Accounting principles, 13th edition ch15

Accounting Principles
Thirteenth Edition
Weygandt Kimmel Kieso

Chapter 15

Long-Term Liabilities
Prepared by

Coby Harmon
University of California, Santa Barbara
Westmont College


Chapter Outline
Learning Objectives
LO 1 Describe the major characteristics of bonds.

LO 2 Explain how to account for bond transactions.
LO 3 Explain how to account for long-term notes

payable.

LO 4 Discuss how long-term liabilities are reported and

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analyzed.

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Major Characteristics of Bonds
Long-term liabilities are obligations that are expected to be paid after one year.
Bonds are a form of interest-bearing notes payable.
Sold in small denominations (usually $1,000 or multiples of $1,000)
Attract many investors
Corporation issuing bonds is borrowing money
Person who buys the bonds (the bondholder) is investing in bonds

LO 1

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Major Characteristics of Bonds
Types of Bonds
Secured bonds have specific assets of issuer pledged as collateral for bonds
Unsecured bonds, also called debenture bonds, are issued against general credit of
borrower
Convertible bonds can be converted into common stock at bondholder’s option
Callable bonds, issuing company can redeem (buy back) at a stated dollar amount prior to
maturity

LO 1

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Major Characteristics of Bonds
Issuing Procedures
State laws grant corporations power to issue bonds
Board of directors and stockholders must approve bond issues
Board of directors must stipulate number of bonds to be authorized, total face value, and
contractual interest rate
Bond terms set forth in bond indenture
Bond certificate, typically a $1,000 face value

LO 1

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Major Characteristics of Bonds
Issuing Procedures
Represents a promise to pay:

.

sum of money at designated maturity date, plus

.

periodic interest at a contractual (stated) rate on maturity amount (face value)

Interest payments usually made semiannually
Issued to obtain large amounts of long-term capital
Investment company sells bonds for issuing company

LO 1

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ILLUSTRATION 15.1
Bond certificate

LO 1

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Major Characteristics of Bonds
Bond Trading
Bondholders can convert their holdings into cash by selling the bonds at the current
market price on national securities exchanges
Prices are quoted as a percentage of the face value

Issuer

Bonds

Maturity

Close

Yield

Time Warner Cable

6.75

June 15, 2039

116.4

5.49

ILLUSTRATION 15.2
Market information for bonds

LO 1

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Major Characteristics of Bonds
Determining the Market Price of a Bond
Current market price (present value) is a function of three factors:

1.

dollar amounts to be received

2.

length of time until the amounts are received

3.

market rate of interest

Market interest rate is the rate investors demand for loaning funds.

LO 1

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Determining the Market Price of a Bond
Illustration: Assume that Acropolis Company on January 1, 2020, issues $100,000 of 9% bonds, due in five
years, with interest payable annually at year-end. The purchaser of the bonds would receive the following
two types of cash payments: (1) principal of $100,000 to be paid at maturity, and (2) five $9,000 interest
payments ($100,000 x 9%) over the term of the bonds.

$100,000 Principal
$9,000

0

ILLUSTRATION 15.3

1

$9,000

$9,000

$9,000

$9,000

2

3

4

5

Interest

Years

Time diagram depicting
LO 1

cash flows

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Determining the Market Price of a Bond
ILLUSTRATION 15.3

$100,000 Principal
$9,000

0

$9,000

$9,000

$9,000

$9,000

2

3

4

5

1

Interest

Years

The current market price of a bond is equal to the present value of all the future cash payments promised
by the bond.
Present value of $100,000 received in 5 years

$ 64,993

Present value of $9,000 received annually for 5 years
Market price of bonds

35,007

$100,000

ILLUSTRATION 15.4
Computing the market price of bonds
LO 1

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DO IT! 1 Bond Terminology

State whether each of the following statements is true or false.
True1. Mortgage bonds and sinking fund bonds are both
_______
_______

2.

examples of secured bonds.

Unsecured bonds are also known as debenture bonds.

True
_______ 3. The contractual interest rate is the rate investors

demand for loaning funds.

False
_______ 4. The face value is the amount of principal the issuing

company must pay at the

maturity date.
True
_______ 5. The market price of a bond is equal to its maturity

value.

False

LO 1

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Accounting for Bond Transactions
Corporation records bond transactions when it
issues (sells) bonds
redeems (buys back) bonds
when bondholders convert bonds into common stock
If bondholders sell their bond investments to other investors, the issuing company receives
no further money on the transaction, nor does the issuing company journalize the
transaction.

LO 2

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Accounting for Bond Transactions
Issuing at Face Value, Discount, or Premium

Bond Contractual
Interest

Market

Bonds

Interest Rate

Sell at

8%

Premium

10%

Face Value

12%

Discount

Issued
when

Rate 10%

ILLUSTRATION 15.5
Interest rates and bond prices
LO 2

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Accounting for Bond Transactions
The market interest rate:

a.

is the contractual interest rate used to determine the amount of cash interest paid by
the borrower.

LO 2

b.

is listed in the bond indenture.

c.

is the rate investors demand for loaning funds.

d.

More than one of the above is true.

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Issuing Bonds at Face Value

Illustration: On January 1, 2020, Candlestick, Inc. issues $100,000, five-year, 10% bonds at 100 (100% of
face value). The entry to record the sale is:
Cash 100,000
Bonds Payable

LO 2

100,000

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Issuing Bonds at Face Value
Illustration: On January 1, 2020, Candlestick, Inc. issues $100,000, five-year, 10% bonds at 100 (100% of
face value). Assume that interest is payable annually on January 1. At December 31, 2020, Candlestick
recognizes interest expense incurred with the following entry. Assume monthly accruals have not been
made.
Interest Expense 10,000
Interest Payable

LO 2

10,000

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Issuing Bonds at Face Value
Illustration: On January 1, 2020, Candlestick, Inc. issues $100,000, five-year, 10% bonds at 100 (100% of
face value). Assume that interest is payable annually on January 1. Candlestick records the payment on
January 1, 2021, as follows.
Interest Payable 10,000
Cash

LO 2

10,000

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Issuing Bonds at a Discount
Illustration: On January 1, 2020, Candlestick Inc. issues $100,000, five-year, 10% bonds for $98,000 (98% of
face value). Interest is payable annually on January 1. The entry to record the issuance is as follows.
Cash 98,000
Discount on Bonds Payable
Bonds Payable

LO 2

2,000
100,000

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Issuing Bonds at a Discount

ILLUSTRATION 15.6
Statement presentation

Candlestick Inc.
Balance Sheet (partial)
Long-term liabilities
Bonds payable

$100,000

Less: Discount on bonds payable

2,000

$98,000

Sale of bonds below face value (discount) =
total cost of borrowing > interest paid.
Reason: Borrower is required to pay the bond discount at the maturity date. Therefore, the bond discount is
considered to be a increase in the cost of borrowing.

LO 2

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Issuing Bonds at a Discount
Total Cost of Borrowing

ILLUSTRATIONS 15.7 and 15.8

Annual interest payments
($100,000 × 10% = $10,000; $10,000 × 5)

$50,000

Add: Bond discount ($100,000 − $98,000)

2,000

Total cost of borrowing

$52,000
or

Principal at maturity

$100,000

Annual interest payments ($10,000 × 5)

50,000

Cash to be paid to bondholders

150,000

Less: Cash received from bondholders

98,000

Total cost of borrowing

LO 2

$ 52,000

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Issuing Bonds at a Discount

ILLUSTRATION 15.9
Amortization of bond discount

LO 2

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Issuing Bonds at a Premium
Illustration: On January 1, 2020, Candlestick Inc. issues $100,000, five-year, 10% bonds for $102,000 (102%
of face value). Interest is payable annually on January 1. The entry to record the issuance is as follows.
Cash 102,000
Bonds Payable

100,000

Premium on Bonds Payable

LO 2

2,000

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Issuing Bonds at a Premium

ILLUSTRATION 15.10
Statement presentation

Candlestick Inc.
Balance Sheet (partial)
Long-term liabilities
Bonds payable

$100,000

Add: Premium on bonds payable

2,000

$102,000

Sale of bonds below face value (premium) =
total cost of borrowing < interest paid.
Reason: Borrower is not required to pay the bond premium at the maturity date. Therefore, the bond premium is
considered to be a reduction in the cost of borrowing.

LO 2

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Issuing Bonds at a Premium
Total Cost of Borrowing

ILLUSTRATIONS 15.11 and 15.12

Annual interest payments
($100,000 × 10% = $10,000; $10,000 × 5)

$50,000

Less: Bond premium ($102,000 − $100,000)

2,000

Total cost of borrowing

$48,000
or

Principal at maturity

$100,000

Annual interest payments ($10,000 × 5)

50,000

Cash to be paid to bondholders

150,000

Less: Cash received from bondholders

102,000

Total cost of borrowing

LO 2

$ 48,000

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