1 Chapter 10 Long-Term Liabilities 1,000 Financial Accounting, Alternate 4e by Porter and Norton.

transcript

Chapter 10

Long-Term Liabilities

Financial Accounting, Alternate 4e by Porter and Norton

Balance Sheet Classifications

Current Liabilities:

Long-Term Liabilities:

due within one year of the balance sheet date

due beyond one year

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Long-Term Liabilities

Bonds Payable Notes Payable Leases Deferred Taxes Pensions Other Postretirement Benefits

Interest forInvestor

Borrower

$10,000 9% BondDue 2019

Long-term borrowing arrangement Interest paid at stated rate and times Principal repaid at maturity date

Investor

Borrower

Bond Features

Collateralized - backed by

specific assets in event of default

Debentures -backed only by general credit-worthiness of issuer

Bond Features

Term - Entire principal due on a specific single date

Serial - Principal repaid in installments over time

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Bond Features

Convertible -

into common stock

Callable / Redeemable - may be retired before maturity date

CommonStock 1,000

Bond Interest Rates

Face Rate -

interest is paid at the rate specified on the bond

Market Rate -

the interest rate the bond will yield after selling at a discount or premium

Payche

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Dept..

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Jane D

8% Return

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

Bonds Sold at Face Value

Issuance of bonds at face value:

Assets = Liab. + O/E + Rev. – Exp.Cash 10,000 Bonds Pay. 10,000

Face Value of Bonds = Sales Price

Relationship of Interest Rates and Bond Prices

BondPrices

MarketInterestRates

PV = ?

Calculating Bond Prices - two sets of cash flows

(2) Principal due at maturity(single sum)

PV = ? $$$$$

(1) Interest Payments made each period (annuity)

etc. $$ $$ $$

Determining Bond Prices

On 1/1/04, Discount Firm issues: $10,000; 8% bonds. due December 31, 2007 Interest payable annually Market rate of interest = 10%

Calculate the issue price of the bonds.

Example:

PV = ?

Calculating Bond Prices

(1) Interest Payments (4 payments @ $800)

2004 2005 2006 2007

$800 $800

Interest is always paid at rate stated

on bonds ($10,000 @ 8%)

Calculating Bond Prices

(2) Principal of $10,000 due at end of 20072007

PV = ? $10,000

(1) Interest Payments (4 payments @ $800)

PV = ? $800 $800

2004 2005 2006 2007

$800 $800

Present value:interest payments - $ 800 x 3.170 = $ 2,536

(PV; n=4; i = 10%)

principal payment - $ 10,000 x 0.683 = 6,830

(PV; n=4; i = 10%)

Bond issue price: $ 9,366

Example of Price Calculation

…butdiscount

@ market rate

Compute interestpayment at stated rate (i.e. 8%) ...

Recording Bond Discounts

Issue bonds at a discount:

Discount on Bonds Pay. (634)

Balance Sheet Presentation of Bond Discount

Long-term Liabilities:

Bonds Payable $10,000 $10,000

Less: Discount on

Bonds Payable (634) - 0 -

$ 9,366 $10,000

At Date Uponof Sale Maturity

amortize to Interest Expense

over the life of th

e bond

Determining Bond Prices

Assume Premium Firm sells the same $10,000; 8% bonds when the market rate on similar bonds is 6%.

Present value:interest payments - $ 800 x 3.465 = $ 2,772

(PV; n=4; i = 6%)

principal payment - $ 10,000 x 0.792 = 7,920

(PV; n=4; i = 6%)

Bond issue price: $10,692

Example of Price Calculation

…butdiscount

@ market rate

Compute interestpayment at stated rate (i.e. 8%) ...

Recording Bond Premiums

Issue bonds at a premium:

Discount on Bonds Pay. 692

Balance Sheet Presentation of Bond Premium

Long-term Liabilities:

Bonds Payable $10,000 $10,000

Plus: Premium on

Bonds Payable 692 - 0 -

$10,692 $10,000

At Date Uponof Sale Maturity

amortize to Interest Expense

over the life of th

e bond

Amortization of Bond Premiums and Discounts

Transfer to interest expense over the life of the bond using effective interest method

Discountincreasesinterestexpense

Premiumreducesinterestexpense

Amortization Schedule - Discount

Cash Interest Discount CarryingDate Interest Expense Amortized Value

8% 10% Col. 2 - Col. 1

1/1/04 – – – $ 9,366

12/31/04 $ 800 $ 937 $ 137 9,503

12/31/05 800 950 150 9,653

12/31/06 800 965 165 9,818

12/31/07 800 982 182 10,000

(rounded)

Amortization Schedule - Premium

Cash Interest Premium Carrying

Date Interest Expense Amortized Value 8% 6% Col. 1 - Col. 2

1/1/04 – – – $ 10,692

12/31/04 $ 800 $ 642 $ 158 10,534

12/31/05 800 632 168 10,366

12/31/06 800 622 178 10,188

12/31/05 800 612 188 10,000

(rounded)

Redemption of Bonds

Reasons for early redemption: Excess cash Changing interest rates

Gain = Carrying Value - Redemption Price

(Loss) = Redemption Price - Carrying Value

Leases

Contractual arrangement Grants right to use asset in exchange for payment Form of financing

FEDERAL RESERVE NOTE

THE UNITED STATES OF AMERICATHE UNITED STATES OF AMERICA

L70744629F

ONE DOLLARONE DOLLAR

WASHINGTON, D.C.

THIS NOTE IS LEGAL TENDER

FOR ALL DEBTS, PUBLIC AND PRIVATE

SERIES

Rights

LesseeLessor

Capital Lease

Record as asset and corresponding liability (as if purchased through borrowings)

Depreciate asset over lease term

Separate payments into principal and interest components using the effective interest method

Criteria for Lease Capitalization

Transfers ownership of property

Contains bargain purchase option

Term is > 75% of property’s life

PV of payments > 90% of property FMV

Title Lease meets one or more:

FEDERAL RESERVE NOTE

THE UNITED STATES OF AMERICATHE UNITED STATES OF AMERICA

L70744629F

ONE DOLLARONE DOLLAR

WASHINGTON, D.C.

THIS NOTE IS LEGAL TENDER

FOR ALL DEBTS, PUBLIC AND PRIVATE

SERIES

Payche

ck for

of Tre

asurer

Jane D

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Operating Leases

Record as rent (lease) expense each period

Disclose future lease obligations in footnotes

OFFICESPACE

FOR LEASE

Long-Term Liabilities on the Statement of Cash Flows

Operating Activities

Net income xxx

Increase in current liability +

Decrease in current liability –

Investing Activities

Financing Activities

Increase in long-term liability +

Decrease in long-term liability –31

Debt-to-Equity Ratio

Total LiabilitiesTotal Stockholders’ Equity

How much have creditors contributed as compared to

owners?

Appendix

Accounting Tools:

Other Liabilities

Deferred Taxes

Reflects temporary differences between book and tax accounting methods

Book tax expense Cash paid to IRS=Tax

ReturnLiability

IncomeStatementExpense

Pay to the order of:

IRSABC Co.

Deferred Income Taxes

Depreciation expense

Income before tax

Tax rate

Income tax

Book Tax

$6,000 $6,000

2,500 4,000

3,500 2,000

40% 40%

$1,400 $ 800

Difference recordedas deferred tax

Deferred Income Taxes

Income tax

Book Tax

$1,400 $ 800

Effect on financial statements:

Assets = Liab. + O/E + Rev. – Exp. Tax Pay. 800 Tax Exp. (1,400)

Deferred Tax 600

Balance Sheet Income Statement

Pensions

Payche

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of Tre

asurer

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Payche

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Payche

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Employercontributes

toPension

Pays benefits to retiredemployees

of Tre

asurer

Pension Fund XYZ Corp.

Pensions

Expense accrued in period employee earns benefits (regardless of when paid)

Expense may amount funded=

Pensions on the Balance Sheet

ASSETS

Prepaid Pension Cost $$

LIABILITIES

Accrued Pension Cost $$

Funding >

Expense

Expense >

Funding

Postretirement Benefits

Benefits paid to employees after retirement e.g., health costs

Record expense when employee earns benefits, not when paid (matching principle)

End of Chapter 10

1 Chapter 10 Long-Term Liabilities 1,000 Financial Accounting, Alternate 4e by Porter and Norton.

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