Chapter 13 LongTerm Liabilities and Receivables An electronic
Chapter 13 Long-Term Liabilities and Receivables An electronic presentation by Douglas Cloud Pepperdine University
Objectives 1. Explain the reasons for issuing long-term liabilities. 2. Understand the characteristics of bonds payable. 3. Record the issuance of bonds. 4. Amortize discounts and premiums under the straight-line method. 5. Compute the selling price of bonds. Continued
3 Objectives 6. Amortize discounts and premiums under the effective interest method. 7. Explain extinguishment of liabilities. 8. Understand bonds with equity characteristics. 9. Account for long-term notes payable. 10. Understand the disclosure of long-term liabilities. Continued
4 Objectives 11. Account for long-term notes receivable, including impairment of a loan. 12. Understand troubled debt restructurings. (Appendix) 13. Account for serial bonds. (Appendix)
5 Reasons for Issuance of Long. Term Liabilities ü Debt financing may be the only available source of funds. ü Debt financing may have a lower cost. ü Debt financing offers an income tax advantage. ü The voting privilege is not shared. ü Debt financing offers the opportunity for leverage.
Characteristics of Bonds • • Debenture bonds Mortgage bonds Registered bonds Coupon bonds Zero-coupon bonds Callable bonds Convertible bonds Serial bonds
Steps a Company Must Follow When It Issues Bonds § It must receive approval from regulatory authorities, such as the Securities and Exchange Commission. § The company must set the terms of the bond issue, such as the contract rate and the maturity date. § It must make a public announcement of its intent to sell the bonds on a particular date and print the bond certificates.
8 Recording the Issuance of Bonds Company J sells bonds with a face value of $400, 000 on the authorization date at 102. Cash ($400, 000 x 1. 02) Bonds Payable Premium on Bonds A contra account —Payable 408, 000 400, 000 8, 000 subtracted Company Mfrom sells Bonds bonds with a face value of $400, 000 Payable on the authorization date at 97. Cash ($400, 000 x. 97) Discount on Bonds Payable 388, 000 12, 000 400, 000
9 Recording the Issuance of Bonds On March 1, 2004, Grimes Corporation issues $800, 000 of 10 -year bonds dated January 1, 2004 at par. The bonds have a contract (stated) interest rate of 12% and pay interest semiannually. Cash Interest Expense Bonds Payable 816, 000 800, 000 $800, 000 x 0. 12 x 2/12 Continued
10 Recording the Issuance of Bonds On July 1, 2004, Grimes Corporation records the semiannual interest payment. Interest Expense Cash Interest Expense 48, 000 16, 000 32, 000 48, 000 $800, 000 x 0. 12 x 6/12 The balance of $32, 000 represents the interest cost since the bonds were issued.
11 Amortizing Discounts and Premiums
12 Issuing Bonds at a Discount Straight-Line Method Jet Company sells bonds for $92, 976. 39 on January 1, 2004. The bonds have a face value of $100, 000 and a 12% stated annual interest rate. Interest is paid semiannually and the bonds mature on December 31, 2008. Cash Discount on Bonds Payable Continued 92, 976. 39 7, 023. 61 100, 000. 00
13 Issuing Bonds at a Discount Straight-Line Method Jet Company records the first interest payment on June 30, 2004. Interest Expense Discount on Bonds Payable Cash 6, 702. 36 6, 000. 00 $6, 000 + $702. 36 $100, 000 x$7, 023. 61 0. 12 x 1/2 ÷ 10
14 Issuing Bonds at a Discount Straight-Line Method After this second entry, the long-term liabilities section of Jet’s December 31, 2004 balance sheet would appear as follows: Bonds payable Less: Discount on Bonds Payable $100, 000. 00 (5, 618. 89 ) $ 94, 381. 11 $7, 023. 61 – $702. 36
15 Issuing Bonds at a Premium Straight-Line Method Jet Company sold bonds on January 1, 2004 for $107, 721. 71. Interest is paid semiannually. Cash 107, 721. 71 Bonds Payable 100, 000. 00 Premium on Bonds Payable 7, 721. 71 Continued
16 Issuing Bonds at a Premium Straight-Line Method The first interest payment is made on June 30. $7, 721. 71 ÷ 10 Interest Expense 5, 227. 83 Premium on Bonds Payable 772. 17 Cash ($100, 0000 x 0. 12 x 1/2) Continued 6, 000. 00
17 Issuing Bonds at a Premium Straight-Line Method After this second entry, the long-term liabilities section of Jet’s December 31, 2004 balance sheet would appear as follows: Bonds payable Add: Premium on Bonds Payable $100, 000. 00 6, 177. 37 $106, 177. 37 $7, 721. 71 – $772. 17
18 Determining the Selling Price Using the straight-line method, Interest Expense is the same every year—which is not realistic when a premium or discount is involved. Instead, the effective-interest method allows for a stable interest rate per year.
19 Determining the Selling Price Jet Company desires to sell $100, 000 of 5 -year bonds paying semiannual interest with a stated rate of 12%. The current effective interest rate is 14%. Present value of principal ($100, 000 x 0. 508349) Present value of interest ($6, 000 x 7. 023582) Less face value Discount $ 50, 834. 90 42, 141. 49 $ 92, 976. 39 (100, 000. 00) $ 7, 023. 61
20 Determining the Selling Price Jet Company desires to sell $100, 000 of 5 -year bonds paying semiannual interest with a stated rate of 12%. The bonds are sold to yield 14% interest. Present value of principal ($100, 000 x 0. 613913) Present value of interest ($6, 000 x 7. 721735) Less face value Premium $ 61, 391. 30 46, 330. 41 $107, 721. 71 (100, 000. 00) $ 7, 721. 71
21 Issuing Bonds at a Discount Effective Interest Jet Company sells bonds for $92, 976. 39 on January 1, 2004. The bonds have a face value of $100, 000 and a 12% stated annual interest rate. Interest is paid semiannually and the bonds mature on December 31, 2008. Cash Discount on Bonds Payable Continued 92, 976. 39 7, 023. 61 100, 000. 00
22 Issuing Bonds at a Discount Effective Interest Jet Company records the first interest payment on June 30, 2004. Interest Expense Discount on Bonds Payable Cash 6, 508. 35 6, 000. 00 $92, 976. 39 x 0. 14 x 1/2 $100, 000 x 0. 12 x 1/2 $6, 508. 35 – $6, 000. 00
23 Issuing Bonds at a Discount Effective Interest Jet Company records the second interest payment on December 31, 2004. Interest Expense Discount on Bonds Payable Cash 6, 543. 93 6, 000. 00 $6, 543. 93 – $6, 000. 00 ($92, 976. 39 + $508. 35) x 0. 14 x 1/2 $100, 000 x 0. 12 x 1/2
24 Issuing Bonds at a Premium Effective Interest Jet Company sold bonds on January 1, 2004 for $107, 721. 71. Interest is paid semiannually. Cash 107, 721. 71 Bonds Payable 100, 000. 00 Premium on Bonds Payable 7, 721. 71 Continued
25 Issuing Bonds at a Premium Effective Interest The first interest payment is made on June 30. Interest Expense Premium on Bonds Payable Cash 5, 386. 09 613. 91 6, 000. 00 $107, 721. 71 x 0. 10 x 1/2– $6, 000. 00 $5, 386. 09 $100, 000 x 0. 12 x 1/2 Continued
26 Issuing Bonds at a Premium Effective Interest Jet Company records the second interest payment on December 31, 2004. Interest Expense Premium on Bonds Payable Cash 5, 355. 39 644. 61 6, 000. 00 ($107, 721. 71 – $613. 91) x 0. 10 x 1/2 $6, 000. 00 – $5, 355. 39 $100, 000 x 0. 12 x 1/2
27 Comparison of Book Values Effective Interest Method Selling Price Premium Face Value Straight-Line Method Discount Selling Price Effective Interest Method Issue Date Maturity Date
28 Bond Issue Costs On January 1, 2004 Bergen Company issues 10 -year bonds with a face value of $500, 000 at 104. Expenditures connected with the issue totaled $8, 000. Cash 512, 000 Deferred Bond Issue Costs 8, 000 Premium on Bonds Payable 20, 000 $520, 000 – $8, 000500, 000 Bonds Payable 0. 04 x $500, 000
29 Bond Issue Costs Each year for the ten years Deferred Bond Issue Costs is amortized on a straight-line basis by charging Bond Interest Expense for $800.
30 Accruing Bond Interest Mc. Adams Company issues $200, 000 of 10%, 5 -year bonds on October 1, 2004 for $185, 279. 87. Interest on these bonds is payable each October 1 and April 1. Cash Discount on Bonds Payable 185, 279. 87 14, 720. 13 Continued 200, 000. 00
31 Accruing Bond Interest At the end of the fiscal year, December 31, 2004, an adjusting entry is required to record interest for three months (assume straight-line amortization). Interest Expense Discount on Bonds Payable Interest Payable 5, 736. 01 5, 000. 00 ($14, 720. 13 ÷ $200, 000 5) x 3/12 x 0. 10 x 3/12
32 Accruing Bond Interest At the end of the fiscal year, December 31, 2004, an adjusting entry is required to record interest for three months (assume the effective-interest amortization). Interest Expense Discount on Bonds Payable Interest Payable 5, 558. 40 5, 000. 00 $185, 279. 87 x 0. 12 x 3/12 $5, 558. 40 – $5, 000
Extinguishment of Liabilities Under FASB Statement No. 140, 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, either judicially or by the creditor.
Bonds Retired Prior to Maturity Conceptually, gains or losses from refundings could be recognized either-- • over the remaining life of the old issue, • over the life of the new bond issue, or • in the current period.
35 Bonds Retired Prior to Maturity Whether bonds are recalled, retired, or refunded prior to maturity, any gain or loss is reported as a component of income from continuing operations.
36 Bonds Retired Prior to Maturity Channing Corporation originally issued $100, 000 of 12% bonds at 97 on January 1, 1999. The bonds have a 10 -year life, pay interest on January 1 and July 1, and are callable at 105 plus accrued interest. The company amortizes the discount by the straight-line method. On June 30, 2004 the company recalls the bonds. Continued
37 Bonds Retired Prior to Maturity First, Channing records the current interest expense and liability, including the amortization of the discount that expired since the last interest payment. Interest Expense Discount on Bonds Payable Interest Payable 6, 150 6, 000 ($3, 000 ÷ 10) x 1/2 x $100, 000 0. 12 x 1/2
38 Bonds Retired Prior to Maturity Channing then records the reacquisition of the bonds at 105 plus accrued interest of $6, 000. Bonds Payable Interest Payable Extraordinary Loss on Bond Redemption Discount on Bonds Payable Cash 100, 000 6, 350 111, 000 Original discount $ 3, 000 Less: Amortization for 5 ½ years (1, 650 ) Unamortized discount $1, 350
Bonds With Equity Characteristics By acquiring bonds with detachable stock warrants or with a conversion feature, the bondholder has-(1) the right to receive interest on the bonds, and… (2) the right to acquire common stock and to participate in the potential appreciation of the market value of the company’s common stock.
40 Bonds Issued with Detachable Stock Warrants Market Value of Bonds Without Warrants Amount Assigned to = x Issuance Price Market Value of Bonds + Market Value Bonds Without Warrants of Warrants Amount Market Value of Warrants Assigned to = x Issuance Price Market Value of Bonds + Market Value Warrants Without Warrants of Warrants
41 Bonds Issued with Detachable Stock Warrants Paul Company sold $800, 000 of 12% bonds at 101 ($808, 000). Each bond carried 10 warrants, and each warrant allows the holder to acquire one share of $5 par common stock for $25 per share. The warrants are quoted at $3 each.
42 Bonds Issued with Detachable Stock Warrants Market Value of Bonds Without Warrants Amount Assigned to = x Issuance Price Market Value of Bonds + Market Value Bonds Without Warrants of Warrants Amount $990 x 800 x $808, 000 Assigned to = ($990 x 800) + ($3 x 800 x 10) Bonds Amount Assigned to = Bonds $784, 235. 29
43 Bonds Issued with Detachable Stock Warrants Amount Market Value of Warrants Assigned to = x Issuance Price Market Value of Bonds + Market Value Warrants Without Warrants of Warrants Amount $3 x 800 x 10 x $808, 000 Assigned to = ($990 x 800) + ($3 x 800 x 10) Warrants Amount Assigned to = Warrants $23, 764. 71
44 Bonds Issued with Detachable Stock Warrants Cash 808, 000. 00 Discount on Bonds Payable 15, 764. 71 Bonds Payable 800, 000. 00 Common Stock Warrants 23, 764. 71 $800, 000. 00 – $784, 235. 29 From slide 43
45 Bonds Issued with Detachable Stock Warrants Later, 500 warrants are exercised at $25 each. Cash 12, 500. 00 Common Stock Warrants 1, 485. 50 Common Stock 2, 500. 00 Additional Paid-in Capital on Common Stock ($23, 765. 71 ÷ 8, 000)11, 485. 50 x 500 $23, 764. 71 – $1, 485. 50 The remaining warrants expire. Common Stock Warrants 22, 279. 21 Additional Paid-in Capital from Expired Warrants 22, 279. 21
46 Convertible Bonds Why issue convertible bonds?
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.
48 Convertible Bonds Shannon Corporation has outstanding convertible bonds with a face value of $10, 000. Each $1, 000 bond is convertible into 40 shares of common stock (par value $20 per share). All bonds are converted into common stock when the market value of Shannon’s common stock is $26. 50 per share.
49 Convertible Bonds Book Value Method Bonds Payable 10, 000 Premium on Bonds Payable 500 Common Stock 8, 000 Additional Paid-in Capital from Bond Conversion 2, 500 40 x 10 x $20 $10, 500 – $8, 000
50 Convertible Bonds Market Value Method Bonds Payable 10, 000 Premium on Bonds Payable 500 Loss on Conversion 100 Common Stock 8, 000 Additional Paid-in Capital from Bond Conversion 40 x 10 x $6. 50 2, 600 40 x 10 x $20
51 Notes Payable Issued for Cash On January 1, 2004, Johnson Company issues a 3 -year, non-interest-bearing note with a face value of $8, 000 and receives $5, 694. 24 in exchange. Cash Discount on Notes Payable Contra account to Notes Payable 5, 694. 24 2, 305. 76 8, 000. 00
52 Notes Payable Issued for Cash On December 31, 2004 Johnson Company records the interest expense on the note. Interest Expense Discount on Notes Payable Notes payable Less: Unamortized discount Carrying value at beginning of year x Effective interest rate Entry amount 683. 31 $8, 000. 00 (2, 305. 76 ) $5, 694. 24 0. 12 $ 683. 31
Notes Payable Exchanged for Cash and Rights or Privileges Verna Company borrows $100, 000 by issuing a 3 year, non-interest-bearing note to a customer. In addition, Verna Company agrees to sell inventory to the customer at a reduced price over a 5 -year period. The firm’s incremental borrowing rate is 12%. $100, 000 – ($100, 000 x 0. 711780) Cash Discount on Notes Payable Unearned Revenue 100, 000. 00 28, 822. 00 53
Notes Payable Exchanged for Cash and Rights or Privileges $71, 178 x 0. 12 End of First Year Interest Expense 8, 541. 36 Discount on Notes Payable 8, 541. 36 Unearned Revenue 5, 764. 40 Sales Revenue 5, 764. 40 End of Second Year $28, 822 ÷ 5 Interest Expense 9, 566. 32 Discount on Notes Payable 9, 566. 32 ($71, 178 5, 764. 40 + $8, 541. 36) x 0. 12 Unearned Revenue Sales Revenue 5, 764. 40 54
Notes Payable Exchanged for Property, Goods, or Services APB Opinion No. 21 states that the stipulated rate of interest should be presumed fair. This presumption can be overcome only if-1. No interest is stated, or 2. The stated rate of interest is clearly unreasonable, or 3. The face value of the note is materially different from the cash sales price of the property, goods, or services, or the fair value of the note at the date of the transaction.
56 Long-Term Notes Receivable A note receivable is recorded at the fair value of the property, goods, or services or the fair value of the note, whichever is more reliable.
57 Long-Term Notes Receivable On January 1, 2004, Joyce Company accepted a $10, 000 non-interest-bearing, 5 -year note in exchange for used equipment it sold to Marsden Company. Notes Receivable 10, 000. 00 Accumulated Depreciation 3, 000. 00 Discount on Notes Receivable 4, 325. 73 Equipment 8, 000. 00 Gain on Sale of Equipment $10, 000 – $5, 674. 27 (present value of equipment)
58 Long-Term Notes Receivable December 31, 2004 Discount on Notes Receivable Interest Revenue December 31, 2005 680. 91 ($10, 000 – $4, 325. 73) x 0. 12 Discount on Notes Receivable Interest Revenue 762. 62 $10, 000 – ($4, 325. 73 – $680. 91) x 0. 12
59 Impairment of a Loan A loan is impaired if it is probable that the creditor will not be able to collect all amounts due according to the contract terms.
60 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, 2009. Ullman paid the December 31, 2004 interest, but informed Snook that it probably would miss the next two year’s interest payments because of financial difficulties. In addition, the principal payment would be one year late.
61 Impairment of a Loan Value Snookof. Company the impaired computes loan isthe $85, 733. 93 present value ($63, 017. 00 of the impaired + $22, 716. 93) loan. Present value of the principal = $100, 000 x present value of a single sum for 6 years at 8% = $100, 000 x 0. 630170 = $63, 017. 00 Present value of the interest = $8, 000 x present value of an annuity for 4 years at 8% deferred 2 years = $8, 000 x 3. 312127 x 0. 857339 = $22, 716. 93
62 Impairment of a Loan December 31, 2004 (Snook Company) Bad Debt Expense 14, 266. 07 Allowance for Doubtful Accts. 14, 266. 07 $100, 000 – $85, 733. 93 December 31, 2005 (Snook Company) Allowance for Doubtful Accounts 6, 858. 71 Interest Revenue 6, 858. 71 8% x $85, 733. 93
63 Future Developments If adopted, Exposure Draft No. 213 -B would require a company that issues a Exposure Draft Another compound financial related to guarantees, if instrument to separately adopted, would require some classify the liability companies to recognize a component and the equityfor the fair value of liability component. the obligation it has incurred by issuing the guarantee.
Troubled Debt Restructuring Modification of Terms 1. Reduction of the stated interest rate for the remainder 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. Click button to skip Appendix material
Troubled Debt Restructuring Modification of Terms When a restructuring involves only a modification of terms, the carrying value of the liability is compared to the undiscounted future cash payments specified by the terms. Then, two different situations may arise: Continued
66 Troubled Debt Restructuring 1. If the undiscounted total future cash payments are greater than (or equal to) the carrying value of the liability, the debtor does not recognize a gain, the carrying value is not reduced, and interest expense is recognized in future periods using an imputed interest rate. Continued
67 Troubled Debt Restructuring 2. If the future cash payments are less than the carrying value of the liability, the debtor recognizes a gain, the carrying value of the liability is reduced, and interest expense is not recognized in future periods.
68 Troubled Debt Restructuring Equity or Asset Exchange When a debtor satisfies a liability by exchanging an equity interest or an asset of lesser value, it records the transfer on the basis of the fair value of the equity interest or asset transferred and recognizes an extraordinary gain.
69 Chapter 13 The End
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