Long-Term Liabilities: Notes, Bonds, and Leases Presentations for Chapter 11 by Glenn Owen.
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Transcript of Long-Term Liabilities: Notes, Bonds, and Leases Presentations for Chapter 11 by Glenn Owen.
Long-Term Liabilities: Long-Term Liabilities: Notes, Bonds, and LeasesNotes, Bonds, and Leases
Presentations for Chapter 11 by Glenn Owen
Key PointsKey Points Long-term notes payable, bonds payable, and leasehold
obligations, and how companies use these instruments as important sources of financing.
Economic consequences created by borrowing. Different forms of contractual obligations. The effective interest rate and how it is determined for
contractual obligations. The effective interest method. How changes in market interest rates can lead to misstated
balance sheet values for long-term liabilities. Operating leases, capital leases, and off-balance-sheet
financing.
Long-Term Liabilities as a Percentage Long-Term Liabilities as a Percentage of Total Assetsof Total Assets
Company (Industry)
LTL Liabilities /Total Assets
General Electric (Manufacturing) .52
Chevron Oil (Oil drilling and refining) .33
Super Value (Grocery) .30
Tommy Hilfiger (Clothing) .33
Yahoo (Internet search engine) .01
Cisco (Internet systems) .03
SBC Communications (Telcom services) .37
Wendy’s (Restaurant services) .17
Bank of America (Banking services) .11
Merrill Lynch (Investment services) .17
Long-Term Liabilities as a Percentage Long-Term Liabilities as a Percentage of Total Liabilitiesof Total Liabilities
Company (Industry)
LTL Liabilities /Total Liabilities
General Electric (Manufacturing) .59
Chevron Oil (Oil drilling and refining) .64
Super Value (Grocery) .44
Tommy Hilfiger (Clothing) .71
Yahoo (Internet search engine) .10
Cisco (Internet systems) .18
SBC Communications (Telcom services) .55
Wendy’s (Restaurant services) .53
Bank of America (Banking services) .14
Merrill Lynch (Investment services) .18
Long-Term Liabilities as a Percentage Long-Term Liabilities as a Percentage of Stockholders’ Equityof Stockholders’ Equity
Company (Industry)
LTL Liabilities /Stockholders’
Equity General Electric (Manufacturing) 4.33
Chevron Oil (Oil drilling and refining) .69
Super Value (Grocery) 1.11
Tommy Hilfiger (Clothing) .61
Yahoo (Internet search engine) .01
Cisco (Internet systems) .04
SBC Communications (Telcom services) 1.19
Wendy’s (Restaurant services) .30
Bank of America (Banking services) 1.57
Merrill Lynch (Investment services) 3.40
Basic Definitions and Different Basic Definitions and Different Contractual FormsContractual Forms
Installment notes– Cash (bank loan)– Noncash (lease or real estate purchase)
Non-interest-bearing notes– Cash (zero coupon bond)– Noncash (equipment purchase)
Interest-bearing notes– Cash (bond)– Noncash (equipment purchase)
Effective Interest RateEffective Interest Rate
Actual interest rate paid by issuer May or may not be same as the stated rate Determined by discount rate that sets the present
value of the future cash outflows equal to the fair market value of that which is received in the exchange.
Effective Interest RateEffective Interest Rate
Installment payment formula– Present Value = – Annuity Cash Payment – x (PV Table Factor Ordinary Annuity: n = period, i = ?)
Non-interest bearing formula– Present Value =– Single Sum Cash Payment– x (PV Table Factor Single Sum: n = period, i = ?)
Effective Interest RateEffective Interest Rate
Interest-bearing formula– Present Value = – Annuity Cash Payment (Interest Payment)– x (PV Table Factor Ordinary Annuity: n = period, i = ?)– + Single Sum Cash Payment– x (PV Table Factor Single Sum: n = period, i = ?)
Accounting for Accounting for Long-Term ObligationsLong-Term Obligations
Record the asset acquired in the exchange at its fair market value.
Record the obligation at its face value. Record a discount if the obligation exceeds the fair
market value of the asset acquired. Record interest expense for each period: Effective
interest rate x Balance sheet value of the obligation at the beginning of the period.
Bonds PayableBonds Payable Terminology and terms of bond contracts
– Life– Maturity date– Face value, principal, par value, or maturity value– Interest payment– Proceeds at issuance– Effective interest rate
Other provisions– Restrictions– Security– Call provision
LeasesLeases Operating leases
– Lessee assumes no risk of ownership– At end of lease term, right to use the property reverts to
the owner
Capital leases– Effectively an installment purchase– Lessee assumes rights and risks of ownership– Treated as purchases
Off-balance-sheet financing
Review ProblemReview Problem Facts
– 500 bonds issued, each with a $1,000 face value– Issued January 1, 2003 at 91.89– Stated annual rate of 6%– Interest paid semiannually on Dec. 31 and June 30– Called July 1, 2004 at 96
Cash Flow– Proceeds $459,450 (500 x $1,000 x 918.90)– Semi-annual interest payments $15,000
(500 x $1,000 x 6% x 1/2)– Redemption payment (7/1/04) $480,000
(500 x $1,000 x .96)
Review ProblemReview ProblemTime Line and SolutionTime Line and Solution
+$459,450(proceeds)
1/1/03 6/30/03 12/31/03 6/30/04
DiscountBalance
Net BookValue
Review ProblemReview ProblemTime Line and SolutionTime Line and Solution
Cash 459,450Discount 40,550 Bonds Payable 500,000
Cash 459,450Discount 40,550 Bonds Payable 500,000
+$459,450(proceeds)
DiscountBalance
Net BookValue
1/1/03 6/30/03 12/31/03 6/30/04
Review ProblemReview ProblemTime Line and SolutionTime Line and Solution
Cash 459,450Discount 40,550 Bonds Payable 500,000
Cash 459,450Discount 40,550 Bonds Payable 500,000
+$459,450(proceeds)
Discount $40,550Balance
Net BookValue $459,450
1/1/03 6/30/03 12/31/03 6/30/04
Review ProblemReview ProblemTime Line and SolutionTime Line and Solution
+$459,450(proceeds)
-$15,000(interest)
Discount $40,550Balance
Net BookValue $459,450
1/1/03 6/30/03 12/31/03 6/30/04
Review ProblemReview ProblemTime Line and SolutionTime Line and Solution
Interest Expense 18,378 Cash 15,000 Discount 3,378
Interest Expense 18,378 Cash 15,000 Discount 3,378
+$459,450(proceeds)
-$15,000(interest)
Discount $40,550Balance
Net BookValue $459,450
Net Book Value x Effective Interest Rate$459,450 x 8% x 1/2 = $18,378
1/1/03 6/30/03 12/31/03 6/30/04
Review ProblemReview ProblemTime Line and SolutionTime Line and Solution
Interest Expense 18,378 Cash 15,000 Discount 3,378
Interest Expense 18,378 Cash 15,000 Discount 3,378
+$459,450(proceeds)
-$15,000(interest)
Discount $40,550 $37,172 ($40,550 - $3,378)Balance
Net BookValue $459,450 $462,828 ($500,000 - $37,172)
1/1/03 6/30/03 12/31/03 6/30/04
Review ProblemReview ProblemTime Line and SolutionTime Line and Solution
+$459,450(proceeds)
-$15,000(interest)
-$15,000(interest)
Discount $40,550 $37,172Balance
Net BookValue $459,450 $462,828
1/1/03 6/30/03 12/31/03 6/30/04
Review ProblemReview ProblemTime Line and SolutionTime Line and Solution
+$459,450(proceeds)
-$15,000(interest)
-$15,000(interest)
Discount $40,550 $37,172Balance
Net BookValue $459,450 $462,828
Interest Expense 18,513 Cash 15,000 Discount 3,513
Interest Expense 18,513 Cash 15,000 Discount 3,513
$462,828 x 8% x 1/2 = $18,513
1/1/03 6/30/03 12/31/03 6/30/04
Review ProblemReview ProblemTime Line and SolutionTime Line and Solution
+$459,450(proceeds)
-$15,000(interest)
-$15,000(interest)
Discount $40,550 $37,172 $33,669Balance
Net BookValue $459,450 $462,828 $466,341
Interest Expense 18,513 Cash 15,000 Discount 3,513
Interest Expense 18,513 Cash 15,000 Discount 3,513
1/1/03 6/30/03 12/31/03 6/30/04
Review ProblemReview ProblemTime Line and SolutionTime Line and Solution
+$459,450(proceeds)
-$15,000(interest)
-$15,000(interest)
-$15,000(interest)
Discount $40,550 $37,172 $33,669Balance
Net BookValue $459,450 $462,828 $466,341
1/1/03 6/30/03 12/31/03 6/30/04
Review ProblemReview ProblemTime Line and SolutionTime Line and Solution
+$459,450(proceeds)
-$15,000(interest)
-$15,000(interest)
-$15,000(interest)
Discount $40,550 $37,172 $33,669Balance
Net BookValue $459,450 $462,828 $466,341
Interest Expense 18,653 Cash 15,000 Discount 3,653
Interest Expense 18,653 Cash 15,000 Discount 3,653
1/1/03 6/30/03 12/31/03 6/30/04
Review ProblemReview ProblemTime Line and SolutionTime Line and Solution
+$459,450(proceeds)
-$15,000(interest)
-$15,000(interest)
-$15,000(interest)
Discount $40,550 $37,172 $33,669 $30,006Balance
Net BookValue $459,450 $462,828 $466,341 $469,994
Interest Expense 18,653 Cash 15,000 Discount 3,653
Interest Expense 18,653 Cash 15,000 Discount 3,653
1/1/03 6/30/03 12/31/03 6/30/04
Review ProblemReview ProblemTime Line and SolutionTime Line and Solution
+$459,450(proceeds)
-$15,000(interest)
-$15,000(interest)
-$15,000(interest)-$480,000
(redemption)
Discount $40,550 $37,172 $33,669 $30,006Balance
Net BookValue $459,450 $462,828 $466,341 $469,994
1/1/03 6/30/03 12/31/03 6/30/04
Review ProblemReview ProblemTime Line and SolutionTime Line and Solution
Bonds Payable 500,000Loss on Retirement 10,006 Discount 30,006 Cash 480,000
Bonds Payable 500,000Loss on Retirement 10,006 Discount 30,006 Cash 480,000
+$459,450(proceeds)
-$15,000(interest)
-$15,000(interest)
-$15,000(interest)-$480,000
(redemption)
Discount $40,550 $37,172 $33,669 $30,006Balance
Net BookValue $459,450 $462,828 $466,341 $469,994
1/1/03 6/30/03 12/31/03 6/30/04
Review ProblemReview ProblemTime Line and SolutionTime Line and Solution
Bonds Payable 500,000Loss on Retirement 10,006 Discount 30,006 Cash 480,000
Bonds Payable 500,000Loss on Retirement 10,006 Discount 30,006 Cash 480,000
+$459,450(proceeds)
-$15,000(interest)
-$15,000(interest)
-$15,000(interest)-$480,000
(redemption)
Discount $40,550 $37,172 $33,669 $0Balance
Net BookValue $459,450 $462,828 $466,341 $0
1/1/03 6/30/03 12/31/03 6/30/04
C O P Y R I G H T
C o p y r i g h t © 2 0 0 3 , J o h n W i l e y & S o n s , I n c . A l l r i g h t s r e s e r v e d .R e p r o d u c t i o n o r t r a n s l a t i o n o f t h i s w o r k b e y o n d t h a t p e r m i t t e d i n S e c t i o n 1 1 7 o f t h e 1 9 7 6 U n i t e d S t a t e s C o p y r i g h t A c t w i t h o u t t h ee x p r e s s w r i t t e n p e r m i s s i o n o f t h e c o p y r i g h t o w n e r i s u n l a w f u l . R e q u e s t f o r f u r t h e r i n f o r m a t i o n s h o u l d b e a d d r e s s e d t o t h e P e r m i s s i o n s D e p a r t m e n t , J o h n W i l e y & S o n s , I n c . T h e p u r c h a s e r m a y m a k e b a c k - u p c o p i e s f o r h i s / h e r o w n u s e o n l y a n d n o t f o r d i s t r i b u t i o n o r r e s a l e . T h e P u b l i s h e r a s s u m e s n o r e s p o n s i b i l i t yf o r e r r o r s , o m i s s i o n s , o r d a m a g e s , c a u s e d b y t h e u s e o f t h e s e p r o g r a m s o r f r o m t h e u s e o f t h e i n f o r m a t i o n c o n t a i n e d h e r e i n .