Long-Term Liabilities: Bonds and Notes: Principles of Financial Accounting

Long-Term Liabilities: Bonds and
Notes
12e
PRINCIPLES OF FINANCIAL ACCOUNTING
24e
PRINCIPLES OF ACCOUNTING
Chapter 14 ACCOUNTING PRINCIPLES

2e
Student Version Using excel for Success
Prepared by: C. Douglas

Prepared by: C. Douglas Cloud
Cloud
These
Theseslides
slidesshould
shouldbe
beviewed
viewedusing
usingthe
thepresentation
Professor Emeritus of
presentation Professor Emeritus of
Accounting
mode
mode(click
(clickthe
the iconicontotostart
startpresentation).
presentation). Accounting
Pepperdine University
2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
2012 CengageinLearning.
permitted All Rights Reserved.
a license distributed May product
with a certain not be copied, scanned,
or service or duplicated,
or otherwise in whole or in part,website
on a password-protected except for
for classroom
use as use.
Reeve Warren Duchac
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Learning Objective 1
1. Compute the potential impact of

long-term borrowing on earnings per
share.
LO 1
Financing Corporations
Corporations finance their operations

using the following sources:
Short-term debt, such as purchasing
goods or services on account.
Long-term debt, such as issuing bonds
or notes payable.
Equity, such as issuing common or
preferred stock.
LO 1
A bond is a form of an interest-

bearing note. Like a note, a bond
requires periodic interest payments,
and the face amount must be repaid
at the maturity date.
LO 1
Huckadee Corporation is considering the following

plans to issue debt and equity:
LO 1
In deciding among financing plans,

the effect on earnings per share is
often considered.
Earnings per share (EPS) measures
the income earned by each share of
common stock. It is computed as
follows: Net Income - Preferred Dividends
Earnings per Share =
Number of Common Shares Outstanding
LO 1
Assume the following data for Huckadee

Corporation:
Earnings before interest and income taxes are
$800,000.
The tax rate is 40%.
All bonds or stocks are issued at their par or face
amount.

share.
2. Describe the characteristics and
terminology of bonds payable.
LO 2
Bond Characteristics and Terminology
The underlying contract between the

company issuing bonds and the
bondholders is called a bond
indenture or trust indenture.
LO 2
Usually, the face amount of each

bond, called the principal, is $1,000,
or a multiple of $1,000. Interest on
bonds may be payable annually,
semiannually, or quarterly. Most pay
interest semiannually.
LO 2
When all bonds of an issue mature at

the same time, they are called term
bonds.
If they mature over several dates,
they are called serial bonds.
Bonds that may be exchanged for
other securities are called convertible
bonds.
LO 2
Bonds that a corporation reserves the

right to redeem before their maturity
are called callable bonds.
Bonds issued on the basis of the
general credit of the corporation are
called debenture bonds.
LO 2
Proceeds from Issuing Bonds
When a corporation issues bonds, the

proceeds received for the bonds
depend on:
The face amount of the bonds, which is
the amount due at the maturity date.
The interest rate on the bonds.
The market rate of interest for similar
bonds.
LO 2
The face amount and the interest rate

on the bonds are identified in the
bond indenture.
The interest rate to be paid on the
face amount of the bond is called the
contract rate or coupon rate.
LO 2
The market rate of interest, or

effective rate of interest, is
determined by transactions between
buyers and sellers of similar bonds.
The market rate of interest is affected
by a variety of factors, including
investors expectations of current and
future economic conditions.
LO 2
Summary
If the market rate equals the contract
rate, bonds will sell at the face amount.
If the selling price of the bonds is less
than the face amount, the bonds are
selling at a discount.
If the selling price of the bonds is more
than the face amount, the bonds are
selling at a premium.
LO 2
The price of a bond is quoted as a

percentage of the bonds face value.
A $1,000 bond quoted at 98 could be
purchased or sold for $980 ($1,000 x
0.98).
A $1,000 bond quoted at 109 could be
purchased or sold for $1,090 ($1,000 x
1.09).

share.
3. Journalize entries for bonds payable.
LO 3
Bonds Issued at Face Amount
On January 1, 2011, Eastern Montana

Communications Inc. issued the following bonds:
LO 3
Since the contract rate of interest and the market rate

of interest are the same, the bonds will sell at their
face amount.
LO 3
Every six months (on June 30 and December 31) after

the bonds are issued, interest of $6,000 ($100,000
0.12 6/12) is paid.
LO 3
The bond matures on December 31, 2015. At this time,

the corporation pays the face amount to the
bondholders.
LO 3
Bonds Issued at a Discount
On January 1, 2011, Western Wyoming Distribution

Inc. issued $100,000, 12%, five-year bonds when the
market rate was 13%. (Interest will be paid
semiannually on June 30 and December 31.)
Reminder:
LO 3
Bonds Issued at a Discount
The firm issued the $100,000 bonds for $96,406 (a

discount of $3,594).
The discount may be viewed

as the amount required by
investors to accept a bond
rate of interest below the
market rate.
LO 3
Amortizing a Bond Discount
The two methods of computing the

amortization of a bond discount are:
1. Straight-line method
2. Effective interest rate method,
sometimes called the interest
method
Both methods amortize the same
total amount of discount over the
life of the bonds.
LO 3
The effective interest rate method is

required by generally accepted
accounting principles.
However, the straight-line method
may be used if the results do not
differ significantly from the interest
method.
LO 3
On June 30, 2011, Western Wyoming Distribution Inc.

pays six-months interest on the five-year bond issued
earlier, and the bond discount is amortized ($3,594
1/10). The interest payment and amortization entries
can be combined as follows:
*$100,000
12% 6/12
LO 3
Bonds Issued at a Premium
On January 1, 2011, Northern Idaho Transportation

Inc. issued $100,000, 12%, five-year bonds for
$103,769. The market rate of interest is 11%.
Reminder:
LO 3
Amortizing a Bond Premium
The entry to record the first interest payment and the

amortization of the premium on the $100,000, 12%,
five-year bonds issued on January 1, 2011, is made on
June 30, 2011. The combined entry is as follows:
premium.
LO 3
Bond Redemption
A corporation may call, or redeem,

bonds before they mature. Callable
bonds can be redeemed by the
issuing corporation within the period
of time and at the price stated in the
bond indenture. Normally, the call
price is above the face value.
LO 3
Bond Redemption
The carrying amount of bonds

payable is the face amount of the
bonds less any unamortized discount
or plus any unamortized premium.
LO 3
Bond Redemption
A gain or loss may be realized on a

bond redemption as follows:
A gain is recorded if the price paid for
the redemption is below the bond
carrying amount.
A loss is recorded if the price paid for
the redemption is above the carrying
amount.
LO 3
Bond Redemption
On June 30, 2011, a corporation has a bond issue of

$100,000 outstanding, on which there is an unamortized
premium of $4,000. The corporation redeems one-fourth
of the bonds for $24,000.
Gains on the redemption of bonds are reported in

the Other Income section of the income statement.
LO 3
Bond Redemption
The corporation calls the remaining $75,000 of

outstanding bonds, which are held by a private
investor, for $79,500 on July 1, 2011.
Losses on the redemption of bonds are reported

in the Other Loss section of the income statement.

share.
4. Describe and illustrate the
accounting for installment notes.
LO 4
Installment Notes
An installment note is a debt that

requires the borrower to make equal
periodic payments to the lender for
the term of the note. Unlike bonds, a
note payment includes the following:
Payment of a portion of the amount
initially borrowed, called the principal
Payment of interest on the outstanding
balance
LO 4
Installment Notes
Installment notes are often used to

purchase specific assets, such as
equipment, and are often secured by
the purchased asset.
When a note is secured by an asset, it
is called a mortgage note.
If the borrower fails to pay a
mortgage note, the lender has the
right to take possession of the
pledged asset.
LO 4
Issuing an Installment Note
Lewis Company issues a $24,000, 6%, five-year note to

City National Bank on January 1, 2010. The annual
payment is $5,698.
LO 4
Annual Payments
The entry to record the first payment on

December 31, 2010, is as follows:
LO 4
Annual Payments
The entry to record the second payment on

LO 4
Annual Payments
The entry to record the final payment on

After the entry is posted, the balance in Notes Payable

related to this note is zero.
1. Compute the potential impact of long-

term borrowing on earnings per share.
4. Describe and illustrate the accounting
for installment notes.
5. Describe and illustrate the reporting
of long-term liabilities including bonds
and notes payable.
LO 5
Reporting Long-Term Liabilities
1. Compute the potential impact of long-term

borrowing on earnings per share.
4. Describe and illustrate the accounting for
installment notes.
5. Describe and illustrate the reporting of
long-term liabilities including bonds and
notes payable.
6. Describe and illustrate how the number of
times interest charges are earned is used
to evaluate a companys financial
LO 6
Number of Times Interest Charges are Earned
Analysts assess the risk that

bondholders will not receive their
interest payments by computing the
number of times interest charges are
earned during the year as follows:
Number of Income Before Income Tax +
Times Interest Interest Expense
Charges are = Interest Expense
Earned
LO 6
Number of Times Interest Charges are Earned
Under Armour, Inc.s 2008 annual report stated that

the firm had interest expense of $850,000 and income
before income taxes of $69,900,000. The number of
times interest charges are earned for Under Armour,
Inc., is computed as follows:
Number of
Times Interest $69,900,000 + $850,000
Charges are = = 83.24
$850,000
Earned
Long-Term Liabilities: Bonds and
Notes
The End
Student Version
Prepared by: C. Douglas
Cloud
Professor Emeritus of
Accounting

Long-Term Liabilities: Bonds and Notes: Principles of Financial Accounting

Uploaded by

Copyright:

Available Formats

You might also like

Long-Term Liabilities: Bonds and Notes: Principles of Financial Accounting

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Long-Term Liabilities: Bonds and Notes: Principles of Financial Accounting

Uploaded by

Copyright:

Available Formats

Long-Term Liabilities: Bonds and

PRINCIPLES OF FINANCIAL ACCOUNTING

Chapter 14 ACCOUNTING PRINCIPLES

Student Version Using excel for Success

Prepared by: C. Douglas

1. Compute the potential impact of

Corporations finance their operations

A bond is a form of an interest-

Huckadee Corporation is considering the following

In deciding among financing plans,

Assume the following data for Huckadee

1. Compute the potential impact of

The underlying contract between the

Usually, the face amount of each

When all bonds of an issue mature at

Bonds that a corporation reserves the

When a corporation issues bonds, the

The face amount and the interest rate

The market rate of interest, or

The price of a bond is quoted as a

1. Compute the potential impact of

On January 1, 2011, Eastern Montana

Since the contract rate of interest and the market rate

Every six months (on June 30 and December 31) after

The bond matures on December 31, 2015. At this time,

On January 1, 2011, Western Wyoming Distribution

The firm issued the $100,000 bonds for $96,406 (a

The discount may be viewed

The two methods of computing the

The effective interest rate method is

On June 30, 2011, Western Wyoming Distribution Inc.

On January 1, 2011, Northern Idaho Transportation

The entry to record the first interest payment and the

A corporation may call, or redeem,

The carrying amount of bonds

A gain or loss may be realized on a

On June 30, 2011, a corporation has a bond issue of

Gains on the redemption of bonds are reported in

The corporation calls the remaining $75,000 of

Losses on the redemption of bonds are reported

1. Compute the potential impact of

An installment note is a debt that

Installment notes are often used to

Lewis Company issues a $24,000, 6%, five-year note to

The entry to record the first payment on

The entry to record the second payment on

The entry to record the final payment on

After the entry is posted, the balance in Notes Payable

1. Compute the potential impact of long-

1. Compute the potential impact of long-term

Analysts assess the risk that

Under Armour, Inc.s 2008 annual report stated that

You might also like