LongTerm Debt Financing

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• Chapter 10
• Long-Term Debt Financing

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Long-Term Liabilities
Debts and other obligations that will not be paid
in cash or satisfied with other assets or
services within one year.

• Notes payable, Bonds payable, Mortgages payable,
  Lease payments, Pension obligations
• Measurement and recording of long-term
  liabilities are based on the time value of money
  concept
• Calculation of present value and future values
• Use of tables
• Terminology compounding periods, annuity,
• Examples from the textbook

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Interest-Bearing Notes
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Mortgage Payable

• A written promise to pay a stated amount of money
  at one or more specified future dates
• Secured by the pledging of certain assets,
  usually real estate, as collateral
• Generally requires periodic (usually monthly)
  payments of principal plus interest

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Mortgages Payable
On January 1, 2003, Blue Bird Corp. borrowed
500,000 to acquire a new building. The building
was signed as collateral for the 30-year, 7
percent loan. Payments of 3,326.51 are to be
made monthly. What are the January 2003 entries?
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Mortgages Payable
A mortgage amortization schedule shows the
breakdown between interest and principal for each
payment over the life of a mortgage.
Monthly Principal Interest
Mortgage Month Payment Paid
Paid Balance 1 3,326.51
409.84 2,916.67 499,590.16 2
3,326.51 412.23 2,914.28 499,177.93
3 3,326.51 414.64 2,911.87
498,763.29 4 3,326.51 417.06
2,909.45 498,346.23 5 3,326.51
419.49 2,907.02 497,926.74 6
3,326.51 421.94 2,904.57 497,504.80
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Lease Obligations
Lease - A contract that specifies the terms
under which the owner of an asset agrees to
transfer the right to use the asset to another
party Lessee - The party that is granted the
right to use property under the terms of a
lease Lessor - The owner of property that is
rented (leased) to another party Operating lease
- A simple short-term rental agreement Capital
lease - A leasing transaction that is recorded
as a purchase of an asset and the incurrence of a
liability by the lessee
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Classifying Leases
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Lease Obligations
On January 1, 2003, The Cockatoo Company leased a
computer. The lease requires annual payments of
5,000 for 8 years, beginning December 31, 2003.
The applicable interest rate is 12 percent. How
is the lease recorded on January 1, 2003 assuming
it is a capital lease? What is the December 31,
2003 entry for interest expense? Present value of
lease payments 5,000 4.9676 24, 838
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Bonds
A contract between a bond issuer and a bond
purchaser that specifies the terms of a
bond. The amount that will be paid on a bond at
the maturity date. The date at which a bond
principal or face amount becomes payable.
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Determining Issuance (Selling) Price
Price present value of the interest payments
(present value of an annuity) present value of
the bonds face value at maturity (present value
of single sum) Market rate (effective rate or
yield rate) of interest The interest rate
investors expect to earn on their
investment Stated rate of interest The rate of
interest printed on the bond Present value
calculations use market rate Interest payment
face value stated rate Adjust time periods
and interest rate if bonds pay interest
semiannually
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Determining Issuance Price
Bonds sold at Face Value Issuance price face
value stated rate market rate (effective
rate) Bond sold at Discount Issuance price face value Stated rate rate) Bond discount - the difference between the
face value and the issuance price Bonds sold at
Premium Issuance price face value Stated rate
market rate (effective rate) Bond premium -
the difference between the face value and the
issuance price
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Characteristics of Bonds
Market Rate
Bond Sold at
Bond Stated Interest Rate 10
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Example Bond Issued at Face Value
Falcon Company agreed to issue 5-year, 500,000
bonds and pay 10 percent interest, compounded
semiannually. Assume the effective and stated
rates are equal. Calculate the issue price.
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Example Bond Issuedat a Discount
Falcon Company agreed to issue 5-year, 500,000
bonds and pay 10 percent interest, compounded
semiannually. Assume the effective rate is 12
percent. Calculate the issue price of the bonds.
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Example Bond Issuedat a Premium
Falcon Company agreed to issue 5-year, 500,000
bonds and pay 10 percent interest, compounded
semiannually. Assume the effective rate is 8
percent. Calculate the issue price of the bonds.
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Example Accounting for Bonds Payable
On January 1, 2003, Falcon Company agreed to
issue 5-year, 500,000 bonds and pay 10 percent
interest, compounded semiannually. Assume the
effective rate is 10 percent. What entry is
needed to record the liability?
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Example Bond Retirements at Maturity
On January 1, 2003, Falcon Company agreed to
issue 5-year, 500,000 bonds and pay 10 percent
interest, compounded semiannually. Assume the
effective rate is 10 percent. What entry is
needed to record the retirement of the bond on
January 1, 2008?
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Example Bond Retirements Before Maturity
The Great Owl Company issued 200,000, 14 percent
bonds, which are now selling for 107 and are
callable (can be retired or paid off) at 110.
The bonds were issued at face value. If the
company decides to call the bonds, what entry is
needed?
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Bond Premium/Discount Amortization Methods

• Straight-line Method
• A method of systematically writing off a bond
  premium or discount, resulting in equal amounts
  being amortized each period.
• Effective-interest Method
• A method of systematically writing off a bond
  premium or discount, taking into consideration
  the time value of money.
• Method preferred by GAAP

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Example Effective interest method premium bond

• The Woodpecker Company issued a 100,000,
  10-year, 12 percent bond for 112,463. The
  market rate was 10 percent at the time of
  issuance. Bond pays interest semiannually.
  Create an amortization table using the
  effective-interest method

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Example Straight-line method premium bond

• The Woodpecker Company issued a 100,000,
  10-year, 12 percent bond for 112,463. The
  market rate was 10 percent at the time of
  issuance. Bond pays interest semiannually.
  Create an amortization table using the
  straight-line method (12,463/20 623)

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Example Effective interest method discount bond

• The Woodpecker Company issued a 100,000,
  10-year, 12 percent bond for 89,404. The
  market rate was 14 percent at the time of
  issuance. Bond pays interest semiannually.
  Create an amortization table using the
  effective-interest method

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Example Straight-line method discount bond

• The Woodpecker Company issued a 100,000,
  10-year, 12 percent bond for 89,404. The
  market rate was 14 percent at the time of
  issuance. Bond pays interest semiannually.
  Create an amortization table using the
  straight-line method