1 chapter 11 long-term liabilities 1,000 adapted from financial accounting 4e by porter and norton
TRANSCRIPT
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Chapter 11
Long-Term Liabilities
1,000
Adapted from Financial Accounting 4e by Porter and Norton
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Balance Sheet Classifications
Current Liabilities:
Long-Term Liabilities:
due within one year of the balance sheet date
due beyond one year
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Long-Term Liabilities
Bonds Payable Notes Payable Leases Deferred Taxes Pensions Other Postretirement Benefits
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Interest forInvestor
Borrower
Bonds
$10,000 9% BondDue 2019
Long-term borrowing arrangement Interest paid at stated rate and times Principal repaid at maturity date
1,000
Investor
Borrower
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Bond Features
Collateralized - backed by
specific assets in event of default
Debentures -backed only by general credit-worthiness of issuer
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Bond Features
Term - Entire principal due on a specific single date
Serial - Principal repaid in installments over time
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Bond Features
Convertible -
into common stock
Callable / Redeemable - may be retired before maturity date
CommonStock 1,000
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Bond Interest Rates
Face Rate -
interest is paid at the rate specified on the bond
Market Rate -
the interest rate the bond will yield after selling at a discount or premium
Payche
ck for
Date
Dept..
of Tr
easure
r
Jane D
oe
8% Return
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Interest Rates and Bond Prices
Above face value (at a premium)
At face value
Below face value (at a discount)
= MARKET RATE
BONDS ISSUED: IF STATED RATE:
> MARKET RATE
< MARKET RATE
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Bonds Sold at Face Value
Cash 10,000
Bonds Payable 10,000
To record issuance of bonds at face value.
Face Value of Bonds = Sales Price
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Relationship of Interest Rates and Bond Prices
BondPrices
BondPrices
MarketInterestRates
MarketInterestRates
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PV = ?
Calculating Bond Prices - two sets of cash flows
$$
(2) Principal due at maturity(single sum)
PV = ? $$$$$
(1) Interest Payments made each period (annuity)
etc. $$ $$ $$
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Determining Bond Prices
On 1/1/04, Discount Firm issues: $10,000; 8% bonds. due December 31, 2007 Interest payable annually Market rate of interest = 10%
Calculate the issue price of the bonds.
Example:
PV = ?
Calculating Bond Prices
$800 $800
(1) Interest Payments (4 payments @ $800)
2004 2005 2006 2007
$800 $800
Interest is always paid at rate stated
on bonds ($10,000 @ 8%)
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Calculating Bond Prices
(2) Principal of $10,000 due at end of 20072007
PV = ? $10,000
(1) Interest Payments (4 payments @ $800)
PV = ? $800 $800
2004 2005 2006 2007
$800 $800
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Present value:interest payments - $ 800 x 3.170 = $ 2,536
(PV; n=4; i = 10%)
principal payment - $ 10,000 x 0.683 = 6,830
(PV; n=4; i = 10%)
Bond issue price: $ 9,366
Example of Price Calculation
…butdiscount
@ market rate
Compute interestpayment at stated rate (i.e. 8%) ...
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Recording Bond Discounts
Cash 9,366Discount on Bonds Payable 634
Bonds Payable 10,000
To record the issuance of bonds at a discount.
Assets = Liabilities + Owners’ Equity
+ 9,366 + 10,000
- 634
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Balance Sheet Presentation of Bond Discount
Long-term Liabilities:
Bonds Payable $10,000 $10,000
Less: Discount on
Bonds Payable (634) - 0 -
$ 9,366 $10,000
At Date Uponof Sale Maturity
amortize to Interest Expense over the life
of the bond
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Determining Bond Prices
Assume Premium Firm sells the same $10,000; 8% bonds when the market rate on similar bonds is 6%.
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Present value:interest payments - $ 800 x 3.465 = $ 2,772
(PV; n=4; i = 6%)
principal payment - $ 10,000 x 0.792 = 7,920
(PV; n=4; i = 6%)
Bond issue price: $10,692
Example of Price Calculation
…butdiscount
@ market rate
Compute interestpayment at stated rate (i.e. 8%) ...
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Recording Bond Premiums
Cash 10,692Bonds Payable 10,000Premium on Bonds Payable 692
To record the issuance of bonds at a premium.
Assets = Liabilities + Owners’ Equity
+10,692 + 10,000
+ 692
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Balance Sheet Presentation of Bond Premium
Long-term Liabilities:
Bonds Payable $10,000 $10,000
Plus: Premium on
Bonds Payable 692 - 0 -
$10,692 $10,000
At Date Uponof Sale Maturity
amortize to Interest Expense over the life
of the bond
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Amortization of Bond Premiums and Discounts
Transfer to interest expense over the life of the bond using effective interest method
Discountincreasesinterestexpense
Premiumreducesinterestexpense
Amortization Schedule - Discount
Cash Interest Discount CarryingDate Interest Expense Amortized Value1/1/04 – – – $ 9,366
12/31/04 $ 800 $ 937 $ 137 9,503
12/31/05 800 950 150 9,653
12/31/06 800 965 165 9,818
12/31/07 800 982 182 10,000
(rounded)
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Amortization Schedule - Premium
Cash Interest Premium Carrying
Date Interest Expense Amortized Value1/1/04 – – – $ 10,692
12/31/04 $ 800 $ 642 $ 158 10,534
12/31/05 800 632 168 10,366
12/31/06 800 622 178 10,188
12/31/05 800 612 188 10,000
(rounded)
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Redemption of Bonds
Reasons for early redemption: Excess cash Changing Interest Rates
Gain = Carrying Value - Redemption Price
(Loss) = Redemption Price - Carrying Value
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Leases
Contractual arrangement Grants right to use asset in exchange for payment Form of financing
A
FEDERAL RESERVE NOTE
THE UNITED STATES OF AMERICATHE UNITED STATES OF AMERICA
L70744629F
12
1212
12
L70744629F
ONE DOLLARONE DOLLAR
WASHINGTON, D.C.
THIS NOTE IS LEGAL TENDER
FOR ALL DEBTS, PUBLIC AND PRIVATE
SERIES
1985
H 293
Rights
LesseeLessor
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Capital Lease
Record as asset and corresponding liability (as if purchased through borrowings)
Depreciate asset over lease term
Separate payments into principal and interest components using the effective interest method
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Criteria for Lease Capitalization
Transfers ownership of property
Contains bargain purchase option
Term is > 75% of property’s life
PV of payments > 90% of property FMV
Title Lease meets one or more:
A
FEDERAL RESERVE NOTE
THE UNITED STATES OF AMERICATHE UNITED STATES OF AMERICA
L70744629F
12
1212
12
L70744629F
ONE DOLLARONE DOLLAR
WASHINGTON, D.C.
THIS NOTE IS LEGAL TENDER
FOR ALL DEBTS, PUBLIC AND PRIVATE
SERIES
1985
H 293
Payche
ck for
Date
Dept.
of Tre
asurer
Jane D
oe
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Operating Leases
Record as rent (lease) expense each period
Disclose future lease obligations in footnotes
OFFICESPACE
FOR LEASE
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Debt-to-Equity Ratio
Total LiabilitiesTotal Stockholders’ Equity
How much have creditors contributed as compared to
owners?
Long-Term Liabilities on the Statement of Cash Flows
Operating Activities
Net income xxx
Increase in current liability +
Decrease in current liability -
Investing Activities
Financing Activities
Increase in long-term liability +
Decrease in long-term liability -32
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Appendix
Accounting Tools:
Other Liabilities
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Deferred Taxes
Reflects temporary differences between book and tax accounting methods
Book tax expense Cash paid to IRS=Tax
ReturnLiability
IncomeStatementExpense
Pay to the order of:
IRSABC Co.
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Deferred Income Taxes
Sales
Depreciation expense
Income before tax
Tax rate
Income tax
Book Tax
$6,000 $6,000
2,500 4,000
3,500 2,000
40% 40%
$1,400 $ 800
$ 600Difference recorded
as deferred tax
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Deferred Income Taxes
Income tax
Book Tax
$1,400 $ 800
Journal Entry: Dr. Cr.
Tax Expense 1,400 Tax Payable 800 Deferred Tax 600
$ 600
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Pensions
Payche
ck for
Date
Dept.
of Tre
asurer
Jane D
oe
Payche
ck for
Date
Dept.
of Tre
asurer
Jane D
oe
Payche
ck for
Date
Dept.
of Tre
asurer
Jane D
oe
Employercontributes
toPension
Fund
Pays benefits to retiredemployees
Date
Dept.
of Tre
asurer
Pension Fund XYZ Corp.
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Pensions
Expense accrued in period employee earns benefits (regardless of when paid)
Expense may amount funded=
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Pensions on the Balance Sheet
ASSETS
Prepaid Pension Cost $$
LIABILITIES
Accrued Pension Cost $$
Funding >
Expense
Expense >
Funding
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Postretirement Benefits
Benefits paid to employees after retirement e.g., health costs
Record expense when employee earns benefits, not when paid (matching principle)
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End of Chapter 11
1,000