Post on 03-Jan-2016
transcript
©CourseCollege.com
1
16 Long Term Debt
ProfitDebit Credit or
Loss
Expenses
BALANCE SHEET INCOME STATEMENT
Assets Liabilities Revenue
Equity
Long term debt -liabilities with
due dates greater than
one year.
Learning Objectives1. Explain accounting for long term
note origination and interest accrual
2. Describe various note types, repayment structures, collateral and loan agreements
3. Explain accounting for capital and operating lease obligations
4. Describe the structure of bonds, their issuance and interest payments
5. Analysis: Compute and explain debt coverage and times interest earned ratios
©CourseCollege.com
2
Objective 16.1: Explain accounting for long term note
origination and interest accrual
O16.1
Long term noteshave due datesbeyond the currentfiscal period*
*or the normal operating cycle whichever is longer
©CourseCollege.com
3
Written promise to pay
Long Term Notes
ProfitDebit Credit or
Loss
Expenses
BALANCE SHEET INCOME STATEMENT
Assets Liabilities Revenue
Equity
Long term notes can be secured or unsecured
Maker is borrower and signs note
Payee is lender and holds note
O16.1
©CourseCollege.com
4
ProfitDebit Credit or
Loss
Expenses
BALANCE SHEET INCOME STATEMENT
Assets Liabilities Revenue
Equity
Why Borrow?All activities can require financing
Investing activities –example: buy equipment
Financing activities –example: payoff debt or fund owner withdrawals or dividends
Operating Activities –example: buy inventory
O16.1
©CourseCollege.com
5
Calculate interest accrued using the following formula:
Calculate interest accrued using the following formula:
With year end Dec 31, 2010, a 3 year note is signed Oct 1 for $100,000 at 8% with annual payments Oct
1
Interest expense and interest payable at year end:
$100,000 x .08 x 90/360 = $2000
With year end Dec 31, 2010, a 3 year note is signed Oct 1 for $100,000 at 8% with annual payments Oct
1
Interest expense and interest payable at year end:
$100,000 x .08 x 90/360 = $2000
Principal amount
Annual Interest
rate
Time Period
in yearsInterestX =
Long Term Notes Payable
Example
X
O16.1
©CourseCollege.com
6
Debit Credit
2009 Balance Forward 0
1-Jul J12 500,000 500,000
LEDGER
Account Name: LONG TERM NOTES PAYABLE Acct #: 280
Date ItemPost Ref. Debit Credit
BALANCE
Debit Credit
2009 Balance Forward 63,200
1-Jul J12 500,000 563,200
LEDGER
Account Name: CASH Acct #: 100
Date ItemPost Ref. Debit Credit
BALANCE
O16.1
Page 12
Date Description PR Debit Credit
1-Jul Cash 100 500,000
Long Term Notes Payable 280 500,000
GENERAL JOURNAL
Example: Origination of a $500,000 long term note
©CourseCollege.com
7
Many note types
Objective 16.2: Describe various note types, repayment
structures, collateral and loan agreements
O16.2
Installment notes
Mortgage notes
Single Pay notes
Interest only notes
©CourseCollege.com
8
Some long term note types
O16.2
Installment notes
Mortgage notes
Single Pay notes
Interest only notesPeriodic interest payments with principal due at maturityPeriodic interest payments with principal due at maturity
Notes accompanying real estate mortgages which secure repaymentNotes accompanying real estate mortgages which secure repayment
Notes with a single payment of interest and principal at maturityNotes with a single payment of interest and principal at maturity
Notes with regular periodic payments of interest and principalNotes with regular periodic payments of interest and principal
©CourseCollege.com
9
CollateralAssets pledged by borrower to secure
notes increasing the assurance of repayment
Collateral pledged such as land, buildings, equipment or financial
assets such as stock & bondsare common
The pledge of collateral gives thelender specific legal rights to the collateral in the event
of nonpayment
Collateral pledged such as land, buildings, equipment or financial
assets such as stock & bondsare common
The pledge of collateral gives thelender specific legal rights to the collateral in the event
of nonpayment
Collateral reduces
risk to the lender
O16.2
©CourseCollege.com
10
Installment Notes –equal principal payments
O16.2
$50,000
Principal Interest
$15,000
$50,000
$12,000
$50,000
$9,000
$50,000
$6,000
$50,000
$3,000
Declining total payments
Yr1
250,000 x .06 = 15,000
Yr2
(250,000-50,000)x .0
6 =12,000
Yr3
(200,000-50,000) x .06 = 9,000
Yr4
(150,000-50,000) x .06 = 6,000
Yr5
(100,000-50,000) x .06 = 3,000
Equal principal payments
©CourseCollege.com
11
Installment Notes –equal principal & interest payments
Original Annual Interest Principal Balance
Note amt payment Accrued reduction after payment
Year 1 $250,000 $59,349 - $15,000 = $44,349 $205,651
Year 2 $59,349 - $12,339 = $47,010 $158,641
Year 3 $59,349 - $9,518 = $49,831 $108,810
Year 4 $59,349 - $6,529 = $52,820 $55,990
Year 5 $59,349 - $3,359 = $55,990 $0
Original Annual Interest Principal Balance
Note amt payment Accrued reduction after payment
Year 1 $250,000 $59,349 - $15,000 = $44,349 $205,651
Year 2 $59,349 - $12,339 = $47,010 $158,641
Year 3 $59,349 - $9,518 = $49,831 $108,810
Year 4 $59,349 - $6,529 = $52,820 $55,990
Year 5 $59,349 - $3,359 = $55,990 $0
$44,349 $47,010
$15,000 $12,339
$49,831
$9,518
$52,820
$6,529$55,990 $3,359
Principal Interest
Yr1 Yr2 Yr3 Yr4 Yr5
Equal total payments
$59,3
49
©CourseCollege.com
12
O16.2
$44,349 $47,010
$15,000 $12,339
$49,831
$9,518
$52,820
$6,529$55,990 $3,359
Principal Interest
Yr1 Yr2 Yr3 Yr4 Yr5
Equal total payments
$59,3
49
Current Portion of Long Term Debt 44,349Long Term Debt 205,651 Total LTD 250,000
Year 1
Equity
Balance SheetAssets Liabilities
Current portion of long term debt
©CourseCollege.com
13
Objective 16.3: Explain accounting for capital and operating lease obligations
A lease is a rental agreement between the user and the owner of an asset
Depending on whether a transfer of ownership takes place, the lease may be
an operating lease or a capital lease
Accounting treatment is very different for the two types of leases
Depending on whether a transfer of ownership takes place, the lease may be
an operating lease or a capital lease
Accounting treatment is very different for the two types of leases
O16.3
©CourseCollege.com
14
Parties involved in a lease
O16.3
Lease Agreement
Lessor:__________Lessee:__________
Lease Agreement
Lessor:__________Lessee:__________ Lessee
Uses the AssetProvides the Asset
Lessor
Lessor
Lessee
©CourseCollege.com
15
Capital or Operating Lease?
ProfitDebit Credit or
Loss
Expenses
BALANCE SHEET INCOME STATEMENT
Assets Liabilities Revenue
Equity
O16.3
YES
Operating Lease
CapitalLease
NO
Virtually all benefits and risks of ownership transferred to
Lessee?
Capital lease is recorded
on the balance sheet
©CourseCollege.com
16
The 4 rules that qualify capital leases
1.The lease transfers ownership of the property to
the lessee.
ProfitDebit Credit or
Loss
Expenses
BALANCE SHEET INCOME STATEMENT
Assets Liabilities Revenue
Equity
Record the leased asset and liability
on the balance sheet
It’s a capital lease if:
O16.3
©CourseCollege.com
17
The 4 rules that qualify capital leases
2.The lease contains a bargain purchase option.
ProfitDebit Credit or
Loss
Expenses
BALANCE SHEET INCOME STATEMENT
Assets Liabilities Revenue
Equity
Record the leased asset and liability
on the balance sheet
It’s a capital lease if:
O16.3
©CourseCollege.com
18
The 4 rules that qualify capital leases
3.The lease term is 75% or more of the estimated
economic life of the leased asset.
ProfitDebit Credit or
Loss
Expenses
BALANCE SHEET INCOME STATEMENT
Assets Liabilities Revenue
Equity
Record the leased asset and liability
on the balance sheet
It’s a capital lease if:
O16.3
©CourseCollege.com
19
The 4 rules that qualify capital leases
4.The present value of the minimum lease payments equals
or exceeds 90% of the fair market
value of the leased asset.
ProfitDebit Credit or
Loss
Expenses
BALANCE SHEET INCOME STATEMENT
Assets Liabilities Revenue
Equity
Record the leased asset and liability
on the balance sheet
It’s a capital lease if:
O16.3
©CourseCollege.com
20
Operating lease -example
O16.3
Cameron Construction signed a 24 month lease for a new compressor. There is no change in ownership and no bargain purchase option. The lease does not meet the 75% and 90% test as shown below. Therefore, this is an operating lease. No asset or liability is recorded, rental payments are expensed as incurred.
Page 4
Date Description PR Debit Credit
1-May Equipment Rental Expense 565 5,500
Cash 100 5,500
GENERAL JOURNAL
Compressor Lease DetailsLease Lease Fair Value Economic 75% of Econ Present 90% of
Payment Term of Equip Life Life Value Fair value706$ 2 years 24,000$ 10 years 7.5 years $15,000 21,600$
Compressor Lease DetailsLease Lease Fair Value Economic 75% of Econ Present 90% of
Payment Term of Equip Life Life Value Fair value706$ 2 years 24,000$ 10 years 7.5 years $15,000 21,600$
Date of first payment
©CourseCollege.com
21
Capital lease -example
O16.3
Boone Excavating signed a 48 month lease for a new backhoe. There is no change in ownership and no bargain purchase option. The lease meets the 90% test as shown below. Therefore, this is a capital lease. Therefore, the present value of the lease payments is recorded as the leased asset and the lease obligation on the balance sheet as the journal entry below illustrates.
Page 4
Date Description PR Debit Credit
1-Apr Leased Backhoe 565 65,000
Lease Obligation Payable 100 65,000
GENERAL JOURNAL
Backhoe Lease DetailsLease Lease Fair Value Economic 75% of Econ Present 90% of
Payment Term of Equip Life Life Value Fair value1,712$ 4 years 70,000$ 6 years 5 years $65,000 63,000$
Backhoe Lease DetailsLease Lease Fair Value Economic 75% of Econ Present 90% of
Payment Term of Equip Life Life Value Fair value1,712$ 4 years 70,000$ 6 years 5 years $65,000 63,000$
Present value is greater than 90% of fair value, therefore this is a capital lease
©CourseCollege.com
22
Objective 16.4: Describe the structure of bonds, their
issuance and interest payments
O16.4
Bonds are a common form of long term debt available, in general, to large publicly traded firms.
Bonds are a common form of long term debt available, in general, to large publicly traded firms.
The Securities and Exchange
Commission regulates bond
issuance by publicly traded firms
©CourseCollege.com
23
Bonds differ from direct commercial loans in that the source of funds for bonds can consist of a large number individual and institutional investors, each of which would own a portion of the total bond debt. With direct commercial loans, the source of loan funds are from a single financial institution.
Bonds differ from direct commercial loans in that the source of funds for bonds can consist of a large number individual and institutional investors, each of which would own a portion of the total bond debt. With direct commercial loans, the source of loan funds are from a single financial institution.
Bonds compared to commercial loans
O16.4
©CourseCollege.com
24
Bond terminology
O16.4
Bond Trustee
Bond Holder
Bond Indenture
Bond IssuerThe borrower who receives bond funds and promises repaymentThe borrower who receives bond funds and promises repayment
The investor who provides bondfunds and awaits repaymentThe investor who provides bondfunds and awaits repayment
The written agreement specifyingterms of the bond issuanceThe written agreement specifyingterms of the bond issuance
Monitors the terms of the bond indenture for the bond holdersMonitors the terms of the bond indenture for the bond holders
Bond Underwriter Analyzes and accepts bond structurefor bond broker or investment bankAnalyzes and accepts bond structurefor bond broker or investment bank
©CourseCollege.com
25
Floating a bond issue
O16.4
Trustee
Bond Holder(Investor)
Bond Issuer
Underwriter
Bond IndentureBond
Indenture
BondBond
©CourseCollege.com
26
Genway Corporation successfully issued $1,500,000 bonds sold at par on July 1, interest rate 8%.Interest payments are promised July 1 and January 1 each year for the 5 years the bonds are outstanding.
The journal entry for the issuance and the first interest payment is shown below.
Genway Corporation successfully issued $1,500,000 bonds sold at par on July 1, interest rate 8%.Interest payments are promised July 1 and January 1 each year for the 5 years the bonds are outstanding.
The journal entry for the issuance and the first interest payment is shown below.
Bond issuance -journal entry
Page 7
Date Description PR Debit Credit
1-Jul Cash 100 1,500,000
Bonds Payable 295 1,500,000
1-Jan Interest Expense 580 60,000
Cash 100 60,000
GENERAL JOURNAL
O16.4
©CourseCollege.com
27
Objective 16.5: Analysis: Compute and explain debt
coverage and times interest earned ratios
ProfitDebit Credit or
Loss
Expenses
BALANCE SHEET INCOME STATEMENT
Assets Liabilities Revenue
Equity
Compares adjusted
earnings to payments
required to creditors
O16.5
Creditors are especially interested inThese ratios which compare earnings
to required debt payments.
©CourseCollege.com
28
Times Interest Earned RatioAdjusted accrual income = the sum of accrual net income + interest expense + income tax expense + non cash expenses such as depreciation, amortization and depletion.
The higher the ratio, the more adequate earnings
are to cover interest expense
O16.5
Times interest earned
Interest expense
Adjusted accrual income=
©CourseCollege.com
29
Debt Coverage RatioAdjusted accrual income = the sum of accrual net income + interest expense + income tax expense + non cash expenses such as depreciation, amortization and depletion.
The higher the ratio, the more adequate earnings are to cover debt service
payments
O16.5
Debt Coverage Principal & Interest
payments
Adjusted accrual income=
©CourseCollege.com
30
Example -Times interest earned and Debt coverage ratios
O16.5
Assets LiabilitiesCash 123,000 Accounts Payable 536,700Accounts receivable 345,000 Current Portion Long Term Debt 138,600Inventory 410,500 Long Term Debt 823,400Property, Plant, Equipment 1,200,500 Total liabilities 1,498,700
Equity Total assets 2,079,000 Owner, Capital 580,300
Sales 2,347,000
Cost of Goods Sold 1,760,250 Adjusted accrual income 376,150Wages expense 210,600 (NP +Inc tax exp + Int exp + depr)Depreciation expense 60,025 Times Interest earned 4.3Interest expense 86,580 Adjusted accrual income / Interest expenseMisc expense 38,400 Debt Coverage 1.7
Net Profit 191,145
Balance Sheet -Ruiz RecyclingAs of 12/31 2009
Adjusted accrual income/ ( Principal + Interest exp)
Income StatementFor the year ended 12/31/09
X
X