Statement Statement

Presentation Presentation

and Analysisand Analysis

Statement Statement

Presentation Presentation

and Analysisand Analysis

Types of Types of bondsbonds

Issuing Issuing proceduresprocedures

TradingTrading

Market valueMarket value

Redeeming Redeeming bonds at bonds at maturitymaturity

Redeeming Redeeming bonds before bonds before maturitymaturity

Converting Converting bonds into bonds into common common stockstock

Long-term Long-term notes payablenotes payable

Lease Lease liabilitiesliabilities

PresentationPresentation

AnalysisAnalysis

Long-Term LiabilitiesLong-Term LiabilitiesLong-Term LiabilitiesLong-Term Liabilities

Page 5: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-5

Bonds are a form of interest-bearing notes payable.

Three advantages over common stock:

Bond BasicsBond BasicsBond BasicsBond Basics

LO 1 Explain why bonds are issued.LO 1 Explain why bonds are issued.

1. Stockholder control is not affected.

2. Tax savings result.

3. Earnings per share may be higher.

Page 6: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-6

Effects on earnings per share—stocks vs. bonds.

Bond BasicsBond BasicsBond BasicsBond Basics

LO 1 Explain why bonds are issued.LO 1 Explain why bonds are issued.

Illustration 15-2

Page 7: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-7

The major disadvantages resulting from the use of bonds are:

a. that interest is not tax deductible and the principal must be repaid.

b. that the principal is tax deductible and interest must be paid.

c. that neither interest nor principal is tax deductible.

d. that interest must be paid and principal repaid.

QuestionQuestion

Bond BasicsBond BasicsBond BasicsBond Basics

LO 1 Explain why bonds are issued.LO 1 Explain why bonds are issued.

Page 8: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-8

Types of Bonds

Secured and Unsecured (debenture) bonds.

Term and Serial bonds.

Registered and Bearer (or coupon) bonds.

Convertible and Callable bonds.

Bond BasicsBond BasicsBond BasicsBond Basics

LO 1 Explain why bonds are issued.LO 1 Explain why bonds are issued.

Page 9: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-9

Issuing Procedures

Bond contract known as a bond indenture.

Represents a promise to pay:

(1) sum of money at designated maturity date, plus

(2) periodic interest at a contractual (stated) rate on the maturity amount (face value).

Paper certificate, typically a $1,000 face value.

Interest payments usually made semiannually.

Generally issued when the amount of capital needed is too large for one lender to supply.

Bond BasicsBond BasicsBond BasicsBond Basics

LO 1 Explain why bonds are issued.LO 1 Explain why bonds are issued.

Page 10: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-10

Bond BasicsBond BasicsBond BasicsBond Basics

LO 1 Explain why bonds are issued.LO 1 Explain why bonds are issued.

Issuer of Bonds

Issuer of Bonds

MaturityDate

MaturityDate

Illustration 15-3

Contractual Interest

Rate

Contractual Interest

Rate

Face or Par ValueFace or

Par Value

Page 11: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-11

Bond Trading

Bonds traded on national securities exchanges.

Newspapers and the financial press publish bond prices and trading activity daily.

Bond BasicsBond BasicsBond BasicsBond Basics

LO 1 Explain why bonds are issued.LO 1 Explain why bonds are issued.

Illustration 15-4

Read as: Outstanding 5.125%, $1,000 bonds that mature in 2011. Currently yield a 5.747% return. On this day, $33,965,000 of these bonds were traded. Closing price was 96.595% of face value, or $965.95.

Page 12: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-12

Determining the Market Value of Bonds

Market value is a function of the three factors that determine present value:

1. the dollar amounts to be received,

2. the length of time until the amounts are received, and

3. the market rate of interest.

Bond BasicsBond BasicsBond BasicsBond Basics

LO 1 Explain why bonds are issued.LO 1 Explain why bonds are issued.

The features of a bond (callable, convertible, and so on) affect the market rate of the bond.

Page 13: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-13

6%

8%

10%

Premium

Face Value

Discount

Assume Contractual Rate of 8%Assume Contractual Rate of 8%

Accounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond Issues

LO 2 Prepare the entries for the issuance of bonds and interest expense.

Bonds Sold AtMarket Interest

Page 14: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-14 LO 2 Prepare the entries for the issuance of bonds and interest

expense.

The rate of interest investors demand for loaning funds to a corporation is the:

a. contractual interest rate.

b. face value rate.

c. market interest rate.

d. stated interest rate.

QuestionQuestion

Accounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond Issues

Page 15: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-15 LO 2 Prepare the entries for the issuance of bonds and interest

expense.

Karson Inc. issues 10-year bonds with a maturity value of $200,000. If the bonds are issued at a premium, this indicates that:

a. the contractual interest rate exceeds the market interest rate.

b. the market interest rate exceeds the contractual interest rate.

c. the contractual interest rate and the market interest rate are the same.

d. no relationship exists between the two rates.

QuestionQuestion

Accounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond IssuesAccounting for Bond Issues

Page 16: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-16

Illustration: On January 1, 2008, San Marcos HS issues $100,000, three-year, 8% bonds at 100 (100% of face value). Interest is paid annually each Dec. 31.

Issuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face ValueIssuing Bonds at Face Value

LO 2 Prepare the entries for the issuance of bonds and interest expense.

Jan. 1 Cash 100,000Bonds payable 100,000

Dec. 31 Interest expense 8,000Cash 8,000

Page 17: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-17

Illustration: On January 1, 2008, San Marcos HS issues $100,000, three-year, 8% bonds for $95,027 (95.027% of face value).

Issuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a Discount

LO 2 Prepare the entries for the issuance of bonds and interest expense.

Jan. 1 Cash 95,027

Discount on bonds payable 4,973

Bonds payable 100,000

Page 18: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-18

Statement PresentationStatement Presentation

Long-term liabilitiesBonds payable 100,000$ Less: Discount on bonds payable 4,973

95,027$

San Marcos HSBalance Sheet (partial)

Issuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a Discount

LO 2 Prepare the entries for the issuance of bonds and interest expense.

Page 19: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-19 LO 2 Prepare the entries for the issuance of bonds and interest

expense.

Discount on Bonds Payable:

a. has a credit balance.

b. is a contra account.

c. is added to bonds payable on the balance sheet.

d. increases over the term of the bonds.

QuestionQuestion

Issuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a Discount

Page 20: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-20

Illustration: On January 1, 2008, San Marcos HS issues $100,000, three-year, 8% bonds for $105,346 (105.346% of face value).

Issuing Bonds at a PremiumIssuing Bonds at a PremiumIssuing Bonds at a PremiumIssuing Bonds at a Premium

LO 2 Prepare the entries for the issuance of bonds and interest expense.

Jan. 1 Cash 105,346

Premium on bonds payable 5,346

Bonds payable 100,000

Page 21: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-21

Statement PresentationStatement Presentation

Long-term liabilitiesBonds payable 100,000$ Add: Premium on bonds payable 5,346

105,346$

San Marcos HSBalance Sheet (partial)

Issuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a DiscountIssuing Bonds at a Discount

LO 2 Prepare the entries for the issuance of bonds and interest expense.

Issuing bonds at an amount different from face value is quite common. By the time a company prints the bond certificates and markets the bonds, it will be a coincidence if the market rate and the contractual rate are the same.

Page 22: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-22

Redeeming Bonds at Maturity

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

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

San Marcos HS records the redemption of its bonds at maturity as follows:

Bonds payable 100,000

Cash 100,000

Page 23: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-23

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.

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

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

Page 24: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-24 LO 3 Describe the entries when bonds are redeemed or LO 3 Describe the entries when bonds are redeemed or

converted.converted.

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

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

Page 25: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-25

Illustration: The San Marcos HS, 8% bonds of $100,000 issued on Jan. 1, 2008, are recalled at 105 on Dec. 31, 2009. Assume that the carrying value of the bonds at the redemption date is $98,183. Journal entry at Dec. 31, 2009:

Bonds payable 100,000

Loss on bond redemption 6,817

Cash ($100,000 x 105%) 105,000

Discount on bonds payable 1,817

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

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

Page 26: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-26

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.

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

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

Page 27: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-27

E15-6 Nocioni Company issued $1,000,000 of bonds on January 1, 2008.

Instructions: Prepare the journal entry to record the conversion of the bonds into 30,000 shares of $10 par value common stock. Assume the bonds were issued at par.

Bonds payable 1,000,000

Common stock (30,000 x $10) 300,000

Paid-in capital in excess of par 700,000

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

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

Page 28: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-28

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

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

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

Page 29: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-29

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 Accounting for Other Long-Term LiabilitiesLiabilitiesAccounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilities

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

Page 30: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-30

Exercise: Tucki Co. receives $240,000 when it issues a $240,000, 10%, mortgage note payable to finance the construction of a building at December 31, 2008. The terms provide for semiannual installment payments of $16,000 on June 30 and December 31. Prepare the journal entries to record the mortgage loan and the first installment payment.

Accounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilitiesAccounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilities

Dec. 31 Cash 240,000Mortgage notes payable 240,000

Jun. 30 Interest expense 12,000Mortgage notes payable 4,000

Cash 16,000* ($240,000 x 10% x 6/12 = $12,000)

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

*

Page 31: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-31

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

Accounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilitiesAccounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilities

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

Page 32: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-32

Lease Liabilities

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

Accounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilitiesAccounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilities

LO 5 Contrast the accounting for operating and capital leases.

Illustration 15-13

Page 33: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-33

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 xxxLease liability xxx

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).

Accounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilitiesAccounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilities

LO 5 Contrast the accounting for operating and capital leases.

Page 34: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-34

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.

Accounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilitiesAccounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilities

LO 5 Contrast the accounting for operating and capital leases.

Page 35: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-35

Exercise: On January 1, 2008, Burke Corporation signed a 5-year noncancelable lease for a machine. The machine has an estimated useful life of 6 years and the present value of the lease payments is $36,144, which is 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 on January 1, 2008.

LO 5 Contrast the accounting for operating and capital leases.

Accounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilitiesAccounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilities

Page 36: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-36

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

Capitalization Criteria:Capitalization Criteria:

1.1. Transfer of ownershipTransfer of ownership

2.2. Bargain purchase optionBargain purchase option

3.3. Lease term => 75% of Lease term => 75% of economic life of leased economic life of leased propertyproperty

4.4. Present value of Present value of minimum lease payments minimum lease payments => 90% of FMV of => 90% of FMV of propertyproperty

NONO

NONO

Lease term

5 yrs.Economic life

6 yrs. YES

83.3%

YES - PV and FMV are the same.

Capital Lease?

LO 5 Contrast the accounting for operating and capital leases.

Accounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilitiesAccounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilities

Page 37: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-37

Exercise: (b) Prepare the journal entry to record the lease on January 1, 2008.

Jan. 1 Leased asset - equipment 36,144 Lease liability 36,144

LO 5 Contrast the accounting for operating and capital leases.

Accounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilitiesAccounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilities

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.

Page 38: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-38

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

Accounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilitiesAccounting for Other Long-Term Accounting for Other Long-Term LiabilitiesLiabilities

LO 5 Contrast the accounting for operating and capital leases.

Page 39: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-39

Presentation

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

Statement Analysis and Statement Analysis and PresentationPresentationStatement Analysis and Statement Analysis and PresentationPresentation

Illustration 15-14

Page 40: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-40

Analysis of Long-Term Debt

Two 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.

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

Statement Analysis and Statement Analysis and PresentationPresentationStatement Analysis and Statement Analysis and PresentationPresentation

Page 41: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-41

Analysis of Long-Term Debt

Two 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.

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

Statement Analysis and Statement Analysis and PresentationPresentationStatement Analysis and Statement Analysis and PresentationPresentation

Page 42: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-42

To illustrate present value concepts, assume that you are willing to invest a sum of money that will yield $1,000 at the end of one year, and you can earn 10% on your money. What is the $1,000 worth today?

To compute the answer, divide the future amount by 1 plus the interest rate ($1,000/1.10 = $909.09.

Present Value Concepts Related to Bond Present Value Concepts Related to Bond PricingPricingPresent Value Concepts Related to Bond Present Value Concepts Related to Bond PricingPricing

LO 7 Compute the market price of a bond.LO 7 Compute the market price of a bond.

Illustration 15A-1

Page 43: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-43

To illustrate present value concepts, assume that you are willing to invest a sum of money that will yield $1,000 at the end of one year, and you can earn 10% on your money. What is the $1,000 worth today?

To compute the answer, divide the future amount by 1 plus the interest rate ($1,000/1.10 = $909.09 or use a Present Value of 1 table. ($1,000 X .90909) = $909.09 (10% per period, one period from now)

Present Value Concepts Related to Bond Present Value Concepts Related to Bond PricingPricingPresent Value Concepts Related to Bond Present Value Concepts Related to Bond PricingPricing

LO 7 Compute the market price of a bond.LO 7 Compute the market price of a bond.

Illustration 15A-1

Page 44: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-44

The selling price of a bond is equal to the sum of two items:

1) The present value of the face value of the bond discounted at the investor’s required rate of return

PLUS

2) The present value of the periodic interest payments discounted at the investor’s required rate of return

Present Value Concepts Related to Bond Present Value Concepts Related to Bond PricingPricingPresent Value Concepts Related to Bond Present Value Concepts Related to Bond PricingPricing

LO 7 Compute the market price of a bond.LO 7 Compute the market price of a bond.

Page 45: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-45

Assume 10%, 5-year bonds with a face value of $100,000 are sold and the investor’s required rate of return is 10%. Interest payments are made semiannually.

Present Value Concepts Related to Bond Present Value Concepts Related to Bond PricingPricingPresent Value Concepts Related to Bond Present Value Concepts Related to Bond PricingPricing

LO 7 Compute the market price of a bond.LO 7 Compute the market price of a bond.

Illustration 15A-8

Page 46: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-46

Assume 10%, 5-year bonds with a face value of $100,000 are sold and the investor’s required rate of return is 12%. Interest is paid semiannually.

Present Value Concepts Related to Bond Present Value Concepts Related to Bond PricingPricingPresent Value Concepts Related to Bond Present Value Concepts Related to Bond PricingPricing

LO 7 Compute the market price of a bond.LO 7 Compute the market price of a bond.

Illustration 15A-10

The .55839 factor is from the present value of 1 table for 10 periods at 6% per period. The 7.36009 factor is from the present value of an annuity table for 10 periods at 6% per period.

Page 47: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-47

Under the effective-interest method, the amortization of bond discount or bond premium results in period interest expense equal to a constant percentage of the carrying value of the bonds. The follow steps are required under the effective-interest method.

Effective-Interest Method of Bond Effective-Interest Method of Bond AmortizationAmortizationEffective-Interest Method of Bond Effective-Interest Method of Bond AmortizationAmortization

LO 8 Apply the effective-interest method of amortizing LO 8 Apply the effective-interest method of amortizing bond discount and bond premium.bond discount and bond premium.

1. Compute the bond interest expense.

2. Compute the bond interest paid or accrued.

3. Compute the amortization amount.

Page 48: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-48

Assume on January 1, 2008, 10%, 5 year bonds with a face value of $100,000, are sold for $92,639, resulting in an effective interest rate of 12%. Interest is paid semiannually. This results in a discount of $7,361. The cash paid each period equals $100,000 X 5% = $5,000. Interest expense the first period = $92,639 X 6% = $5,558. This results in a discount amortization of $558.

Effective-Interest Method of Bond Effective-Interest Method of Bond AmortizationAmortizationEffective-Interest Method of Bond Effective-Interest Method of Bond AmortizationAmortization

LO 8 Apply the effective-interest method of amortizing LO 8 Apply the effective-interest method of amortizing bond discount and bond premium.bond discount and bond premium.

Illustration 15B-2

Page 49: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-49

Assume on January 1, 2008, 10%, 5 year bonds with a face value of $100,000, are sold for $92,639, resulting in an effective interest rate of 12%. Assume interest is paid semiannually. This results in a discount of $7,361. The cash paid each period equals $100,000 X 5% = $5,000. Interest expense the first period = $92,639 X 6% = $5,558. This results in a discount amortization of $558.

The journal entry on July 1, 2008, to record the interest payment and amortization of discount is as follows:

Effective-Interest Method of Bond Effective-Interest Method of Bond AmortizationAmortizationEffective-Interest Method of Bond Effective-Interest Method of Bond AmortizationAmortization

LO 8 Apply the effective-interest method of amortizing LO 8 Apply the effective-interest method of amortizing bond discount and bond premium.bond discount and bond premium.

Interest Expense 5,558 Cash 5,000 Discount on Bonds Payable 558

July 1

Page 50: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-50

Assume on January 1, 2008, 10%, 5 year bonds with a face value of $100,000, are sold for $92,639, resulting in an effective interest rate of 12%. Interest is paid semiannually. This results in a discount of $7,361. The cash paid each period equals $100,000 X 5% = $5,000. The discount to be amortized each period is $7,361/10 periods = $736 per period. Therefore Interest Expense each period will be $5,000 + $736 = $5,736.

The journal entry on July 1, 2008, to record the interest payment and amortization of discount is as follows:

Straight-line Method of Bond AmortizationStraight-line Method of Bond AmortizationStraight-line Method of Bond AmortizationStraight-line Method of Bond Amortization

LO 9 Apply the straight-line method of amortizing bond LO 9 Apply the straight-line method of amortizing bond discount and bond premium.discount and bond premium.

July 1 Interest Expense 5,736 Cash 5,000 Discount on Bonds Payable 736

Page 51: Chapter 15-1. Chapter 15-2 CHAPTER 15 LONG-TERM LIABILITIES Accounting Principles, Eighth Edition.

Chapter 15-51

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