long-term debt financing long-term debt financing c h a p t e r 11
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Long-TermDebt FinancingLong-TermDebt Financing
C H A P T E R 11
Learning Objective 1
Use present value concepts to measure long-term liabilities.
Define Long-Term Liabilities
Accounting forLong-Term Liabilities
Measurement and recording of long-term liabilities are based on the time value of money concept.
If money can earn 10% per year, $100 to be received 1 year from now is approximately equal to $90.91 received today.
Present value of $1 is the value today of $1 to be received or paid in
the future, given a specific interest rate.
Present and FutureValue Tables
Present Value TableLocate the number of periods in the left column and the interest rate in the row at the top of the table.This intersection is the factor representing the present value of $1.Discounting—present value amount is the amount that could be paid today to satisfy the obligation.
Future Value TableLocate the number of periods in the left column and the interest rate in the row at the top of the table.
This intersection is the factor representing the future value of $1.
Compounding—the frequency with which interest is added to the principal.
Present value of $100 paid in 5 years discounted at 10 percent.
PV = $62.09
Today 1 2 3 4 Future
$100
Discount at 10%
Present Value
$90.90$82.64
Future value of $100 today compounded for 5 years at 10 percent.
FV = $161.05
Today 1 2 3 4 Future
$100
Future Value
Compound at 10%
$110 $121
Value Table — Future ValueJoan invested $2,000 for 3 years at 12 percent, compounded annually. Using the table below, what is the future value of the $2,000?
Periods 6% 8% 10% 12% 3 1.1910 1.2597 1.3310 1.4049 4 1.2625 1.3605 1.4641 1.5735 5 1.3382 1.4693 1.6105 1.7623 6 1.4185 1.5869 1.7716 1.9738
Joan invested $2,000 for 3 years at 12 percent, compounded semiannually. Using the table below, what is the future value of the $2,000?
Periods 6% 8% 10% 12% 3 1.1910 1.2597 1.3310 1.4049 4 1.2625 1.3605 1.4641 1.5735 5 1.3382 1.4693 1.6105 1.7623 6 1.4185 1.5869 1.7716 1.9738
Value Table — Future Value
Computing the Interest RateProvide the Appropriate Formula.
Interest rate per compounding period =
Number of interest periods =
Define Annuities
Annuity
Present Value of an Annuity
Value Tables — Annuity
Joan is paid $8,000 a year for 8 years at 10 percent interest per year. Using the table below, what is the present value of the annuity?
Periods 6% 8% 10% 12% 7 5.5824 5.2064 4.8684 4.5683 8 6.2098 5.7466 5.3349 4.9676 9 6.8017 6.2469 5.7590 5.3282 10 7.3601 6.7101 6.1446 5.6502
Learning Objective 2
Account for long-term liabilities, including notes payable and mortgages payable.
Time Line ofBusiness Issues
Choose Issue Pay Amortize Retire
NotePayable
MortgagePayable
Bond
Bond +–
Bond
Example: Interest-Bearing Notes
On January 1, 2004, Silver Eagle Co. borrowed $20,000 for 3 years at 12 percent interest. The interest is payable on December 31 of each year. What entries are necessary for 2004?
Example: Interest-Bearing Notes
What entry is needed when Silver Eagle Co. repays the loan on December 31, 2005?
What is a Mortgage Payable?
Example: Mortgages Payable
On January 1, 2006, Blue Bird Corp. borrowed $500,000 to acquire a new building. The building was signed as collateral for the 30-year, 7 percent loan. Payments of $3,326.51 are to be made monthly. What are the January 2006 entries?
A mortgage amortization schedule shows the breakdown between interest and principal for each payment over the life of a mortgage.
Monthly Principal Interest MortgageMonth Payment Paid Paid Balance 1 3,326.51 409.84 2,916.67 499,590.16 2 3,326.51 412.23 2,914.28 499,177.93 3 3,326.51 414.64 2,911.87 498,763.29 4 3,326.51 417.06 2,909.45 498,346.23 5 3,326.51 419.49 2,907.02 497,926.74 6 3,326.51 421.94 2,904.57 497,504.80
Mortgages Payable
Learning Objective 3
Account for capital lease obligations
and understand the significance of
operating leases being excluded
from the balance sheet.
Lease ObligationsMatch the Following
Terms.
1.1. The party that is granted the right to use property under the terms of a lease.
2.2. The owner of property that is rented (leased) to another party.
3. A simple short-term rental agreement.
4.4. A leasing transaction that is recorded as a purchase by the lessee.
5. A contract that specifies the terms under which the owner of an asset agrees to transfer the right to use the asset to another party.
Lessor
Operating Lease
Lease
Lessee
Capital Lease
Classifying LeasesIf the lease is cancelable or does not meet any of the four requirements, is it an operating lease?
Transfer of Ownership?
Bargain PurchaseOption?
Term 75% ofUseful Life?
PV Payment 90%of FMV?
CapitalLease
OperatingLease
Example: Lease ObligationsOn January 1, 2006, The Cockatoo Company leased a computer. The lease requires annual payments of $5,000 for 8 years. The applicable interest rate is 12 percent. How is the lease recorded? What is the December 31, 2006 entry for interest expense?
Learning Objective 4
Account for bonds, including the original issuance, the payment of interest, and the retirement of bonds.
Bond
Unsecured Bonds (Debentures)
Secured Bonds
Coupon (Bearer) Bonds
Define These Types of Bonds
1. Bonds that mature in one lump sum on a specified future date.
2. Bonds that mature in a series of installments at specified future dates.
3. Bonds for which the issuer reserves the right to pay the obligation before its maturity date.
4. Bonds that can be traded for, or converted to, other securities after a specified period of time.
5. The names and addresses of the bondholders are kept on file by the issuing company.
Types of Bonds Matching
Serial Bonds
Convertible Bonds
Term Bonds
Callable Bonds
Registered Bonds
Zero-Coupon Bonds
Junk Bonds
Discuss These Types of Bonds
A contract between a bond issuer and a bond purchaser that specifies the terms of a bond.
The amount that will be paid on a bond at the maturity date.
The date at which a bond principal or face amount becomes payable.
Characteristics of BondsMatch Correctly.
Principal (face value or market value)
Bond Indenture
Bond Maturity Date
A contract between a bond issuer and a bond purchaser that specifies the terms of a bond.
The amount that will be paid on a bond at the maturity date.
The date at which a bond principal or face amount becomes payable.
Price should equal:
Market rate (effective rate or yield rate) of interest
Stated rate of interest
How Do You Determine Issuance Price?
Determining Issuance PriceCorrectly Define Each Term
Face Value
Bond Discount
Bond Premium
BondStatedInterest
Rate10%
Market Rate Bond Sold at
Characteristics of Bonds Complete the Chart
8%
10%
12%
Falcon Company agreed to issue 5-year, $500,000 bonds and pay 10 percent interest, compounded semiannually. Assume the effective and stated rates are equal. Calculate the issue price.
Example: Bond Issued at Face Value
1. Semiannual interest paymentsPresent value of interest annuity
2. Maturity value of bondsPresent value of bonds
3. Issuance price of bonds
Falcon Company agreed to issue 5-year, $500,000 bonds and pay 10 percent interest, compounded semiannually. Assume the effective rate is 12 percent. Calculate the issue price of the bonds.
Example: Bond Issuedat a Discount
1. Semiannual interest paymentsPresent value of interest annuity
2. Maturity value of bondsPresent value of bonds
3. Issuance price of bonds
Falcon Company agreed to issue 5-year, $500,000 bonds and pay 10 percent interest, compounded semiannually. Assume the effective rate is 8 percent. Calculate the issue price of the bonds.
Example: Bond Issuedat a Premium
1. Semiannual interest paymentsPresent value of interest annuity
2. Maturity value of bondsPresent value of bonds
3. Issuance price of bonds
Example: Accounting for Bonds Payable
On January 1, 2006, Falcon Company agreed to issue 5-year, $500,000 bonds and pay 10 percent interest, compounded semiannually. Assume the effective rate is 10 percent. What entry is needed to record the liability?
Example: Accounting for Bonds Payable
On January 1, 2006, Falcon Company agreed to issue 5-year, $500,000 bonds and pay 10 percent interest, compounded semiannually. Assume the effective rate is 10 percent. What entry is needed to record the first interest payment?
Example: Bond Retirements at Maturity
On January 1, 2006, Falcon Company agreed to issue 5-year, $500,000 bonds and pay 10 percent interest, compounded semiannually. Assume the effective rate is 10 percent. What entry is needed to record the retirement of the bond on January 1, 2011?
Example: Bond Retirements Before Maturity
The Great Owl Company issued $200,000, 14 percent bonds, which are now selling for 107 and are callable at 110. The bonds were issued at face value. If the company decides to call the bonds, what entry is needed?
Learning Objective 5
Use debt-related ratios to determine the degree of a
company’s financial leverage and its ability to
repay loans
Define Debt Ratio
Define Debt-to-Equity Ratio
Times Interest Earned Ratio
Expanded MaterialLearning Objective 6
Amortize bond discounts and bond premiums using either the straight-line method or the effective-interest method.
Define the Two Bond Premium/Discount Amortization
Methods
Straight-line Method
Effective-interest Method
Which method is preferred by GAAP?
On January 1, 2006, The Ostrich Company agreed to issue 10-year, $200,000 bonds and pay 10 percent interest, compounded semiannually. The company received $196,000 for the bonds. Make the entry to record the issuance of the bonds.
Example: Bond Issuedat a Discount
On January 1, 2006, The Ostrich Company agreed to issue 10-year, $200,000 bonds and pay 10 percent interest, compounded semiannually. Using straight-line amortization, what entry is made for the interest payment on June 30, 2006?
Example: Bond Issuedat a Discount
On January 1, 2006, The Ostrich Company agreed to issue 10-year, $200,000 bonds and pay 10 percent interest, compounded semiannually. Using straight-line amortization, what adjusting entry is needed on December 31, 2006?
Example: Bond Issuedat a Discount
On January 1, 2006, The Ostrich Company agreed to issue 10-year, $200,000 bonds and pay 10 percent interest, compounded semiannually. What entry is necessary to retire the debt after 10 years?
Example: Bond Issuedat a Discount
Example: Bond Issuedat a Premium
On January 1, 2006, The Parrot Company agreed to issue 10-year, $200,000 bonds and pay 10 percent interest, compounded semiannually. The company received $210,000 for the bonds. Make the entry to record the issuance of the bonds.
Example: Bond Issuedat a Premium
On January 1, 2006, The Parrot Company agreed to issue 10-year, $200,000 bonds and pay 10 percent interest, compounded semiannually. The company received $210,000 for the bonds. Using straight-line amortization, what entry is made for the interest payment on June 30, 2006?
Example: Bond Issuedat a Premium
On January 1, 2006, The Parrot Company agreed to issue 10-year, $200,000 bonds and pay 10 percent interest, compounded semiannually. The company received $210,000 for the bonds. Using straight-line amortization, what entry is needed on December 31, 2006?
Example: Bond Issuedat a Premium
On January 1, 2006, The Parrot Company agreed to issue 10-year, $200,000 bonds and pay 10 percent interest, compounded semiannually. The company received $210,000 for the bonds. What entry is necessary to retire the debt after 10 years?
Effective-Interest MethodThe Woodpecker Company issued a $1,000, 8 percent bond. The market rate was 7 percent at the time of issuance. Create an effective-interest table.
A B C D E(
Premium Amortization # Payment
Interest Expense
Unamortized Premium
Bond Book
Chapter 11 Complete