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Long-Term Liabilities
and Receivables
Intermediate Accounting 11th edition
Bonds
1. A bond is a type of note in which a company
agrees to pay the holder the face value at the
maturity date and usually to pay interest
periodically at a specified rate on the face
value.
2. A bond indenture is a document (contract) that
defines the rights of the bondholders.
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Types of Bonds
Debenture bonds
Mortgage bonds
Registered bonds
Coupon bonds
Zero-coupon bonds
Callable bonds
Convertible bonds
Serial bonds
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Bond Terminology
1. The face (or par) value is the amount that the
issuer agrees to pay at maturity.
2. The stated, face, nominal, or contract rate is the
rate at which the issuer of the bond agrees to
pay interest each period until maturity.
3. The yield (effective rate) is the market rate at
which the bonds are actually sold.
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Straight-Line
Method
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Continued
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Continued
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Continued
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Straight-Line Method
Effective
Interest
Method
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Continued
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Continued
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$6,000.00 $5,386.09
$100,000 0.12 1/2
Continued
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$6,000.00 $5,355.39
$100,000 0.12 1/2
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0.04 $500,000
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Continued
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$5,558.40 $5,000.00
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Extinguishment of Liabilities
Under GAAP, a liability is considered extinguished
for financial reporting purposes if either of the
following occurs:
1. The debtor pays the creditor and is relieved of
its obligation for the liability.
2. The debtor is released legally from being the
primary obligor under the liability.
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Conceptually, gains or
losses from refundings
could be recognized either:
Amount Issuance
Market Value of Bonds Without Warrants
Assigned to = Price
Bonds Market Value of Bonds Market Value of
Without Warrants + Warrants
Amount Issuance
Market Value of Warrants
Assigned to = Price
Warrants Market Value of Bonds Market Value of
Without Warrants + Warrants
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Convertible Bonds
Why issue
convertible
bonds?
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Convertible Bonds
1. Avoid the downward price pressures on its
stock that placing a large new issue of common
stock on the market would cause
2. Avoid the direct sale of common stock when it
believes its stock currently is undervalued in
the market
3. Penetrate that segment of the capital market
that is unwilling or unable to participate in a
direct common stock issue
4. Minimize the costs associated with selling
securities
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Conversion Methods
Book value method. Record the stock at the
book value of the convertible bonds and do not
record a gain or loss. This method is the most
widely used.
Market value method. Record the stock at
the market value of the stock or debt,
whichever is more reliable, and recognize a
gain or loss.
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Induced Conversions
A company that has issued
convertible bonds may desire
bondholders to convert the bonds
to common stock.
Induced Conversions
$71,178 0.12
$10,000 $5,674.27
(present value of equipment)
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Impairment of a Loan
Impairment of a Loan
Snook Company has a $100,000 note receivable
from the Ullman Company that it is carrying at
face value. The loan agreement called for Ullman
to pay 8% interest each December 31 and the
principal on December 31, 2015. Ullman paid the
December 31, 2010 interest, but informed Snook
that it probably would miss the next two years
interest payments because of financial difficulties.
In addition, the principal payment would be one
year late.
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Impairment of a Loan
Snook Company computes the present value of the
impaired loan.
Present value of principal = $100,000 present value of a single sum for
6 years at 8%
= $100,000 0.630170
= $63,017.00
Present value of interest = $8,000 present value of an annuity for 4
years at 8% deferred 2 years
= $8,000 3.312127 0.857339
= $22,716.93
Guarantees
Sometimes a company may guarantee another
companys debt. For example, suppose the Probst
Company sells a product to the Metcalf Company for
$10 million. Since Metcalf does not have sufficient
cash, it decides to take out a bank loan to finance the
purchase. However, its financial status is such that the
bank will not provide an unsecured loan. So, the
Probst Company agrees to guarantee Metcalfs loan
from the bank so that it can make the sale. GAAP
requires the Probst Company to determine the fair
value of the guarantee and recognize it as a liability.
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Modification of Terms
1. Reduction of the stated interest rate for the
remaining original life of the debt
2. Extension of the maturity date at a stated
interest rate lower than the current market
rate for new debt with similar risk
3. Reduction of the face amount or maturity
amount of the debt
4. Reduction of accrued interest
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Modification of Terms
Continued
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Continued
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Chapter 14
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