Chapter 10, Slide #1 Ch.10 Long-Term Liabilities Prof. J. Wang.
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Transcript of Chapter 10, Slide #1 Ch.10 Long-Term Liabilities Prof. J. Wang.
Chapter 10, Slide #1
Ch.10Long-Term Liabilities
Prof. J. Wang
Chapter 10, Slide #2
Balance Sheet Classification of Liabilities
Current liabilities:
Long-term liabilities:
Due within one year of the balance sheet date
Due beyond one year
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4 5 6 7 8 9 10
11 12 13 14 15 16 17
18 19 20 21 22 23 24
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1 2 3
4 5 6 7 8 9 10
11 12 13 14 15 16 17
18 19 20 21 22 23 24
25 26 28 29 30 3127
LO1
Chapter 10, Slide #3
Long-Term Liabilities
Bonds payable Notes payable Leases Deferred taxes Pensions Postretirement benefits
Chapter 10, Slide #4
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
LO2
Chapter 10, Slide #5
Chapter 10, Slide #6
Bond Features
Collateralized backed by specific assets in event of default
Debentures backed only by general creditworthiness of issuer
Chapter 10, Slide #7
Bond Features
Term entire principal due on a specific single date
Serial principal repaid in installments over time
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4 5 6 7 8 9 10
11 12 13 14 15 16 17
18 19 20 21 22 23 24
25 26 28 29 30 3127
1 2 3
4 5 6 7 8 9 10
11 12 13 14 15 16 17
18 19 20 21 22 23 24
25 26 28 29 30 3127
Chapter 10, Slide #8
Bond Features
Convertible into common stock
Callable / Redeemable may be retired before maturity date
CommonStock 1,000
Chapter 10, Slide #9
Bonds Prices
• Market rate v. stated rate– Market rate: interest rate offered by similar
bonds in the market– Stated rate: interest offered by the specific
bonds
Chapter 10, Slide #10
• On Jan. 1, 2006, Johnson Company issued $10,000,000 bonds with a stated interest rate of 10%. The bonds mature in 20 years and interest is paid annually on Jan. 1.
Chapter 10, Slide #11
• Johnson promised two things:– Principal: $10,000,000 paid at maturity – Interest: $1,000,000 paid each year for 20 years
(10,000,000x10%)
Chapter 10, Slide #12
PV = ?
Calculating Bond Prices
$$
(2) Principal due at maturity
PV = ? $$$$$
(1) Interest payments made each period
etc. $$ $$ $$
Chapter 10, Slide #13
• Investors earn the market interest rate (which is also referred to as the real/effective rate) regardless of the stated rate (which is also referred to as the nominal rate)
Chapter 10, Slide #14
• How much the bonds can be sold for depends on the market interest rate for similar bonds
• Discount rate used in the present value calculations is the market interest rate
Chapter 10, Slide #15
• When stated rate is greater than the market rate, the bonds will sold at premium
• When stated rate is less than the market rate, the bonds will sold at discount
• When stated rate is equal to the market rate, the bonds will sold at face value
Chapter 10, Slide #16
• Compute the price of Johnson’s bonds assume the market interest rate is 12%
Calculating Bond Prices
(2) Principal of $10,000,000 due at end of 2026
2026
PV = ? $10,000,000
(1) Interest payments (20 payments @ $1,000,000)
PV = ?
2006 2007 2008 2009
$1m $1m $1m $1m
Chapter 10, Slide #18
Present value:Interest payments: $1,000,000 × 7.469 = $7,469,000
(PV; n = 20; i = 12%)
Principal payment: $10,000,000 × 0.104 = 1,040,000
(PV; n = 20; i = 12%)
Bond issue price: $8,509,000
Example of Price Calculation
…butdiscount
@ market rate
Compute interestpayment at stated rate (i.e., 10%)...
Chapter 10, Slide #19
Recording Bond Discounts
Cash 8,509,000
Discount on Bonds Payable 1,491,000
Bonds Payable 10,000,000
To record the issuance of bonds payable.
Assets = Liabilities + Owners’ Equity+8,509,000 –1,491,000
+10,000,000
LO4
Chapter 10, Slide #20
Balance Sheet Presentation of Bond Discount
Long-term liabilities:
Bonds payable $10,000,000
Less: Discount on bonds payable 1,491,000
$ 8,509,000
Chapter 10, Slide #21
Determining Bond Prices
•Compute the price of Johnson’s bonds assume the market interest rate is 8%
Chapter 10, Slide #22
Present value:Interest payments: $1,000,000 × 9.818 = $9,818,000
(PV; n = 20; i = 8%)
Principal payment: $10,000,000 × 0.215 = 2,150,000
(PV; n = 20; i = 8%)
Bond issue price: $11,968,000
Example of Price Calculation
…butdiscount
@ market rate
Compute interestpayment at stated rate (i.e., 10%)...
Chapter 10, Slide #23
Recording Bond Premiums
Cash 11,968,000Bonds Payable 10,000,000Premium on Bonds Payable 1,968,000
To record the issuance of bonds payable.
Assets = Liabilities + Owners’ Equity+11,968,000 +10,000,000
+1,968,000
Chapter 10, Slide #24
Balance Sheet Presentation of Bond Premium
Long-term liabilities:
Bonds payable $10,000,000
Plus: Premium on bonds payable 1,968,000
$11,968,000
Chapter 10, Slide #25
Bonds Sold at Face Value
Cash 10,000
Bonds Payable 10,000
To record the issuance of bonds at face value.
Face value of bonds = Sales price
When stated rate=market rate
Chapter 10, Slide #26
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
Chapter 10, Slide #27
Amortization of Bond Premiums and Discounts
Transferring an amount from the discount or premium account to interest expense over the life of the bond using the effective interest method
Discountincreasesinterestexpense
Premiumreducesinterestexpense
LO5
Chapter 10, Slide #28
When bonds are issued at discount:
Interest expense = (cash interest) + (discount amortization) = $1,000,000 + (1,491,000/20)
= $1,074,55012/31/06Dr. Interest Expense 1,074,550
Cr. Interest payable 1,000,000Cr. Discount on B/P 74,500
1/1/07Dr. Interest payable 1,000,000
Cr. Cash 1,000,000
Chapter 10, Slide #29
• Total interest expense during the life of the bonds = 1,000,000*20 + 1,491,000
= $21,491,000
Chapter 10, Slide #30
• Prepare appropriate journal entries for Johnson Company when the bonds were issued at premium