Chapter

10

LIABILITIES COMMON TO CORPORATE BUSINESSES

Long-Term Debt
Relatively small debt needs can be filled from single sources.

or
Banks

Insurance Companies

or

Pension Plans

Long-Term Debt
Large debt needs are often filled by issuing bonds.

Maturing Obligations Intended to be Refinanced

Example: A short term Loan being
routinely extended or Long term Liability to be rescheduled before its maturity. The long term liabilities of this nature are classified as Long Term Liabilities in Balance Sheet.

Installment Notes Payable

Long-term notes that call for a series of installment payments.

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.

Allocating Installment Payments Between Interest and Principal

Identify the unpaid principal
balance.

Unpaid Principal Interest

rate = Interest expense.

Installment payment - Interest

expense = Reduction in unpaid principal balance. balance.

Compute new unpaid principal

Allocating Installment Payments Between Interest and Principal

On January 1, 2003, Rocket Corp. borrowed $7,581.57 from First Bank of River City. The loan was a five-year loan and had an interest rate of 10%. The annual payment is $2,000.
Prepare an amortization table for Rocket Corp.s loan.

Allocating Installment Payments Between Interest and Principal

Interest Reduction in Expense Unpaid (10%) Balance $ 758.16 633.97 497.37 347.11 181.82 $ 1,241.84 1,366.03 1,502.63 1,652.89 1,818.18

Date Payment Jan. 1, 2003 Dec. 31, 2003 $ 2,000.00 Dec. 31, 2004 2,000.00 Dec. 31, 2005 2,000.00 Dec. 31, 2006 2,000.00 Dec. 31, 2007 2,000.00

Unpaid Balance $ 7,581.57 6,339.73 4,973.70 3,471.07 1,818.18 (0.00)

Allocating Installment Payments Between Interest and Principal

The information needed for the journal entry can be found on the amortization table. The payment amount, the interest expense, and the amount to credit to principal are all on the table.
Date Description Debit Credit

Dec. 31 Interest Expense Note Payable Cash

758.16 1,241.84 2,000.00

Bonds Payable

Bonds usually involve the borrowing of a large sum of money, called principal. The principal is usually paid back as a lump sum at the end of the bond period.

Individual bonds are often denominated with a par value, or face value, of $1,000.

Bonds Payable
Bonds usually carry a
stated rate of interest, also called a contract rate/coupon rate. semiannually.

Interest is normally paid Interest is computed as:

Interest = Principal Stated Rate Time

Bonds Payable
Bonds are issued through an intermediary called
an underwriter.

Bonds can be sold on organized securities

exchanges.

Types of Bonds
Mortgage Bonds Debenture Bonds

Convertible Bonds

Junk Bonds

Accounting for Bonds Payable

On January 1, 2003, Rocket Corp. issues $1,500,000 of 12%, 10-year bonds payable. Interest is payable semiannually, each July 1 and January 1. Assume the bonds are issued at face value. Record the issuance of the bonds.
Date Description Debit Credit

Jan. 1 Cash Bonds Payable

1,500,000 1,500,000

Accounting for Bonds Payable

Record the interest payment on July 1, 2003.
Date Description Debit Credit

July 1 Interest Expense Cash

90,000 90,000

Accounting for Bonds Payable: Issuance at Discount

On January 1, 2005, wells Corporation issues $1,000,000 of 12%, 20-year bonds payable at 97 to underwriter. Interest is payable semiannually, each July 1 and January 1.

Record the issuance of the bonds.

Date Description Date Description Jan. Jan. 11 Cash Discount on Bonds Payble Bonds Payable Debit Debit Credit Credit

970,000 30,000 1,000,000

Accounting for Bonds Payable: Issuance at Discount

To Record the Interest Expense of the bonds.
Semiannual Interest Payment ($1,000,000 x 12% x ) Add: Semiannual Amortization of Bond Discount ($30,000 discount / 20 years) x 1/2 Semiannual Interest Expense $60,000 750 $60,750

Date Description Date Description Jan. Jan. 11 Bond Interest Expense Cash Discount on Bonds Payable

Debit Debit

Credit Credit

60,750 60,000 750

Accounting for Bonds Payable: Issuance at Premium

On March 1, 2005, wells Corporation issues $1,000,000 of 12%, 20-year bonds payable at 103 to underwriter. Interest is payable semiannually, each September 1 and March 1.

Record the issuance of the bonds.

Date Description Debit Date Description Debit Jan. Jan. 11 Cash 1,030,000 Premium on Bonds Payable Bonds Payable Credit Credit

30,000 1,000,000

Accounting for Bonds Payable: Issuance at Premiums

To Record the Interest Expense of the bonds.
Semiannual Interest Payment ($1,000,000 x 12% x ) Less: Semiannual Amortization of Bond Discount ($30,000 discount / 20 years) x 1/2 Semiannual Interest Expense $60,000 750 $59,250

Date Description Date Description Jan. Jan. 11 Bond Interest Expense Premium on BondsPayable Cash

Debit Debit

Credit Credit

59,250 750 60,000

Bonds Sold Between Interest Dates

Bonds are often sold between interest
dates. The selling price of the bond is computed as:
Present value of the bond + Accrued interest since the last interest payment = Selling price of the bond

Bonds Sold Between Interest Dates

Example: Wells Corporation issues $1 Million of 12% bonds at par value. On May 1 two months after the March issuance date printed on bond. Interest is paid bi-annually
Date Description Debit Credit

May 1

Cash Bonds Payable Bond Interest Payable

1,020,000 1,000,000 20,000

Bonds Sold Between Interest Dates

Four Months later on the regular semi annual interest payment date, following entry is passed:
Date Description Debit Credit

September 1 Bond Interest Payable Bond Interest Expense Cash

20,000 40,000 60,000

Early Retirement of Debt

Bonds can be retired by . . .
Exercising a call provision. Purchasing the bonds on the open market.

Gains or losses incurred as a result of retiring bonds should be reported as extraordinary items on the income statement.

Accounting for Bond Retirements

Redeeming Bonds at Maturity
San Marcos HS records the redemption of its bonds at maturity as follows assuming bonds were issued at par and are redeemed at par:

Bonds payable Cash

100,000 100,000

Accounting for Bond Retirements

Redeeming Bonds before Maturity
When a company retires bonds before maturity, it is necessary to:
1. eliminate the carrying value of the bonds at the redemption date; 2. record the cash paid; and 3. recognize the gain or loss on redemption.
The carrying value of the bonds is the face value of the bonds less unamortized bond discount or plus unamortized bond premium at the redemption date.

Accounting for Bond Retirements

Illustration: The San Marcos HS, 8% bonds of $100,000 issued on Jan. 1, 2007, are recalled at 105 on Dec. 31, 2008. Assume that the carrying value of the bonds at the redemption date is $98,183. Journal entry at Dec. 31, 2008: Bonds payable 100,000

Loss on bond redemption Cash ($100,000 x 105%) Discount on bonds payable

6,817
105,000 1,817

Accounting for Bond Retirements

Converting Bonds into Common Stock
Until conversion, the bondholder receives interest on the bond.
For the issuer, the bonds sell at a higher price and pay a lower rate of interest than comparable debt securities without the conversion option. Upon conversion, the company transfers the carrying value of the bonds to paid-in capital accounts. No gain or loss is recognized.

Accounting for Bond Retirements

E15-6 Nocioni Company issued $1,000,000 of bonds on January 1, 2008.
Instructions: Prepare the journal entry to record the conversion of the bonds into 30,000 shares of $10 par value common stock. Assume the bonds were issued at par. Bonds payable Common stock (30,000 x $10) Paid-in capital in excess of par 1,000,000 300,000 700,000