GOLIS UNIVERSITY

FACULTY OF SOCIAL SCIENCE AND

ECONOMICS
COURSE: INTERMEDIATE ACCOUNTING TWO
CHAPTER FOUR

LONG TERM LIABILITIES

(PART TWO)
 Long-Term Notes Payable
• The use of notes payable in long-term debt financing is quite
common.
• Long-term notes payable are similar to short-term interest-
bearing notes payable except that the term of the notes
exceeds one year..
• A long-term note may be secured by a mortgage that pledges
title to specific assets as security for a loan.
• Individuals widely use mortgage notes payable to purchase
homes, and many small and some large companies use them to
acquire plant assets. At one time, approximately 18% of
McDonald’s long-term debt related to mortgage notes on land,
buildings, and improvements.
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• Companies initially record mortgage notes payable at face
value. They subsequently make entries for each installment
payment.
• Example
• To illustrate, assume that Porter Technology Inc. issues a
$500,000, 8%, 20-year mortgage note on December 31, 2017,
to obtain needed financing for a new research laboratory. The
terms provide for annual installment payments of $50,926 (not
including real estate taxes and insurance). The instalment
payment schedule for the first four years is as follows.
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 Example
• Cole Research issues a $250,000, 6%, 20-year mortgage note
to obtain needed financing for a new lab. The terms call for
annual payments of $21,796 each. Prepare the entries to record
the mortgage loan and the first payment.
 Presentation
• Companies report long-term liabilities in a separate section of
the balance sheet immediately following current liabilities, as
shown in Illustration below.
 Use of Ratios
• Two ratios are helpful in better understanding a company’s
debt-paying ability and long-term solvency. Long-term
creditors an stockholders are interested in a company’s long-
run solvency. One Of particular interest is the company’s
ability to pay interest as it comes due and to repay the face
value of the debt at maturity.
• The debt to assets ratio measures the percentage of the total
assets provided by creditors. It is computed by dividing total
liabilities (both current and long-term liabilities) by total
assets.
 Example
• To illustrate, we use data from a recent Kellogg Company
annual report. The company reported total liabilities of $8,925
million, total assets of $11,200 million, interest expense of
$295 million, income taxes of $476 million, and net income of
$1,208 million. As shown in Illustration 15-15, Kellogg’s debt
to assets ratio is 79.7%. The higher the percentage of debt to
assets, the greater the risk that the company may be unable to
meet its maturing obligation.
 Times interest earned
• indicates the company’s ability to meet interest payments as
they come due. It is computed by dividing the sum of net
income, interest expense, and income tax expense by
interest expense. As shown in Illustration below, Kellogg’s
times interest earned is 6.71 times. This interest coverage is
considered safe.