chapter 14 long term liabilities

bearer bond

Bonds made payable to whoever holds them (the bearer); also called unregistered bonds.

Bond

Written promise to pay the bond’s par (or face) value and interest at a stated contract rate; often issued in denominations of $1,000.Bond certificate

Bond certificate

Document containing bond specifics such as issuer’s name, bond par value, contract interest rate, and maturity date.

Bond indenture

Contract between the bond issuer and the bondholders; identifies the parties’ rights and obligations.

Callable bonds

Company can retire bonds early

Debit Bonds Payable 100,000 / Credit Cash 102,000 / Record $2,000 Loss on Retirement

Carrying (book) value of bonds

Net amount at which bonds are reported on the balance sheet; equals the par value of the bonds less any unamortized discount or plus any unamortized premium; also called carrying amount or book value.

Convertible bonds

Bondholders can swap for stock

Debit Bonds Payable 100,000 / Credit Common Stock (par value) + Paid-in Capital for balance

Coupon bonds

Bonds with interest coupons attached to their certificates; bondholders detach coupons when they mature and present them to a bank or broker for collection.

Debt-to-equity ratio

Defined as total liabilities divided by total equity; shows the proportion of a company financed by nonowners (creditors) in comparison with that financed by owners.

Discount on bonds payable

Difference between a bond’s par value and its lower issue price or carrying value; occurs when the contract rate is less than the market rate.

Effective interest method

Allocates interest expense over the bond life to yield a constant rate of interest; interest expense for a period is found by multiplying the balance of the liability at the beginning of the period by the bond market rate at issuance; also called interest method.

Finance lease

Long-term lease where the lessee receives substantially all remaining benefits of the asset (one or more of five criteria must be met); a finance lease is similar to the financing of an asset purchase.

Greenwashing

An organization’s release of deceptive or misleading statements for purposes of making that organization appear more environmentally responsible than it is.

Installment note

Liability requiring a series of periodic payments to the lender.

Lease

Contract specifying the rental of property.

Market rate

Interest rate that borrowers are willing to pay and lenders are willing to accept for a specific lending agreement given the borrowers’ risk level.

Mortgage

Legal loan agreement that protects a lender by giving the lender the right to be paid from the cash proceeds from the sale of a borrower’s assets identified in the mortgage.

Operating lease

Short-term (or cancelable) lease in which the lessor retains risks and rewards of ownership.

Par value of a bond

Amount the bond issuer agrees to pay at maturity and the amount on which cash interest payments are based; also called face amount or face value of a bond.

Pension plan

Contractual agreement between an employer and its employees for the employer to provide benefits to employees after they retire; expensed when incurred.

Premium on bonds

Difference between a bond’s par value and its higher carrying value; occurs when the contract rate is higher than the market rate; also called bond premium.

Registered bonds

Bonds owned by investors whose names and addresses are recorded by the issuer; interest payments are made to the registered owners.

Secured bonds

Bonds that have specific assets of the issuer pledged as collateral.

Serial bonds

Bonds consisting of separate amounts that mature at different dates.

Short-term lease

A lease where the term is 12 months or less and that does not have a long-term purchase option; the lessee records such lease payments as expenses.

Sinking fund bonds

Bonds that require the issuer to make deposits to a separate account; bondholders are repaid at maturity from that account.

Straight-line bond amortization

Method allocating an equal amount of bond interest expense to each period of the bond life.

Term bonds

Bonds scheduled for payment (maturity) at a single specified date.

Unsecured bonds

Bonds backed only by the issuer’s credit standing; almost always riskier than secured bonds; also called debentures.

Contract rate

Interest rate specified in a bond indenture (or note); multiplied by the par value to determine the interest paid each period; also called coupon rate, stated rate, or nominal rate.

Debt to equity ratio =

Total liabilities / Total equity

A five-year, $100,000, 4% Note payable was issued on December 31, 2011. The note requires principal payments of $20,000 plus interest due each year beginning December 31, 2012. On December 31, 2013, immediately after the note payment, the balance sheet would show

A.         $40,000 in Long-term notes payable.

            B.         $6,000 in Interest payable.

            C.         $20,000 in Current portion of long-term notes payable and $6,000 in Interest payable.

            D.         $60,000 in Long-term notes payable.

 

A

       Crystal, Inc.’s trial balance shows $800,000 face value of bonds with a discount balance of $12,000. The bonds mature in 20 years. How will the bonds be presented on the balance sheet?

A.         Bonds payable $800,000 will be listed as a long-term liability. A $12,000 discount on

                        bonds payable will be listed as a current liability.

            B.         Bonds payable $800,000 will be listed as a long-term liability. A $12,000 discount on

                        bonds payable will be listed as a contra-current liability.

            C.         Bonds payable $800,000 will be listed as a long-term liability.

            D.         Bonds payable $788,000 (net of $12,000 discount) will be listed as a long-term liability.

 

D

 

       Bonds payable with face value of $500,000 and term of 20 years were issued on January 1, 2014, for $510,000. On the maturity date, what amount will the company pay to bondholders?

            A.         $25,000

            B.         $510,000

            C.         $500,000

            D.         $2,550

 

C

Dawson Company issued $400,000 of 8% serial bonds at face value on December 31, 2014. Half of the bonds mature January 1, 2017, while the other half of the bonds mature January 1, 2025. On December 31, 2016, the balance sheet will show which of the following?

            A.        Bonds payable of $400,000 will be listed as a long-term liability.

            B.         Bonds payable of $400,000 will be listed as a current liability

            C.         Bonds payable of $200,000 will be listed as a long-term liability. Bonds payable of

                        $200,000 will be listed as a current liability.

            D.         Bonds payable of $408,000 will be listed as a long-term liability.

C

Which of the following is the correct journal entry to record the issuance of a $250,000 face value bond at 95?

            A.        Bonds Payable                                      12,500

                                    Discount on Bonds Payable                    12,500

            B.         Cash                                                     237,500

                                    Bonds Payable                                      237,500

            C.         Cash                                                     237,500

                        Discount on Bonds Payable                    12,500

                                    Bonds Payable                                      250,000

            D.        Bonds Payable                                      237,500

                                    Cash                                                     237,500

C

A $400,000 bond priced at 102 can be bought or sold for

      A.  $400,000 plus interest.

       B.         $102,000.

        C.         $392,000.

          D.         $408,000.

D

Devon signed a 20-year note payable on January 1, 2016. The note requires annual principal payments plus interest. The entry to record the annual payment on December 31, 2016 includes

            A.         a credit to Interest expense.

            B.         a debit to Interest expense.

            C.         a credit to Long-term notes payable.

            D.         a credit to Cash.

 

B

Cat Corporation’s bonds payable carry a stated interest rate of 8%, and the market rate of interest is 5%. The price of the Cat’s bonds will be at

            A.         par value.

            B.         a premium.

            C.         maturity value.

            D.         a discount.

 

B

Cat Corporation’s bonds payable carry a stated interest rate of 8%, and the market rate of interest is 5%. The price of the Cat’s bonds will be at

            A.         par value.

            B.         a premium.

            C.         maturity value.

            D.         a discount.

 

D

       Jana’s Fitness Drinks has $850,000 of 20-year bonds payable outstanding. These bonds had a discount of $42,000 at issuance, which was 8 years ago. The company uses the straight-line amortization method. The carrying amount of these bonds payable is

            A.         $808,000

            B.         $833,200

            C.         $850,000

            D.         $892,000

B

Three Main Bond Transactions

-Issuance

-Interest Payment

-Amortization

Issuance

Sell the bond at par, discount, or premium

Debit Cash Credit Bonds Payable (+ Discount or Premium plug)

Issued $100,000 bond at 98 → Cash 98,000; Discount 2,000; Bonds Payable 100,000

Interest Payment

Pay stated interest every 6 months

Debit Interest Expense Credit Cash

$100,000 × 6% × ½ = $3,000

Amortization

Reduce discount or premium each period

Discount → Debit Interest Expense Premium → Credit Interest Expense

$2,000 discount ÷ 10 periods = $200 added each time

Carrying Value (“Book Value”)

Formulas:

• At Discount → Bonds Payable − Unamortized Discount

• At Premium → Bonds Payable + Unamortized Premium

Behavior Over Time:

• Discounted bond ➡ carrying value increases to face value

• Premium bond ➡ carrying value decreases to face value

Straight-Line Amortization Formula

Amortization per period=Total Discount or Premium/Number of Interest Periods​

Example: $2,000 discount ÷ 10 semiannual periods = $200 each period

Accrued Interest at Year-End

If the year ends before an interest payment date:

Debit Interest Expense, Credit Interest Payable

Example: 3 months accrued on $100,000 × 6% = $1,500