Download Chapter 14 Bonds Bonds Long-Term Liabilities Learning Objectives

Chapter 14
Bonds
Long-Term Liabilities
Annual reports: Coca-Cola
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Bonds
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Long-Term Liabilities
§  Chapter 14
§  Bonds payable
§  Long-term notes payable
§  Mortgages payable
§  Other chapters
§  Pension liabilities
§  Lease liabilities
§  Tax liabilities
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Learning Objectives
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Learning Objective 1
§  Describe formal procedures associated
with issuing long-term debt
1.  Describe formal procedures issuing long-term debt
2.  Identify various types of bond issues
3.  Valuation for bonds at date of issuance
4.  Amortization of bond discount and premium
5.  Extinguishment of non-current liabilities
6.  Accounting for long-term notes payable
7.  Accounting for fair value option
8.  Explain reporting of off-balance-sheet financing
9.  Indicate how to present and analyze long-term debt
10.  Appendix: Troubled debt restructuring
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Long-Term Liabilities
Issuing Bonds
§  Probable sacrifice of future economic
benefits
§  Arising from present obligations
§  Payable in more than one year or
operating cycle, whichever is longer
§  Bond contract = Bond indenture
§  Promise to pay
§  Face value at maturity (single amount)
§  Periodic interest (annuity)
§  Typically a $1,000 face value
§  Interest usually paid semi-annually
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CASH FOR SMALL DEBT
Small debt borrowed from single source
2
$1.6 Billion Bank Loan? No!
§  Bank does not have $1,600,000,000
§  Diversify risk
§  Many small loans
§  A few small defaults
§  Not one big default
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NEED $1.6 BILLION LOAN
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CASH FOR LARGE DEBT
§  Tesla needs cash to build factory
§  Large debt broken into small pieces
Large debts financed by selling bonds to banks,
insurance companies, pension funds, public
Bonds
Cash
$1,600,000,000
Sell 1,600,000 bonds at $1,000 each
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Learning Objective 2
§  Identify various types of bond issues
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Types of Bonds
Secured
Unsecured (debenture)
Term
Serial
Callable
Convertible
Commodity-Backed
Deep-Discount
Registered
Income
Bearer (Coupon)
Revenue
Bond Listings
Zero-coupon
Company
Name
Price as a % of par
Interest rate based on price
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Learning Objective 3, 4
Interest rate paid as
a % of par value
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Issuance, Marketing of Bonds
§  Describe accounting valuation for bonds
at date of issuance
§  Apply methods of bond discount and
premium amortization
§  Issuing company must
§  Arrange for underwriters
§  Obtain SEC approval of bond issue,
undergo audits, and issue a prospectus
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4
Selling Price Determined By
Two Interest Rates
§  Supply of bonds
§  Demand of buyers
§  Relative risk
§  Market conditions
§  State of economy
§  Stated, coupon, nominal, contract
§  Rate written in bond contract
§  Bond issuer sets coupon rate
§  Stated as percentage of face value (par)
§  Market rate, effective yield
§  Rate that provides acceptable return to
bond buyers, considering risk
§  Rate of interest earned by bondholders
25
Par, Premium, Discount
26
Book Value (Carrying Amount)
Bond stated rate, 8%
Market Interest
Bonds Sold At
6%
Premium
8%
Par Value
10%
Discount
−
+
Bonds issued at a discount
Face value
Remaining discount
Book value (Carrying amount)
Bonds issued at a premium
Face value
Remaining premium
Book value (Carrying amount)
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Interest Calculations
Amortization Amount
Effective Interest = Bond book value × market rate × time
Effective interest expense (Market rate)
Annuity Payment = Face value × stated rate × time
Effective Interest = Book value × market rate × time
Changes
Changes
Same
Same
−
Annuity payment (Interest paid)
Annuity Payment = Face value × stated rate × time
Same
Same
Same
Amortization Amount
Effective interest expense
Annuity payment
Amortization amount
Same
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BONDS
BONDS
§  Notes payable
§  Issued to multiple lenders
§  Sold in units of $1,000
§  Bond buyers loan money to earn
interest on excess cash
§  Issuing company to pay bondholder
§  Interest semi-annually
§  Face value on maturity date
§  Face value
§  Par value
§  Maturity value
§  Amount bond holder receives on maturity
date (future value)
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Two Interest Rates
Face value
Issue date
Coupon rate
Maturity date
Interest rate
Note issued at
Stated rate = Market rate
Face value (par)
Stated rate < Market rate
Discount (less than par)
Stated rate > Market rate
Premium (more than par)
Payment dates
33
ISSUED AT PAR
34
ISSUED AT PAR
§  A $1,000 bond issued at par
§  Market rate = coupon rate
§  Bond sells for face value
§  Quoted at 100
§  Sell for 100% of face value
§  Bought or sold for $1,000
§  Interest only loan
§  Interest paid in full at end of each period
§  Face value paid in full on maturity date
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6
Bond Contract
ISSUED AT PAR
Face value
$50,000
Life
3 years
Stated interest rate
Bond Contract
Face value
$50,000
Life
3 years
Stated interest rate
Semi-Annually
Market Rate
10%
Compounding (interest paid)
10%
Compounding (interest paid)
Semi-Annually
Effective interest rate
(market rate)
10%
Issue price
(market price)
$50,000
Market Rate
Effective interest rate
(market rate)
10%
Issue price
(market price)
$50,000
Description
Cash
Debit
50,000
Bonds Payable
Credit
50,000
37
CALCULATE ANNUITY
PAYMENT AT MATURITY
§  Coupon rate used to compute annuity
(periodic interest payments)
§  On maturity date
§  Make last interest payment
§  Pay face value in full
Coupon Payment Calculation
Payment =
Face Value
Payment =
$50,000
Payment =
$2,500
Description
Interest Expense
× Coupon Rate × Time
×
10%
×
38
Description
Interest Expense
1/2
Debit
2,500
Cash
Debit
2,500
Cash
2,500
Beginning
Balance
Effective
Interest
Annuity
Payment
1
50,000
2,500
2,500
50,000
2
50,000
2,500
2,500
50,000
3
50,000
2,500
2,500
50,000
4
50,000
2,500
2,500
50,000
5
50,000
2,500
2,500
50,000
6
50,000
2,500
2,500
50,000
15,000
15,000
0
Description
Bonds Payable
Credit
39
Cash
Credit
2,500
Debit
50,000
Credit
50,000
40
Ending
Balance
50,000
Effective Interest = Beginning balance × market rate × time
Annuity Payment = Face value × stated rate × time
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TWO INTEREST RATES
TWO INTEREST RATES
§  Rate printed on bond called
§  Coupon interest rate
§  Coupon rate
§  Stated rate
§  Contract rate
§  Determines semi-annual payment
§  Market interest rate
§  Determines bond market price (PV)
§  Effective interest expense
§  Market interest rate called
§  Effective-rate
§  Yield-to-maturity
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46
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BOND MARKET
MARKET RATE
§  Many buyers
§  Many sellers
§  Almost perfect information because
§  Compare to bonds from similar corps
§  Due date
§  Industry
§  Risk of default (rating)
§  Bonds are rated
§  Information available over internet
§  Highly efficient
§  Fairly priced
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BOND RATING
50
BOND RATING
§  Independent opinion of risk of default
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BOND RATING
Ç
Investment grade
È
Ç
Junk bonds
È
S&P
AAA
AA
A
BBB
BB
B
C
D
Moody’s
Aaa
Aa
A
Baa
Ba
B
C
D
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ISSUED AT DISCOUNT
§  A $1,000 bond issued at a discount
§  Market rate > coupon rate
§  Bond sells for less than face value
§  For example
§  Quoted at 88 3/8
§  Sells for 88 3/8% of face value
§  Bought or sold for $ 883.75
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10
Two Interest Rates
Interest Calculations
§  Coupon interest rate
Effective interest expense (Market rate)
§  Determines semi-annual payment
Effective Interest = Book value × market rate × time
§  Market interest rate
§  Determines bond market price (PV)
§  Effective interest expense
Changes
Changes
Same
Same
Annuity payment (Interest paid)
Annuity Payment = Face value × stated rate × time
Same
Same
Same
Same
10:61
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Two interest rates
Bond Issued At Discount
Interest rate
Note issued at
Stated rate = Market rate
Face value (par)
Stated rate < Market rate
Discount (less than par)
Stated rate > Market rate
Premium (more than par)
Bond Contract
Face value
$5,000
Life
3 years
Stated interest rate
7%
Compounding (interest paid)
Semi-Annually
Market Rate
Effective interest rate
Issue price
Discount
63
Bond Issued at Discount
Face value
$5,000
Stated rate
7%
Payment =
Face Value
$175
=
Term
Rate per period
PV
PV
0
5%
$382
64
5%
Number of periods
6
Future Value × PV$1 Factor = Present Value
7%
×
$5,000 × 0.746 = $3,730
1/2
Annuity × PV$1 Annuity Factor = Present Value
Rate and Periods (Semi-annual Coupon Payments)
Rate per period
(market discount)
10%
× Coupon Rate × Time
×
10%
$4,618
Rate and Periods (Semi-annual Coupon Payments)
3 years
Market rate
$5,000
(market rate)
(market price)
Number of periods
Present value of future value discounted at market rate of 5%
$175 × 5.076 = $888
6
5,000
3,730
Present value of annuity discounted at market rate of 5%
888
175
175
175
175
175
175
1
2
3
4
5
6
65
Present value of future value discounted at market rate of 5%
5,000
Present value of annuity discounted at market rate of 5%
4,618
175
175
175
175
175
175
0
1
2
3
4
5
6
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11
Calculation of Present Value of Bond (Issue Price)
Present value of future value
+ Present value of annuity
888
Face value of bond
888
Present value of bond (issue price)
3,730
Calculation of Discount on Bond Payable
$3,730
$4,618
Present value of future value discounted at market rate of 5%
5,000
3,730
888
4,618
175
175
175
175
175
175
0
1
2
3
4
5
6
67
Bond Price Stated as
Percentage of Face Value
=
Bond price
=
Bond price
=
Market value of bond
Face value of bond
4,618
5,000
4,618
Discount on bond payable
Present value of annuity discounted at market rate of 5%
Bond price
$5,000
− Present value of bond (issue price)
$ 382
Present value of future value discounted at market rate of 5%
5,000
Present value of annuity discounted at market rate of 5%
4,618
175
175
175
175
175
175
0
1
2
3
4
5
6
Given Bond Price
Calculate Market Value
Ï 100
Market value
=
Ï 100
Market value
=
Market value
=
92.36
Face value Ï Price
100
5,000 Ï 92.36
100
4,618
69
Journal Entry to Issue Bond
Calculation of Discount on Bond Payable
Face value of bond
$5,000
− Present value of bond (issue price)
4,618
Discount on bond payable
Description
Cash
$ 382
Debit
4,618
68
Credit
70
Discount on Bonds Payable
§  Additional interest expense over life of
bond to increase effective interest from
stated rate to market rate
Bonds Payable
5,000
Discount on Bonds Pay
382
Discount on Bonds Payable
382
Bonds Payable
5,000
Issued $5,000 bond at discount; stated rate 7%, market rate 10%
Discount on Bonds Payable is a contra-liability account
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12
Calculation of Discount on Bond Payable
Note Issued at Discount
Face value of bond
4,618
Discount on bond payable
Effective
Interest
Annuity
Payment
Balance Sheet
[Date Bonds Issued]
$ 5,000
Less Discount on Bonds Payable
382
Net Bonds Payable
Discount
Discount
Amortized Remaining
Ending
Balance
1
4,618
231
175
56
382
4,618
326
2
4,674
234
175
4,674
59
267
3
4,733
237
4,733
175
62
205
4
4,795
4,795
240
175
65
140
5
4,860
4,860
243
175
68
72
6
4,928
4,928
246
175
72
0
5,000
0
$ 382
Bonds Payable
$ 382
Beginning
Balance
$5,000
− Present value of bond (issue price)
4,618
Discount on bond payable
Calculation of Discount on Bond Payable
Face value of bond
$5,000
− Present value of bond (issue price)
$ 4,618
73
74
Effective
Interest
=
Beginning
Balance
×
Market
Rate
×
Time
Annuity
=
Face Value
×
Coupon
Rate
×
Time
231
=
4,618
×
10%
×
1/2
175
=
5,000
×
7%
×
1/2
Beginning
Balance
Effective
Interest
Annuity
Payment
Discount
Discount
Amortized Remaining
Ending
Balance
Beginning
Balance
Effective
Interest
Annuity
Payment
1
4,618
231
175
56
382
4,618
0
326
4,674
1
4,618
231
175
56
2
4,674
234
175
59
267
4,733
2
4,674
234
175
3
4,733
237
175
62
205
4,795
3
4,733
237
4
4,795
240
175
65
140
4,860
4
4,795
5
4,860
243
175
68
72
4,928
5
6
4,928
246
175
72
0
5,000
6
0
Discount
Discount
Amortized Remaining
Ending
Balance
382
4,618
326
4,674
59
267
4,733
175
62
205
4,795
240
175
65
140
4,860
4,860
243
175
68
72
4,928
4,928
246
175
72
0
5,000
75
76
Discount
Amortized
=
Effective
Interest
−
Annuity
Payment
Discount
Remaining
=
Prior Discount
Remaining
−
Discount
Amortized
56
=
231
−
175
326
=
382
−
56
Beginning
Balance
Effective
Interest
Annuity
Payment
Discount
Discount
Amortized Remaining
Ending
Balance
Beginning
Balance
Effective
Interest
Annuity
Payment
1
4,618
231
175
56
382
4,618
0
326
4,674
1
4,618
231
175
56
2
4,674
234
175
59
267
4,733
2
4,674
234
175
3
4,733
237
175
62
205
4,795
3
4,733
237
4
5
4,795
4,860
240
243
175
175
65
68
140
72
4,860
4,928
4
5
4,795
4,860
6
4,928
246
175
72
0
5,000
6
4,928
0
77
Discount
Discount
Amortized Remaining
Ending
Balance
382
4,618
326
4,674
59
267
4,733
175
62
205
4,795
240
243
175
175
65
68
140
72
4,860
4,928
246
175
72
0
5,000
78
13
Ending
Balance
=
Face Value
−
Discount
Remaining
4,674
=
5,000
−
326
Beginning
Balance
Effective
Interest
Annuity
Payment
Beginning
Balance
Effective
Interest
Annuity
Payment
Discount
Discount
Amortized Remaining
Ending
Balance
1
4,618
231
175
56
382
4,618
326
2
4,674
234
175
4,674
59
267
3
4,733
237
4,733
175
62
205
4,795
0
Discount
Discount
Amortized Remaining
Ending
Balance
382
4,618
4
4,795
240
175
65
140
4,860
0
1
4,618
231
175
56
326
4,674
5
4,860
243
175
68
72
4,928
2
4,674
234
175
59
267
4,733
6
4,928
246
175
72
0
5,000
3
4,733
237
175
62
205
4,795
1,432
1,050
382
4
4,795
240
175
65
140
4,860
5
4,860
243
175
68
72
4,928
6
4,928
246
175
72
0
5,000
Discount [382] is additional interest expense paid to raise
coupon payments [1,050] to market interest [1,432]
79
80
First Coupon Payment
Beginning
Balance
Effective
Interest
Annuity
Payment
4,618
231
175
Discount
Discount
Amortized Remaining
Ending
Balance
382
4,618
0
326
4,674
267
4,733
Debit
Credit
62
205
4,795
231
65
140
4,860
56
68
72
4,928
175
72
0
5,000
0
1
2
4,674
234
175
Description
3
4,733
237
175
Interest Expense
4
4,795
240
175
Discount on Bonds Payable
5
4,860
243
175
Cash
6
4,928
246
175
First coupon payment on bonds payable
Second Coupon Payment
56
59
Beginning
Balance
Effective
Interest
Annuity
Payment
Discount
Discount
Amortized Remaining
Ending
Balance
1
4,618
231
175
56
382
4,618
326
2
4,674
234
175
59
4,674
267
4,733
3Description
4,733
237
175
4Interest
4,795
240
175
Expense
5 Discount
4,860 on Bonds
243 Payable
175
6
4,928
246
175
Cash
Second coupon payment on bonds payable
62 Debit
205 Credit
4,795
65
140
4,860
234
68
72
4,928
59
72
0
5,000
175
81
Balance Sheet:
End of Second Period
Beginning
Balance
Effective
Interest
Annuity
Payment
1
4,618
231
175
56
2
4,674
234
175
3
4
4,733
4,795
237
240
175
175
5
4,860
243
6
4,928
246
Balance Sheet:
End of Second Period
Discount
Discount
Amortized Remaining
Ending
Balance
382
4,618
326
4,674
59
267
4,733
62
65
205
140
4,795
4,860
175
68
72
4,928
175
72
0
5,000
0
82
83
Bonds Payable
Discount on Bonds Pay
5,000
382
56
59
5,000
267
Balance Sheet
[End of Second Period]
Bonds Payable
$ 5,000
Less Discount on Bonds Payable
Net Bonds Payable
267
$ 4,733
84
14
Two interest rates
Bond Issued At Premium
Interest rate
Note issued at
Stated rate = Market rate
Face value (par)
Stated rate < Market rate
Discount (less than par)
Stated rate > Market rate
Premium (more than par)
§  A $1,000 bond issued at a premium
§  Market rate < coupon rate
§  Bond sells for more than face value
§  For example
§  Quoted at 101½
§  Sells for 101½% of face value
§  Bought or sold for $ 1,015
85
86
Bond Issued at Premium
Bond Issued At Premium
Bond Contract
Face value
$6,000
Life
3 years
Stated interest rate
Premium
12%
Payment =
Face Value
=
Term
3 years
Market rate
8%
× Coupon Rate × Time
$6,000
×
12%
×
1/2
Rate and Periods (Semi-annual Coupon Payments)
Rate per period
4%
Number of periods
6
Semi-Annually
Present value of future value discounted at market rate of 4%
PV
Market Rate
Effective interest rate
Issue price
$6,000
Stated rate
$360
12%
Compounding (interest paid)
Face value
(market rate)
(market price)
8%
$6,627
(market discount)
$627
PV
87
6,000
Present value of annuity discounted at market rate of 4%
0
360
360
360
360
360
360
1
2
3
4
5
6
88
Rate and Periods (Semi-annual Coupon Payments)
Rate per period
4%
Number of periods
6
Calculation of Present Value of Bond (Issue Price)
Present value of future value
Future Value × PV$1 Factor = Present Value
$4,740
+ Present value of annuity
$6,000 × 0.790 = $4,740
1,887
Present value of bond (issue price)
$6,627
Annuity × PV$1 Annuity Factor = Present Value
$360 × 5.242 = $1,887
4,740
1,887
Present value of future value discounted at market rate of 4%
6,000
4,740
Present value of annuity discounted at market rate of 4%
1,887
6,627
360
360
360
360
360
360
0
1
2
3
4
5
6
89
Present value of future value discounted at market rate of 4%
6,000
Present value of annuity discounted at market rate of 4%
6,627
360
360
360
360
360
360
0
1
2
3
4
5
6
90
15
Journal Entry to Issue Bond
Calculation of Premium on Bond Payable
Present value of bond (issue price)
$6,627
− Face value of bond
Calculation of Premium on Bond Payable
6,000
Premium on bond payable
Present value of bond (issue price)
$ 627
$6,627
− Face value of bond
6,000
Premium on bond payable
4,740
1,887
Present value of future value discounted at market rate of 4%
Description
Cash
6,000
360
360
360
360
360
360
0
1
2
3
4
5
6
Debit
6,627
627
Bonds Payable
6,000
Issued $5,000 bond at premium; stated rate 12%, market rate 8%
91
Premium on Bonds Payable
Note Issued at Premium
§  Overpayment of coupon payments
collected in advance to lower effective
interest from stated rate to market rate
Calculation of Premium on Bond Payable
Present value of bond (issue price)
$ 6,627
− Face value of bond
6,000
Premium on bond payable
Bonds Payable
Credit
Premium on Bonds Payable
Present value of annuity discounted at market rate of 4%
6,627
$ 627
$
627
Premium on Bonds Pay
6,000
627
Balance Sheet
[Date Bonds Issued]
Bonds Payable
$ 6,000
Add Premium on Bonds Payable
Premium on Bonds Payable is an adjunct account
$ 6,627
− Face value of bond
6,000
Premium on bond payable
$
Beginning
Balance
Effective
Interest
Annuity
Payment
1
6,627
265
360
95
2
6,532
261
360
3
6,433
257
4
5
6,330
6,223
6
6,112
$ 6,627
93
Calculation of Premium on Bond Payable
Present value of bond (issue price)
627
Net Bonds Payable
94
Effective
Interest
=
Beginning
Balance
×
Market
Rate
×
Time
265
=
6,627
×
8%
×
1/2
627
Premium
Premium
Amortized Remaining
Ending
Balance
Beginning
Balance
Effective
Interest
Annuity
Payment
627
6,627
0
532
6,532
1
6,627
265
360
95
99
433
6,433
2
6,532
261
360
360
103
330
6,330
3
6,433
257
253
249
360
360
107
111
223
112
6,223
6,112
4
5
6,330
6,223
244
360
112
0
6,000
6
6,112
0
95
Premium
Premium
Amortized Remaining
Ending
Balance
627
6,627
532
6,532
99
433
6,433
360
103
330
6,330
253
249
360
360
107
111
223
112
6,223
6,112
244
360
112
0
6,000
96
16
Annuity
=
Face Value
×
Coupon
Rate
×
Time
Premium
Amortized
=
Annuity
Payment
−
Effective
Interest
360
=
6,000
×
12%
×
1/2
95
=
360
−
265
Beginning
Balance
Effective
Interest
Annuity
Payment
Premium
Premium
Amortized Remaining
Ending
Balance
Beginning
Balance
Effective
Interest
Annuity
Payment
1
6,627
265
360
95
627
6,627
0
532
6,532
1
6,627
265
360
95
2
6,532
261
360
99
433
6,433
2
6,532
261
360
3
6,433
257
360
103
330
6,330
3
6,433
257
4
6,330
253
360
107
223
6,223
4
6,330
5
6,223
249
360
111
112
6,112
5
6
6,112
244
360
112
0
6,000
6
0
Premium
Premium
Amortized Remaining
Ending
Balance
627
6,627
532
6,532
99
433
6,433
360
103
330
6,330
253
360
107
223
6,223
6,223
249
360
111
112
6,112
6,112
244
360
112
0
6,000
97
98
Premium&
Remaining
=
Prior Premium
Remaining
−
Premium
Amortized
Ending
Balance
=
Face Value
+
Premium
Remaining
532
=
627
−
95
6,532
=
6,000
+
532
Beginning
Balance
Effective
Interest
Annuity
Payment
Premium
Premium
Amortized Remaining
Ending
Balance
Beginning
Balance
Effective
Interest
Annuity
Payment
1
6,627
265
360
95
627
6,627
0
532
6,532
1
6,627
265
360
95
2
6,532
261
360
99
433
6,433
2
6,532
261
360
3
6,433
257
360
103
330
6,330
3
6,433
257
4
6,330
253
360
107
223
6,223
4
6,330
5
6,223
249
360
111
112
6,112
5
6
6,112
244
360
112
0
6,000
6
0
Premium
Premium
Amortized Remaining
Ending
Balance
627
6,627
532
6,532
99
433
6,433
360
103
330
6,330
253
360
107
223
6,223
6,223
249
360
111
112
6,112
6,112
244
360
112
0
6,000
99
Beginning
Balance
Effective
Interest
Annuity
Payment
1
6,627
265
360
2
6,532
261
3
6,433
257
4
6,330
5
6,223
6
6,112
Premium
Premium
Amortized Remaining
Ending
Balance
0
627
6,627
95
532
6,532
360
99
433
6,433
360
103
330
6,330
253
360
107
223
6,223
249
360
111
112
6,112
0
6,000
244
360
112
1,533
2,160
627
Premium [627] is annuity overpayment collected in advance to
lower coupon payments [2,160] to market interest [1,533]
101
100
First Coupon Payment
Beginning
Balance
Effective
Interest
Annuity
Payment
6,627
265
360
Premium
Premium
Amortized Remaining
Ending
Balance
627
6,627
532
6,532
0
1
2
6,532
261
360
Description
3
6,433
257
360
Interest Expense
4
6,330
253
360
Premium on Bonds Payable
5
6,223
249
360
Cash
6
6,112
244
360
First coupon payment on bonds payable
95
99
433
6,433
Debit
Credit
103
330
6,330
265
107
223
6,223
95
111
112
6,112
360
112
0
6,000
102
17
Balance Sheet:
End of Second Period
Second Coupon Payment
Beginning
Balance
Effective
Interest
Annuity
Payment
Premium
Premium
Amortized Remaining
Ending
Balance
Beginning
Balance
Effective
Interest
Annuity
Payment
1
6,627
265
360
95
627
6,627
0
532
6,532
1
6,627
265
360
95
2
6,532
261
360
99
433
6,433
2
6,532
261
360
3Description
6,433
257
4Interest
6,330
Expense 253
360
360
103 Debit
330 Credit
6,330
107
223
6,223
261
111
6,112
99112
3
4
6,433
6,330
257
253
360
360
5
6,223
249
112
6
6,112
244
0
5Premium
6,223
249
on Bonds
Payable 360
6 Cash
6,112
244
360
0
6,000
360
Premium
Premium
Amortized Remaining
Ending
Balance
627
6,627
532
6,532
99
433
6,433
103
107
330
223
6,330
6,223
360
111
112
6,112
360
112
0
6,000
Second coupon payment on bonds payable
103
Balance Sheet:
End of Second Period
Bonds Payable
104
Book Value (Carrying Amount)
Premium on Bonds Pay
6,000
95
Bonds issued at a discount
627
99
6,000
−
433
Balance Sheet
[End of Second Period]
Bonds Payable
Add Premium on Bonds Payable
$ 6,000
433
Net Bonds Payable
$ 6,433
+
Face value
Remaining discount
Book value (Carrying amount)
Bonds issued at a premium
Face value
Remaining premium
Book value (Carrying amount)
105
106
Bonds Issued Between
Interest Dates
WileyPLUS
§  Brief exercises 1 - 8
§  Bond buyer pays seller interest accrued
from last interest payment date to date
of purchase
§  On next semiannual interest payment
date, bond investors will receive full
annuity payment
107
108
18
Bonds Issued Between
Interest Dates
Bond Issue Costs
§  Debit asset account
Interest payment dates
§  Legal fees
§  Accounting fees
§  Commissions
Interest accrued
§  Amortize over life of debt
§  Effective interest preferred
§  Straight-line commonly used (immaterial)
Bond purchased
109
Bond Issue Costs
WileyPLUS
§  Brief exercises 10
Description
Debit
Credit
Cash
20,550
Unamortized bond issue costs (asset)
240
Premium on bonds payable
790
Bonds payable
20,000
Issued bonds with face value $20,000 for $20,790. Issuing costs, $240
Description
Debit
Bond issue expense
24
Unamortized bond issue costs
End of year AJE: Amortize issue costs over 10 years
110
Credit
24
111
Learning Objective 5
112
Extinguishment of Debt
§  Extinguishment of debt
§  If paid on maturity date
§  Premium / discount fully amortized
§  Issuing costs fully amortized
§  Make last interest payment
§  Pay face value in full
§  Face value = Fair value
§  No gain or loss
§  If debt retired early gain or loss possible
113
114
19
−
Carrying amount
Reacquisition price
Gain (loss) on extinguishment of debt
+
−
−
Face value
Unamortized premium
Unamortized discount
Unamortized issuance costs
Carrying amount (book value)
+
+
Face value
Call premium (callable at 103)
Reacquisition expenses
Reacquisition price
115
WileyPLUS
116
Learning Objective 6
§  Brief exercise 11
§  Explain accounting for long-term notes
payable
117
Long-Term Notes Payable
118
Stated Rate = Market Rate
Description
Debit
Credit
Cash
10,000
Note payable
10,000
$10,000, 10%, 3 year note issued at par (market rate 10% = stated rate)
§  Accounting similar to bonds
§  Note valued at present value of future
interest and principal cash flows
§  Company amortizes discount or premium
over life of note
119
Description
Debit
Interest expense
1,000
Cash
Annual interest payment, $10,000 × 10% × 1 = $1,000
Credit
Description
Debit
Note payable
10,000
Cash
Face value of note payable paid in full on maturity date
Credit
1,000
10,000
120
20
Stated Rate ≠ Market Rate
Zero-Interest-Bearing Notes
§  Stated interest ≠ Effective interest
§  Note face value ≠ Present value
§  Evaluate exchange to properly value
assets, liabilities, and interest
§  Record difference between
§  Face amount (future cash outflow, FV)
§  Cash received (present cash inflow, PV)
§  Discount
§  Discount = Face amount − Cash received
§  Discount is future interest expense
§  Amortize discount using effective interest
method over life of note
121
122
Zero-Interest-Bearing Notes
Zero-Interest-Bearing Notes
§  Implicit interest rate is rate that equates
cash received (present value) with
amount paid in future (future value)
PV
PV
0
PV
123
0
Present value of future value discounted at market rate of 4%
6,000
Present value of annuity discounted at market rate of 4%
360
360
360
360
360
360
1
2
3
4
5
6
Present value of future value discounted at market rate of 4%
1
2
3
4
5
124
6,000
6
124
Note Exchanged For
Noncash Consideration
Interest-Bearing Notes
§  Stated interest rate ≠ Market rate
§  Stated rate unreasonable
§  Use market rate to imputed interest
§  Discount or premium recognized and
amortized over life of note
§  When note exchanged for noncash
consideration (bargained transaction)
stated rate presumed fair unless
§  No interest rate is stated
§  Stated interest rate is unreasonable
§  Stated face amount of debt instrument is
materially different from
§  Current cash sales price for similar items
§  Current fair value of debt instrument
125
126
21
Imputed Rate
Imputed Interest Calculation
§  Imputed rate = Market rate
§  Rate debtor would receive from
independent lender
§  Imputed interest rate to note
1.  Create a timeline showing all future
cash flows
1.  Face value of note paid at maturity date
2.  Interest payments using stated rate
2.  Discount future cash flows using
imputed interest rate
3.  Value asset at discounted amount
4.  Use effective interest calculations
127
128
Note With Unreasonable Stated Interest Rate
Face value
$6,000
Stated rate
12%
Payment =
Face Value
$360
=
Term
Note With Unreasonable Stated Interest Rate
3 years
Face value
$6,000
8%
Stated rate
12%
Payment =
Face Value
Market rate
× Coupon Rate × Time
$6,000
×
12%
×
1/2
$360
Rate and Periods (Semi-annual Coupon Payments)
Rate per period
PV
PV
0
4%
Number of periods
3 years
Market rate
8%
× Coupon Rate × Time
$6,000
×
12%
×
1/2
Rate and Periods (Semi-annual Coupon Payments)
6
Present value of future value discounted at market rate of 4%
=
Term
Rate per period
6,000
4,740
Present value of annuity discounted at market rate of 4%
1,887
360
360
360
360
360
360
1
2
3
4
5
6
129
Notes Issued for Property,
Goods, or Services
4%
Number of periods
Present value of future value discounted at market rate of 4%
6
6,000
Present value of annuity discounted at market rate of 4%
6,627
360
360
360
360
360
360
0
1
2
3
4
5
6
130
WileyPLUS
§  If fair value of property, goods, services
exchanged cannot be determined and
note has no FMV, estimate interest rate
§  Brief exercise 12 - 15
§  Prevailing rates for similar instruments
§  Consider factors such as restrictive
covenants, collateral, payment schedule,
and existing prime interest rate
131
132
22
Mortgage Notes Payable
Learning Objective 7
§  Common method of financing property,
plant, equipment
§  Title to asset pledged as security
§  Points raise effective interest rate
§  If paid on installment basis, current
installment classified as current liability
§  Describe accounting for fair value option
133
134
Fair Value Option
Fair Value Measurement
§  Companies have option to record most
financial assets and liabilities, including
bonds and notes payable, at fair value
§  FASB believes valuing financial
instruments at fair value provides more
relevant, understandable information
than amortized cost
§  Non-current liabilities are recorded at
fair value, with unrealized holding gains
or losses reported as part of net income
Description
Debit
Credit
Bond payable
20,000
Unrealized holding gain (loss)
20,000
Fair value of bonds $20,000 less than book value, write down bonds
§  Amortized cost = Face value + Accrued int
135
WileyPLUS
136
Learning Objective 8
§  Brief exercise 16
§  Explain reporting of off-balance-sheet
financing arrangements
137
138
23
Off-Balance-Sheet Financing
Learning Objective 9
§  Attempt to borrow monies in manner to
avoid recording a liability
§  Indicate how to present and analyze
long-term debt
§  Non-Consolidated Subsidiary
§  Special Purpose Entity (SPE)
§  Operating Leases
§  FASB response: increased disclosure
139
Note Disclosures
140
Note Disclosures
§  Nature of liabilities
§  Maturity dates
§  Interest rates
§  Call provisions
§  Conversion privileges
§  Restrictions imposed by creditors
§  Assets designated, pledged as security
§  Fair value of debt
§  Future payments for sinking fund
requirements
§  Maturity amounts of long-term debt
during each of next five years
141
Ratios
Debt Ratio
(Debt to
Total Assets)
=
Times-InterestEarned Ratio
=
142
WileyPLUS
§  Brief exercise 9
Total Liabilities
Total Assets
Income before taxes, interest
Interest Expense
143
144
24
Learning Objective 10
Troubled-Debt Restructurings
§  Describe accounting for a debt
restructuring (Appendix 14A)
§  Creditor grants concession to debtor
that creditor would not otherwise make
§  Two types of troubled-debt restructuring
1.  Settlement at less than carrying amount
2.  Continuation with modification of terms
Loan
Origination
Loan
Impairment
Modification
of Terms
Possible
Bankruptcy
145
Settlement of Debt:
Two Options
146
Two Gain (Loss) Calculations
§  Transfer of noncash assets
§  Settlement creates two calculations
§  Receivables, inventory, property
#1: Compare BV Debt to FV Assets (Equity) Given
§  Issuance of stock by debtor
Carrying amount of debt (book value)
− Fair value of assets (or equity) given
Creditor records incoming assets (or equity)
at fair value
Debtor’s Gain (Creditor’s Loss)
#2: Assets (Equity) Given: Compare FV to BV
Fair value of assets (or equity) given
− Book value of assets (or equity) given
147
Lender Accepts Land in in Debt Settlement
Book value of debt
$20,000
Fair value of land
$16,000
Land book value (borrower)
$21,000
Lender Accepts Land in in Debt Settlement
$16,000
Debtor’s Gain (Creditor’s Loss)
$ 4,000
$20,000
Fair value of land
$16,000
Description
Debit
Credit
Land
16,000
Allowance for doubtful accounts Plug 4,000
Note receivable
20,000
Lenders books: Lender accepts land in full settlement of $20,000 loan
#2: Assets (Equity) Given: Compare FV to BV
Fair value of assets (or equity) given
$16,000
Debtor’s Gain (or Loss)
Book value of debt
$20,000
− Fair value of assets (or equity) given
− Book value of assets (or equity) given
148
Lender: Debt Settlement #1
#1: Compare BV Debt to FV Assets (Equity) Given
Carrying amount of debt (book value)
Debtor’s Gain (or Loss)
$21,000
($ 5,000)
149
150
25
Lender Accepts Common Stock in Debt Settlement
Borrower: Debt Settlement #1
Lender Accepts Land in in Debt Settlement
Book value of debt
$20,000
Fair value of land
$16,000
Land book value (borrower)
$21,000
Description
Debit
Credit
Note payable
20,000
Loss on disposal of land
5,000
Land
21,000
Gain on debt restructuring
4,000
Plug
Borrowers books: Lender accepts land in full settlement of $20,000 loan
Book value of debt
$20,000
Fair value of common stock
$16,000
Stock book value (borrower)
None
#1: Compare BV Debt to FV Assets (Equity) Given
Carrying amount of debt (book value)
$20,000
− Fair value of assets (or equity) given
$16,000
Debtor’s Gain (Creditor’s Loss)
$ 4,000
#2: Assets (Equity) Given: Compare FV to BV
Fair value of assets (or equity) given
− Book value of assets (or equity) given
151
Lender: Debt Settlement #2
Debtor’s Gain (or Loss)
$16,000
None
None
152
Borrower: Debt Settlement #2
Lender Accepts Common Stock in Debt Settlement
Lender Accepts Common Stock in Debt Settlement
Book value of debt
$20,000
Book value of debt
$20,000
Fair value of common stock
$16,000
Fair value of common stock
$16,000
Description
Debit
Credit
Equity investments (common stock)
16,000
Allowance for doubtful accounts
4,000
Note receivable
20,000
Lenders books: Lender accepts stock in full settlement of $20,000 loan
153
Types of Modifications
Shares issued
320
Par value per share
$10
Description
Debit
Credit
Note payable
20,000
Common stock (320 × $10)
3,200
Additional paid-in capital
12,800
Plug
Gain on debt restructuring
4,000
Borrowers books: Lender accepts land in full settlement of $20,000 loan 154
Modification of Terms
§  Extension of maturity date
§  Reduction of face amount of debt
§  Reduction of stated interest rate
§  Reduction (or deferral) of interest due
§  All of the above
§  Creditor’s loss ≠ Debtor’s gain
Creditor’s Loss
Based upon discounted cash flows
Debtor’s Gain
Based upon undiscounted cash flows
Lender takes a haircut
155
156
26
Modification of Terms
Example 1: Debtor, No Gain
§  Debtor does not record gain when total
future cash flows exceed prerestructuring carrying amount of debt
§  Debtor records gain when prerestructuring carrying amount of debt
exceeds future cash flows
Original
Restructuring
Due date
Dec 31, 2011
Dec 31, 2015
Principal
$10,500,000
$9,000,000
12%
8%
Interest rate
Date of restructuring
Dec 31, 2011
Future cash flows > Pre-restructuring carrying amount
$9,000,000 + ($9,000,000 × 8% × 4) > $10,500,000
$11,880,000 > $10,500,000
157
Debtor makes no entry on restructuring
158
Example 1: Debtor, No Gain
§  Debtor computes effective-interest rate
§  Use PV of new future cash flows and
carrying amount of pre-structuring debt
Description
Debit
Credit
Note payable
356,056
Interest expense
363,944
Cash
720,000
Debtor JE: 12/31/2012, First interest payment after restructuring
159
Example 1: Creditor, Loss
160
Example 1: Creditor, Loss
§  Creditor calculates loss based on future
cash flows discounted at original
(historical) effective interest rate
§  Recognize full loss in period of
restructuring
§  Record periodic interest revenue using
original rate
161
Description
Debit
Credit
Bad debt expense
2,593,428
Allowance for doubtful accounts
2,593,428
162
Creditor JE: 12/31/2011, Record loss on date of restructuring
27
Example 1: Creditor, Loss
Example 2: Debtor, Gain
§  Debtor records gain when prerestructuring carrying amount of debt
exceeds future cash flows
Description
Debit
Credit
Cash
720,000
Allowance for doubtful accounts
228,789
Interest revenue
948,789
Creditor JE: 12/31/2012, First interest payment after restructuring
163
Example 2: Debtor, Gain
Example 2: Debtor, Gain
Future cash flows < Pre-restructuring carrying amount
$7,000,000 + ($7,000,000 × 8% × 4) < $10,500,000
$9,240,000 < $10,500,000
On Dec 31, 2011
§  Principal reduced
§  $10,500,000 to $7,000,000
Calculation of Debtor Gain
Pre-restructuring carrying amount
§  Maturity date extended
§  Dec 31, 2011 to Dec 31, 2015
§  Interest rate reduced
§  From 12% to 8%
Future cash flows < Pre-restructuring carrying amount
$7,000,000 + ($7,000,000 × 8% × 4) > $10,500,000
164
165
Example 2: Debtor, Gain
$10,500,000
Future cash flows
$9,240,000
Gain on debt restructuring
$1,260,000
Description
Debit
Credit
Note payable
1,260,000
Gain on debt restructuring
1,260,000
166
Debtor JE: 12/31/201, Write-down of debt principal after restructuring
Example 2: Creditor, Loss
§  Principal balance on loan is equal to
actual (undiscounted) future cash flows
§  Imputed interest rate = 0%
§  All period payments principal only
§  No interest expense
Description
Debit
Credit
Note payable
560,000
Cash
560,000
167
Debtor JE: 12/31/2012, First interest payment after restructuring
Description
Debit
Credit
Bad debt expense
4,350,444
Allowance for doubtful accounts
4,350,444
Creditor JE: 12/31/2011, Record loss on date of restructuring
168
28
Description
Debit
Credit
Cash
560,000
Allowance for doubtful accounts
177,947
Interest revenue
737,947
Creditor JE: 12/31/2012, First interest payment after restructuring
169
WileyPLUS
170
End of Chapter
§  Exercise 26
171
29