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Chapter Ten

Chapter Ten. Accounting for Long-Term Debt. Show how the amortization of long-term notes affects financial statements. LO 1. LO 1. Principal. Payments. Long-Term Notes Payable. Long-term notes are liabilities that usually have terms from two to five years. Company. Lender.

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Chapter Ten

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  1. Chapter Ten Accounting for Long-Term Debt

  2. Show how the amortization of long-term notes affects financial statements. LO 1 LO 1

  3. Principal Payments Long-Term Notes Payable Long-term notes are liabilities that usuallyhave terms from two to five years. Company Lender Each payment covers interest for the period and a portion of the principal. With each payment, the interest portion gets smaller and the principal portion gets larger.

  4. Long-Term Notes Payable Applying payments to principal and interest • Identify the unpaid principal balance. • Amount applied to interest = Unpaid principal balance × Interest rate. • Amount applied to principal = Cash payment – amount applied to interest in . • Unpaid principal balance = Unpaid principal balance in  – amount applied to principalin .

  5. Long-Term Notes Payable On January 1, 2008, Blair Company issued a $100,000 face value long-term note to National Bank. The note had a 9 percent annual interest rate and a five year term. The loan agreement called for five equal payments of $25,709 to be made on December 31 of each year. Prepare an amortization table for Blair’s note.

  6. Long-Term Notes Payable

  7. Long-Term Notes Payable Annual payments are constant. The amount applied to the principal increases each year. The amount of interest decreases each year.

  8. Issuing the note has the following effecton Blair’s 2008 financial statements: The December 2008 cash payment has the followingeffect on Blair’s 2008 financial statements: Long-Term Notes Payable

  9. Impact on Financial Statements

  10. Security for Bank Loan Agreements To reduce the risk that theywill not be repaid, lenders often: Require debtors topledge collateralto secure the loan Include covenants in theloan agreement restricting: • Additional borrowing • Dividends • Salary increases.

  11. Show how a line of credit affects financial statements. LO 1 LO 2

  12. Line of Credit • Enable the company to borrow and repay funds • Usually specify a maximum credit line • Normally used for short-term borrowing to finance seasonal business needs.

  13. Explain how bond liabilities and their related interest costs affect financial statements. LO 1 LO 3

  14. Bond Liabilities Significant debt needs of a company are often filled by issuingbonds. Bonds Cash

  15. Bond Liabilities • Long-term borrowing of a large sum of money, called the principal. • Principal is usually paid back as a lump sum at maturity. • Individual bonds are often denominated with a face value, of $1,000.

  16. Bond Liabilities • Periodic interest payments based on a stated rate of interest. • Interest is paid semiannually. • Interest paid is computed as: Interest = Principal × Stated Interest Rate × Time • Bond prices are quoted as a percentage of the face amount. For example, a $1,000 bond priced at 104 would sell for $1,040.

  17. Bond Liabilities Bond Selling Price Bond Certificate at Face Value Corporation Investors Bond Issue Date

  18. Bond Liabilities Bond Interest Payments Corporation Investors Bond Interest Payments Interest Payment = Principal × Interest Rate × Time Bond Issue Date

  19. Bond Liabilities Bond Principal at Maturity Date Corporation Investors Bond Issue Date Bond Maturity Date

  20. Bond Liabilities Advantages of bonds • Longer term to maturity than notes payable issued to banks. • Bond interest rates are usually lower than bank loan rates.

  21. Characteristics of Bonds Term and Serial Convertible and Callable Secured and Unsecured

  22. Bonds Issued at Face Value Mason Company issues bonds on January 1, 2008. Principal = $100,000 Stated Interest Rate = 9% Interest Paid Annually on 12/31 Maturity Date = Dec. 31, 2012 (5 years) Bond Selling Price Bond Certificate at Face Value Mason Company Investors

  23. Bonds Issued at Face Value Issuing the bonds has the following effecton Mason’s 2008 financial statements: To record the bond issue, Mason makes the following entry on January 1, 2008:

  24. Bonds Issued at Face Value On each interest payment date, Mason will pay $9,000 in interest. The amount is computed as follows: $100,000 × 9% = $9,000 Bond Interest Payments Mason Company Investors

  25. Bonds Issued at Face Value The December 31, 2008 interest payment (and all other annual interestpayments) has the following effect on Mason’s financial statements: To record an interest payment, Mason makes the following entry on each December 31:

  26. Bonds Issued at Face Value On December 31, 2012, Mason will return the $100,000 principal amount to the investors. Bond Principal at Maturity Date Mason Company Investors

  27. Bonds Issued at Face Value The principal repayment on December 31, 2012 will have thefollowing effect on Mason’s 2012 financial statements: To record an the principal repayment, Mason Company would makethe following entry on December 31, 2012:

  28. Bonds Issued at Face Value

  29. Bonds Issued at Face Value

  30. Use the straight-line method to amortize bond discounts and premiums. LO 1 LO 4

  31. Bonds Issued at a Discount If bonds of other companies are yielding more than 9 percent, investors will be unwilling to pay the full face amount for Mason’s 9 percent bonds. The issue price of Mason’s 9 percent bonds will have to be lower to entice investor interest. The difference between the lower issue price and the principal of $100,000 is called a discount. Let’s continue the Mason Company example.

  32. The only change fromprevious Mason example. Bonds Issued at a Discount Mason Company issues bonds on January 1, 2008. Principal = $100,000 Issue price = $95,000 Stated Interest Rate = 9% Interest Date = 12/31 Maturity Date = Dec. 31, 2012 (5 years)

  33. Issuing the bonds at a discount has the followingeffect on Mason’s 2008 financial statements: Bonds Issued at a Discount To record the bond issue, Mason Company wouldmake the following entry on January 1, 2008:

  34. Bonds Issued at a Discount Face Value Carrying Value

  35. Bonds Issued at a Discount Amortizing the discount over the term of the bond increases Interest Expense each interest payment period. Using the straight-line method, the discount amortization will be $1,000 every year. $5,000 ÷ 5 years = $1,000

  36. Bonds Issued at a Discount The December 31, 2008 interest payment (and all other annual interest payments) has the following effect on Mason’s financial statements: To record an interest payment, Mason Company would makethe following entry on each December 31: Contra Liability – decrease with a credit

  37. Bonds Issued at a Discount $5,000 – $1,000 = $4,000 Face Value The carrying value willincrease to exactly $100,000on the maturity date. Carrying Value

  38. Bonds Issued at a Discount The principal repayment on December 31, 2012 will have thefollowing effect on Mason’s 2012 financial statements: To record an the principal repayment, Mason Company would makethe following entry on December 31, 2012:

  39. Effect of Semiannual Interest Payments For semiannual interest payments, the company would make payments of $4,500 on June 30 and December 31 of each year.

  40. Use the straight-line method to amortize bond discounts and premiums. LO 1 LO 4

  41. Bonds Issued at a Premium If bonds of other companies are yielding less than 9 percent, investors will be willing to pay more than the face amount for Mason’s 9 percent bonds. The issue price of Mason’s 9 percent bonds will rise because of investor demand for the 9 percent bonds. The difference between the higher issue price and the principal of $100,000 is called a premium. Let’s continue the Mason Company example.

  42. The only change from theoriginal Mason example. Bonds Issued at a Premium Mason Company issues bonds on January 1, 2008. Principal = $100,000 Issue price = $105,000 Stated Interest Rate = 9% Interest Date = 12/31 Maturity Date = Dec. 31, 2012 (5 years)

  43. Bonds Issued at a Premium Issuing the bonds at a premium has the followingeffect on Mason’s 2008 financial statements: To record the bond issue, Mason Company wouldmake the following entry on January 1, 2008:

  44. Bonds Issued at a Premium Face Value Carrying Value

  45. Bonds Issued at a Premium Amortizing the premium over the term of the bond decreases Interest Expense each interest payment period. Using the straight-line method, the premium amortization will be $1,000 every year. $5,000 ÷ 5 periods = $1,000

  46. To record an interest payment, Mason Company would makethe following entry on each December 31: Bonds Issued at a Premium The December 31, 2008 interest payment (and all other annual interestpayments) has the following effect on Mason’s financial statements:

  47. $5,000 – $1,000 = $4,000 Bonds Issued at a Premium Face Value The carrying value willdecrease to exactly $100,000on the maturity date. Carrying Value

  48. Bonds Issued at a Premium The principal repayment on December 31, 2012 will have thefollowing effect on Mason’s 2012 financial statements: To record an the principal repayment, Mason Company would makethe following entry on December 31, 2012:

  49. The selling price of a bond is determined by the market rate of interest versus the stated rate of interest. The Market Rate of Interest = = < < > >

  50. Bond Redemptions Gains or losses incurred as a result of early redemption of bonds should be reported as other income or other expense on the income statement. Companies may redeem bonds with acall provision prior to the maturity date.

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