Upload
gloria-flynn
View
232
Download
0
Tags:
Embed Size (px)
Citation preview
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-1
LIABILITIES
Chapter
10
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-2
Defined as debts or obligations arising from past transactions or
events.
Defined as debts or obligations arising from past transactions or
events.
Maturity = 1 year or less Maturity > 1 year
Current Liabilities
(Accounts Payable)
Noncurrent Liabilities
The Nature of LiabilitiesThe Nature of Liabilities
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-3
Total Notes Payable
Current Notes Payable
Noncurrent Notes Payable
When a company borrows money, a note payable is created.
Current Portion of Notes Payable
The portion of a note payable that is due within one year, or one operating cycle, whichever is longer.
When a company borrows money, a note payable is created.
Current Portion of Notes Payable
The portion of a note payable that is due within one year, or one operating cycle, whichever is longer.
Notes PayableNotes Payable
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-4
PROMISSORY NOTE
Location Date
after this date
promises to pay to the order of
the sum of with interest at the rate
of per annum.
signed
title
Miami, Fl Nov. 1, 2007
Six months Porter Company
John Caldwell
Security National Bank
$10,000.00
12.0%
treasurer
Notes PayableNotes Payable
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-5
On November 1, 2007, Porter Company would make the following entry after
issuing the note.
Notes PayableNotes Payable
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-6
• Interest expenseInterest expense is the is the compensation to the lender for compensation to the lender for giving up the use of money for a giving up the use of money for a period of time.period of time.
• The liability is called The liability is called interest interest payablepayable..
• To the lender, interest is a To the lender, interest is a revenuerevenue..
• To the borrower, interest is an To the borrower, interest is an expenseexpense..
• Interest expenseInterest expense is the is the compensation to the lender for compensation to the lender for giving up the use of money for a giving up the use of money for a period of time.period of time.
• The liability is called The liability is called interest interest payablepayable..
• To the lender, interest is a To the lender, interest is a revenuerevenue..
• To the borrower, interest is an To the borrower, interest is an expenseexpense..
Interest Rate Up!
Interest PayableInterest Payable
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-7
The interest formula includes three variables that must be considered when
computing interest:
The interest formula includes three variables that must be considered when
computing interest:
Interest = Principal × Interest Rate × Time
When computing interest for one year, “Time” equals 1. When the computation period is less
than one year, then “Time” is a fraction.
When computing interest for one year, “Time” equals 1. When the computation period is less
than one year, then “Time” is a fraction.
Interest PayableInterest Payable
For example, if we needed to compute interest for 3 months, “Time” would be 3/12.
For example, if we needed to compute interest for 3 months, “Time” would be 3/12.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-8
What entry would Porter Company make on December 31, the fiscal year-end?
What entry would Porter Company make on December 31, the fiscal year-end?
Interest Payable – ExampleInterest Payable – Example
$10,00012% 2/12 = $200$10,00012% 2/12 = $200
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-9
Porter will pay the note on January 31, 2008. Let’s look at the entry.
Porter will pay the note on January 31, 2008. Let’s look at the entry.
Interest Payable – ExampleInterest Payable – Example
$10,00012% 1/12 = $100$10,00012% 1/12 = $100
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-10
Net Pay
Payroll LiabilitiesPayroll Liabilities
Medicare Taxes
State and Local Income
TaxesFICA Taxes
Federal Income Tax
Voluntary Deductions
Gross Pay
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-11
Deferred revenue is recorded.
a liability account.a liability account.
Cash is received
in advance.
Cash is sometimes collected from the customer before the revenue is
actually earned.
Cash is sometimes collected from the customer before the revenue is
actually earned.
Unearned RevenueUnearned Revenue
Earned revenue is recorded.
As the earnings process is
completed . .
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-12
Relatively small debt needs can be filled from
single sources.
Relatively small debt needs can be filled from
single sources.
BanksInsurance
CompaniesPension
Plans
oror oror
Long-Term LiabilitiesLong-Term Liabilities
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-13
Large debt needs are often filled by issuing bonds.
Large debt needs are often filled by issuing bonds.
Long-Term LiabilitiesLong-Term Liabilities
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-14
With each payment, the interest portion gets
smaller and the principal portion gets larger.
With each payment, the interest portion gets
smaller and the principal portion gets larger.
Installment Notes PayableInstallment Notes Payable
Long-term notes that call for a series of installment payments.
Long-term notes that call for a series of installment payments.
Each payment covers interest for the period AND a portion of the
principal.
Each payment covers interest for the period AND a portion of the
principal.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-15
• Identify the unpaid principal balance.
• Interest expense = Unpaid Principal × Interest rate.
• Reduction in unpaid principal balance = Installment payment – Interest expense.
• Compute new unpaid principal balance.
• Identify the unpaid principal balance.
• Interest expense = Unpaid Principal × Interest rate.
• Reduction in unpaid principal balance = Installment payment – Interest expense.
• Compute new unpaid principal balance.
Allocating Installment Payments Between Interest and Principal
Allocating Installment Payments Between Interest and Principal
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-16
On January 1, 2007, 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.
On January 1, 2007, 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
Allocating Installment Payments Between Interest and Principal
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-17
Now, prepare the entry for the first payment on December 31, 2007.
Now, prepare the entry for the first payment on December 31, 2007.
Allocating Installment Payments Between Interest and Principal
Allocating Installment Payments Between Interest and Principal
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-18
The information needed for the journal entry can be found on the amortization table. The payment
amount, the interest expense, and the amount to debit to principal are all on the table.
The information needed for the journal entry can be found on the amortization table. The payment
amount, the interest expense, and the amount to debit to principal are all on the table.
Allocating Installment Payments Between Interest and Principal
Allocating Installment Payments Between Interest and Principal
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-19
Bonds usually involve the Bonds usually involve the borrowing of a large sum of borrowing of a large sum of money, called money, called principalprincipal..
The principal is usually paid The principal is usually paid back as a back as a lump sumlump sum at the end at the end of the bond period.of the bond period.
Individual bonds are often Individual bonds are often denominated with a par value, denominated with a par value, or or face valueface value, of $1,000., of $1,000.
Bonds usually involve the Bonds usually involve the borrowing of a large sum of borrowing of a large sum of money, called money, called principalprincipal..
The principal is usually paid The principal is usually paid back as a back as a lump sumlump sum at the end at the end of the bond period.of the bond period.
Individual bonds are often Individual bonds are often denominated with a par value, denominated with a par value, or or face valueface value, of $1,000., of $1,000.
Bonds PayableBonds Payable
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-20
Bonds usually carry a stated rate of interest, also called a contract rate.
Interest is normally paid semiannually.
Interest is computed as:
Bonds usually carry a stated rate of interest, also called a contract rate.
Interest is normally paid semiannually.
Interest is computed as:
Interest = Principal × Stated Rate × Time Interest = Principal × Stated Rate × Time
Bonds PayableBonds Payable
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-21
Bonds are issued through an intermediary called an underwriter.
Bonds can be sold on organized securities exchanges.
Bond prices are usually quoted as a percentage of the face amount.
For example, a $1,000 bond For example, a $1,000 bond priced at 102 would sell for priced at 102 would sell for $1,020$1,020..
Bonds are issued through an intermediary called an underwriter.
Bonds can be sold on organized securities exchanges.
Bond prices are usually quoted as a percentage of the face amount.
For example, a $1,000 bond For example, a $1,000 bond priced at 102 would sell for priced at 102 would sell for $1,020$1,020..
Bonds PayableBonds Payable
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-22
Mortgage Bonds
Mortgage Bonds
Convertible Bonds
Convertible Bonds
Junk BondsJunk
Bonds
Debenture Bonds
Debenture Bonds
Types of BondsTypes of Bonds
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-23
On January 1, 2007, 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.
On January 1, 2007, 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.
Accounting for Bonds PayableAccounting for Bonds Payable
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-24
Record the interest paymenton July 1, 2007.
Record the interest paymenton July 1, 2007.
Accounting for Bonds PayableAccounting for Bonds Payable
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-25
Bonds Sold Between Interest DatesBonds Sold Between Interest Dates
• Bonds are often sold between interest dates.Bonds are often sold between interest dates.• The selling price of the bond is computed as:The selling price of the bond is computed as:
• Bonds are often sold between interest dates.Bonds are often sold between interest dates.• The selling price of the bond is computed as:The selling price of the bond is computed as:
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-26
The Present Value Concept and Bond Prices
The Present Value Concept and Bond Prices
The selling price of the bond is determined by the market based
on the time value of money.
==
>>
<<
>>
<<
==
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-27
Bonds Issued at a DiscountBonds Issued at a Discount
Matrix, Inc. is attempting to issue $1,000,000 Matrix, Inc. is attempting to issue $1,000,000 principal amount of 9% bonds. The bonds pay principal amount of 9% bonds. The bonds pay
interest on June 30 and December 31 each year interest on June 30 and December 31 each year and mature in 20 years. Investors are unwilling to and mature in 20 years. Investors are unwilling to
pay the full face amount for Matrix’s bonds because pay the full face amount for Matrix’s bonds because they believe the interest rate is too low. To entice they believe the interest rate is too low. To entice
investors, Matrix must lower the price of the bonds. investors, Matrix must lower the price of the bonds. The difference between the new lower issue price The difference between the new lower issue price
and the principal of $1,000,000 is called a discount.and the principal of $1,000,000 is called a discount.
Let’s see how we account for these bonds.Let’s see how we account for these bonds.
Matrix, Inc. is attempting to issue $1,000,000 Matrix, Inc. is attempting to issue $1,000,000 principal amount of 9% bonds. The bonds pay principal amount of 9% bonds. The bonds pay
interest on June 30 and December 31 each year interest on June 30 and December 31 each year and mature in 20 years. Investors are unwilling to and mature in 20 years. Investors are unwilling to
pay the full face amount for Matrix’s bonds because pay the full face amount for Matrix’s bonds because they believe the interest rate is too low. To entice they believe the interest rate is too low. To entice
investors, Matrix must lower the price of the bonds. investors, Matrix must lower the price of the bonds. The difference between the new lower issue price The difference between the new lower issue price
and the principal of $1,000,000 is called a discount.and the principal of $1,000,000 is called a discount.
Let’s see how we account for these bonds.Let’s see how we account for these bonds.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-28
Principal
Cash Proceeds Discount
1,000,000$ - 950,000$ = 50,000$
Bonds Issued at a DiscountBonds Issued at a Discount
Matrix, Inc. issues bonds on January 1, 2007.Matrix, Inc. issues bonds on January 1, 2007.Principal = $1,000,000Principal = $1,000,000Issue price = $950,000Issue price = $950,000Stated Interest Rate = 9%Stated Interest Rate = 9%Interest Dates = 6/30 and 12/31Interest Dates = 6/30 and 12/31Maturity Date = Dec. 31, 2026 (20 years)Maturity Date = Dec. 31, 2026 (20 years)
Matrix, Inc. issues bonds on January 1, 2007.Matrix, Inc. issues bonds on January 1, 2007.Principal = $1,000,000Principal = $1,000,000Issue price = $950,000Issue price = $950,000Stated Interest Rate = 9%Stated Interest Rate = 9%Interest Dates = 6/30 and 12/31Interest Dates = 6/30 and 12/31Maturity Date = Dec. 31, 2026 (20 years)Maturity Date = Dec. 31, 2026 (20 years)
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-29
Bonds Issued at a DiscountBonds Issued at a Discount
To record the bond issue, Matrix, Inc. wouldTo record the bond issue, Matrix, Inc. wouldmake the following entry on January 1, 2007:make the following entry on January 1, 2007:To record the bond issue, Matrix, Inc. wouldTo record the bond issue, Matrix, Inc. wouldmake the following entry on January 1, 2007:make the following entry on January 1, 2007:
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-30
Partial Balance Sheet as of January 1, 2007
Long-term Liabilities: Bonds Payable 1,000,000$ Less: Discount on Bonds Payable 50,000 950,000$
Partial Balance Sheet as of January 1, 2007
Long-term Liabilities: Bonds Payable 1,000,000$ Less: Discount on Bonds Payable 50,000 950,000$
Maturity ValueMaturity ValueMaturity ValueMaturity Value
Carrying ValueCarrying ValueCarrying ValueCarrying Value
Bonds Issued at a DiscountBonds Issued at a Discount
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-31
Amortizing the discount over the term of the Amortizing the discount over the term of the bond increases Interest Expense each bond increases Interest Expense each
interest payment period.interest payment period.
Amortizing the discount over the term of the Amortizing the discount over the term of the bond increases Interest Expense each bond increases Interest Expense each
interest payment period.interest payment period.
Bonds Issued at a DiscountBonds Issued at a Discount
Using the Using the straight-linestraight-line method, the method, the discount amortization will be $1,250 discount amortization will be $1,250
every six months. every six months.
$50,000 ÷ 40 periods = $1,250$50,000 ÷ 40 periods = $1,250
Using the Using the straight-linestraight-line method, the method, the discount amortization will be $1,250 discount amortization will be $1,250
every six months. every six months.
$50,000 ÷ 40 periods = $1,250$50,000 ÷ 40 periods = $1,250
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-32
Amortization of the DiscountAmortization of the Discount
We prepare the following journal entry to recordWe prepare the following journal entry to recordthe first interest payment.the first interest payment.We prepare the following journal entry to recordWe prepare the following journal entry to recordthe first interest payment.the first interest payment.
$1,000,000 × 9% = $90,000 ÷ 2 = $45,000$45,000
Interest paid every six months is calculated as follows:Interest paid every six months is calculated as follows:Interest paid every six months is calculated as follows:Interest paid every six months is calculated as follows:
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-33
Partial Balance Sheet as of December 31, 2007
Long-term Liabilities: Bonds Payable 1,000,000$ Less: Discount on Bonds Payable 47,500 952,500$
Partial Balance Sheet as of December 31, 2007
Long-term Liabilities: Bonds Payable 1,000,000$ Less: Discount on Bonds Payable 47,500 952,500$
Maturity ValueMaturity ValueMaturity ValueMaturity Value
Carrying ValueCarrying ValueCarrying ValueCarrying Value
$50,000 – $1,250 – $1,250$50,000 – $1,250 – $1,250$50,000 – $1,250 – $1,250$50,000 – $1,250 – $1,250
The carrying value willThe carrying value willincrease to exactly $1,000,000increase to exactly $1,000,000
on the maturity date.on the maturity date.
The carrying value willThe carrying value willincrease to exactly $1,000,000increase to exactly $1,000,000
on the maturity date.on the maturity date.
Bonds Issued at a DiscountBonds Issued at a Discount
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-34
To record the principal repayment, Matrix, IncTo record the principal repayment, Matrix, Incwould make the following entry on December 31, 2026:would make the following entry on December 31, 2026:To record the principal repayment, Matrix, IncTo record the principal repayment, Matrix, Incwould make the following entry on December 31, 2026:would make the following entry on December 31, 2026:
Bonds Issued at a DiscountBonds Issued at a Discount
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-35
Bonds Issued at a PremiumBonds Issued at a Premium
If bonds of other companies are yielding less thanIf bonds of other companies are yielding less than9 percent, investors will be willing to pay more than9 percent, investors will be willing to pay more thanthe face amount for Matrix’s 9% bonds. The issuethe face amount for Matrix’s 9% bonds. The issue
price of Matrix’s 9% bonds will rise because ofprice of Matrix’s 9% bonds will rise because ofinvestor demand for the 9% bonds. Theinvestor demand for the 9% bonds. The
difference between the higher issue price and thedifference between the higher issue price and theprincipal of $1,000,000 is called a premium.principal of $1,000,000 is called a premium.
Let’s look at accounting for a premium.Let’s look at accounting for a premium.
If bonds of other companies are yielding less thanIf bonds of other companies are yielding less than9 percent, investors will be willing to pay more than9 percent, investors will be willing to pay more thanthe face amount for Matrix’s 9% bonds. The issuethe face amount for Matrix’s 9% bonds. The issue
price of Matrix’s 9% bonds will rise because ofprice of Matrix’s 9% bonds will rise because ofinvestor demand for the 9% bonds. Theinvestor demand for the 9% bonds. The
difference between the higher issue price and thedifference between the higher issue price and theprincipal of $1,000,000 is called a premium.principal of $1,000,000 is called a premium.
Let’s look at accounting for a premium.Let’s look at accounting for a premium.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-36
Cash Proceeds Principal Premium
1,050,000$ - 1,000,000$ = 50,000$
Matrix, Inc. issues bonds on January 1, 2007.Matrix, Inc. issues bonds on January 1, 2007.Principal = $1,000,000Principal = $1,000,000Issue price = $1,050,000Issue price = $1,050,000Stated Interest Rate = 9%Stated Interest Rate = 9%Interest Dates = 6/30 and 12/31Interest Dates = 6/30 and 12/31Maturity Date = Dec. 31, 2026 (20 years)Maturity Date = Dec. 31, 2026 (20 years)
Matrix, Inc. issues bonds on January 1, 2007.Matrix, Inc. issues bonds on January 1, 2007.Principal = $1,000,000Principal = $1,000,000Issue price = $1,050,000Issue price = $1,050,000Stated Interest Rate = 9%Stated Interest Rate = 9%Interest Dates = 6/30 and 12/31Interest Dates = 6/30 and 12/31Maturity Date = Dec. 31, 2026 (20 years)Maturity Date = Dec. 31, 2026 (20 years)
The only change fromprevious Matrix example.
Bonds Issued at a PremiumBonds Issued at a Premium
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-37
To record the bond issue, Matrix, Inc. wouldTo record the bond issue, Matrix, Inc. wouldmake the following entry on January 1, 2007:make the following entry on January 1, 2007:To record the bond issue, Matrix, Inc. wouldTo record the bond issue, Matrix, Inc. wouldmake the following entry on January 1, 2007:make the following entry on January 1, 2007:
Bonds Issued at a PremiumBonds Issued at a Premium
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-38
Partial Balance Sheet as of January 1, 2007
Long-term Liabilities: Bonds Payable 1,000,000$ Add: Premium on Bonds Payable 50,000 1,050,000$
Partial Balance Sheet as of January 1, 2007
Long-term Liabilities: Bonds Payable 1,000,000$ Add: Premium on Bonds Payable 50,000 1,050,000$
Maturity ValueMaturity ValueMaturity ValueMaturity Value
Carrying ValueCarrying ValueCarrying ValueCarrying Value
Bonds Issued at a PremiumBonds Issued at a Premium
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-39
Amortizing the premium over the term of the Amortizing the premium over the term of the bond decreases Interest Expense each bond decreases Interest Expense each
interest payment period.interest payment period.
Amortizing the premium over the term of the Amortizing the premium over the term of the bond decreases Interest Expense each bond decreases Interest Expense each
interest payment period.interest payment period.
Using the Using the straight-linestraight-line method, the method, the premium amortization will be premium amortization will be
$1,250 every six months. $1,250 every six months.
$50,000 ÷ 40 periods = $50,000 ÷ 40 periods = $1,250$1,250
Using the Using the straight-linestraight-line method, the method, the premium amortization will be premium amortization will be
$1,250 every six months. $1,250 every six months.
$50,000 ÷ 40 periods = $50,000 ÷ 40 periods = $1,250$1,250
Bonds Issued at a PremiumBonds Issued at a Premium
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-40
Bonds Issued at a PremiumBonds Issued at a Premium
To record an interest payment, Matrix, Inc. would makeTo record an interest payment, Matrix, Inc. would makethe following entry on each June 30 and December 31:the following entry on each June 30 and December 31:To record an interest payment, Matrix, Inc. would makeTo record an interest payment, Matrix, Inc. would makethe following entry on each June 30 and December 31:the following entry on each June 30 and December 31:
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-41
Bonds Issued at a PremiumBonds Issued at a Premium
Partial Balance Sheet as of December 31, 2007
Long-term Liabilities: Bonds Payable 1,000,000$ Add: Premium on Bonds Payable 47,500 1,047,500$
Partial Balance Sheet as of December 31, 2007
Long-term Liabilities: Bonds Payable 1,000,000$ Add: Premium on Bonds Payable 47,500 1,047,500$
Maturity ValueMaturity ValueMaturity ValueMaturity Value
Carrying ValueCarrying ValueCarrying ValueCarrying Value
$50,000 – $1,250 – $1,250$50,000 – $1,250 – $1,250$50,000 – $1,250 – $1,250$50,000 – $1,250 – $1,250
The carrying value willThe carrying value willdecrease to exactly $1,000,000decrease to exactly $1,000,000
on the maturity date.on the maturity date.
The carrying value willThe carrying value willdecrease to exactly $1,000,000decrease to exactly $1,000,000
on the maturity date.on the maturity date.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-42
To record an the principal repayment, Matrix would makeTo record an the principal repayment, Matrix would makethe following entry on December 31, 2026:the following entry on December 31, 2026:To record an the principal repayment, Matrix would makeTo record an the principal repayment, Matrix would makethe following entry on December 31, 2026:the following entry on December 31, 2026:
Bonds Issued at a PremiumBonds Issued at a Premium
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-43
Present Value
Present Value
The Concept of Present ValueThe Concept of Present Value
Future Value
Future Value
$1,000 invested
today at 10%.
In 25 years it will be worth $10,834.71!
Money can grow over time, because it can earn interest.
In 5 years it will be worth
$1,610.51.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-44
How much is a future amount worth today?How much is a future amount worth today?
Present Value
FutureValue
Interest compounding periods
Today
The Concept of Present ValueThe Concept of Present Value
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-45
The Concept of Present ValueThe Concept of Present Value
How much is a future amount worth today?
Three pieces of information must be known to solve a present value problem:
o The future amount.o The interest rate (i).o The number of periods (n) the
amount will be invested.
How much is a future amount worth today?
Three pieces of information must be known to solve a present value problem:
o The future amount.o The interest rate (i).o The number of periods (n) the
amount will be invested.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-46
Two types of cash flows are involved with bonds:
Today
Principal payment at maturity.
Periodic interest payments called annuities.
Maturity
The Concept of Present ValueThe Concept of Present Value
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-47
Gains or losses incurred as a result of retiring bonds should be reported as other income or
other expense on the income statement.
Gains or losses incurred as a result of retiring bonds should be reported as other income or
other expense on the income statement.
Early Retirement of DebtEarly Retirement of Debt
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-48
Evaluating the Safetyof Creditors’ Claims
Evaluating the Safetyof Creditors’ Claims
This ratio indicates a margin of protection for creditors.
This ratio indicates a margin of protection for creditors.
Operating Income
Interest Expense
Interest
Coverage
Ratio=
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-49
Devon Mfg. reports annual operating income of $100,000 and annual interest expense of
$10,000.
What is Devon’s interest coverage ratio?
Devon Mfg. reports annual operating income of $100,000 and annual interest expense of
$10,000.
What is Devon’s interest coverage ratio?
Liabilities – QuestionLiabilities – Question
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-50
Lease agreement transfers risks and benefits
associated with ownership to lessee.
Lease agreement transfers risks and benefits
associated with ownership to lessee.
Lessee records a leased asset and lease liability.
Lessee records a leased asset and lease liability.
Lessor retains risks and benefits associated with
ownership.
Lessor retains risks and benefits associated with
ownership.
Lessee records rent expense as incurred.
Lessee records rent expense as incurred.
Lease Payment ObligationsLease Payment Obligations
Operating LeasesOperating Leases Capital LeasesCapital Leases
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
10-51
The lease transfersow nership to the
lessee.
The lease containsa bargain purchase
option.
The lease term is equal toor > 75% of the econom ic
life of the property.
The PV of the m inim umlease paym ents = 90% ofthe FM V of the property.
A lease must be recorded asa Capital Lease if it meets
any of the follow ing criteria.
Capital Lease CriteriaCapital Lease Criteria