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Liabilities. Chapter 7. Learning Objectives. Explain the characteristics of a liability. Account for compensated absences . Understand and record payroll taxes and deductions. Record property taxes. Account for warranty costs. - PowerPoint PPT Presentation
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Chapter 7
LiabilitiesLiabilities
1. Explain the characteristics of a liability.
2. Account for compensated absences.
3. Understand and record payroll taxes and deductions.
4. Record property taxes.
5. Account for warranty costs.
7. Explain the terms “probable,” “reasonably possible,” and “remote” related to contingencies.
8. Record and report a loss contingency.
9. Disclose a gain contingency.
10. Explain the reasons for issuing long-term liabilities.
11. Understand the characteristics of bonds payable.
12. Record the issuance of bonds.
13. Amortize discounts and premiums under the straight-line method.
14. Compute the selling price of bonds.
15. Amortize discounts and premiums under the effective interest method.
16. Explain extinguishment of liabilities.
17. Understand bonds with equity characteristics.
18. Account for long-term notes payable.
19. Understand the disclosure of long-term liabilities.
Defined by SFAC No. 6 as: Probable future sacrifices of economic benefits
arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.
LiabilitiesLiabilitiesLiabilitiesLiabilities
1. It involves a present duty or responsibility of the company to one or more entities that will be settled by the probable future transfer or use of assets at a specified or determinable date, on occurrence of a specific event, or on demand.
2. The duty or responsibility obligates the company, leaving it little or no discretion to avoid the future sacrifice.
3. The transaction or other event obligating the company has already happened.
Three Essential Characteristics of a LiabilityThree Essential Characteristics of a LiabilityThree Essential Characteristics of a LiabilityThree Essential Characteristics of a Liability
Interest that is not explicitly specified in the terms of the liability.
Need not be recognized.
Liabilities - Implicit InterestLiabilities - Implicit InterestLiabilities - Implicit InterestLiabilities - Implicit Interest
Current liabilities are
obligations whose
liquidation is expected
to require the use of
existing current assets
or the creation of other
current liabilities within
one year or an
operating cycle,
whichever is longer.
Current liabilities are
obligations whose
liquidation is expected
to require the use of
existing current assets
or the creation of other
current liabilities within
one year or an
operating cycle,
whichever is longer.
Current LiabilitiesCurrent LiabilitiesCurrent LiabilitiesCurrent Liabilities
Having Contractual Amount
Having Contractual Amount
Accounts payableNotes payableCurrently maturing portion of long-term debtDividends payableAdvances and refundable depositsAccrued itemsUnearned items
Accounts payableNotes payableCurrently maturing portion of long-term debtDividends payableAdvances and refundable depositsAccrued itemsUnearned items
Type of Current LiabilitiesType of Current Liabilities Type of Current LiabilitiesType of Current Liabilities
Amount Depends on Operations
Amount Depends on Operations
Sales (use) taxesPayroll taxesIncome taxesBonuses
Sales (use) taxesPayroll taxesIncome taxesBonuses
Type of Current LiabilitiesType of Current Liabilities Type of Current LiabilitiesType of Current Liabilities
Amount Must Be Estimated
Amount Must Be Estimated
Property taxesWarrantiesPremiums and couponsOther contingencies
Property taxesWarrantiesPremiums and couponsOther contingencies
Type of Current LiabilitiesType of Current Liabilities Type of Current LiabilitiesType of Current Liabilities
Obligations arising from the company’s ongoing operations
-- includes the acquisition of inventory, supplies, materials and services.
Commonly called trade payables.
Other current payables should be reported separately.
Accounts PayableAccounts Payable Accounts PayableAccounts Payable
Notes that arise from the same types of transactions as trade payables.
Can be secured or unsecured. Can be interest-bearing or
noninterest-bearing.
-- Interest-bearing notes carry a stated rate of interest.
-- Noninterest-bearing notes reflect an effective rate of interest or a yield.
Short-Term Notes PayableShort-Term Notes Payable Short-Term Notes PayableShort-Term Notes Payable
The rate of interest is specified and is called the stated rate.
The debtor (or borrower) receives cash, other assets, or services.
The debtor repays the face amount of the note plus interest at the stated rate.
Short-Term Notes PayableShort-Term Notes PayableInterest-BearingInterest-Bearing
Short-Term Notes PayableShort-Term Notes PayableInterest-BearingInterest-Bearing
On September 1, Eagle Boats borrows $80,000 from Cooke Bank. The note is due in 180 days and has a stated interest rate of 9%.
Record the borrowing on September 1.
Interest-Bearing NotesInterest-Bearing NotesExampleExample
Interest-Bearing NotesInterest-Bearing NotesExampleExample
On September 1, Eagle Boats borrows $80,000 from Cooke Bank. The note is due in 180 days and has a stated interest rate of 9%.
Record the borrowing on September 1.
Interest-Bearing NotesInterest-Bearing NotesExampleExample
Interest-Bearing NotesInterest-Bearing NotesExampleExample
How much interest is due to Cooke Bank at year-end, on December 31?
a. $2,400
b. $3,600
c. $7,200
d. $87,200
Interest-Bearing NotesInterest-Bearing NotesExampleExample
Interest-Bearing NotesInterest-Bearing NotesExampleExample
How much interest is due to Cooke Bank at year-end, on December 31?
a. $2,400
b. $3,600
c. $7,200
d. $87,200
Interest is calculated as:Principal Stated Portion
Amount Rate of of Year = of Note Interest Outstanding
$80,000 × 9% × 4/12 =
$2,400 interest due to Cooke Bank.
Interest is calculated as:Principal Stated Portion
Amount Rate of of Year = of Note Interest Outstanding
$80,000 × 9% × 4/12 =
$2,400 interest due to Cooke Bank.
Interest-Bearing NotesInterest-Bearing NotesExampleExample
Interest-Bearing NotesInterest-Bearing NotesExampleExample
Assume Eagle Boats’fiscal year-end is December 31.
Record the necessary adjustment at year-end.
Interest-Bearing NotesInterest-Bearing NotesExampleExample
Interest-Bearing NotesInterest-Bearing NotesExampleExample
Assume Eagle Boats’fiscal year-end is December 31.
Record the necessary adjustment at year-end.
Interest-Bearing NotesInterest-Bearing NotesExampleExample
Interest-Bearing NotesInterest-Bearing NotesExampleExample
Assume Eagle Boats’fiscal year-end is December 31.
Record the necessary journal entry when the note matures on February 28.
Interest-Bearing NotesInterest-Bearing NotesExampleExample
Interest-Bearing NotesInterest-Bearing NotesExampleExample
Assume Eagle Boats’fiscal year-end is December 31.
Record the necessary journal entry when the note matures on February 28.
Interest-Bearing NotesInterest-Bearing NotesExampleExample
Interest-Bearing NotesInterest-Bearing NotesExampleExample
Notes without a stated interest rate carry an implicit, or effective, rate.
The face of the note includes the principal and the interest.
The borrower receives the difference between the face amount and the interest on the note.-- The cash received is the discounted present value
of the face of the note.
Short-Term Notes PayableShort-Term Notes PayableNoninterest-BearingNoninterest-Bearing
Short-Term Notes PayableShort-Term Notes PayableNoninterest-BearingNoninterest-Bearing
On May 1, 2007, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount of $10,000 in exchange for equipment valued at $9,434.
How much interest will Batter-Up pay on the note?
Noninterest-Bearing NotesNoninterest-Bearing NotesExampleExample
Noninterest-Bearing NotesNoninterest-Bearing NotesExampleExample
On May 1, 2007, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount of $10,000 in exchange for equipment valued at $9,434.
How much interest will Batter-Up pay on the note?
Interest = Face Amount - Amount Received
= $10,000 - $9,434
= $566
Noninterest-Bearing NotesNoninterest-Bearing NotesExampleExample
Noninterest-Bearing NotesNoninterest-Bearing NotesExampleExample
On May 1, 2007, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount of $10,000 in exchange for equipment valued at $9,434.
What is the implicit interest rate on the note?
Noninterest-Bearing NotesNoninterest-Bearing NotesExampleExample
Noninterest-Bearing NotesNoninterest-Bearing NotesExampleExample
On May 1, 2007, Batter-Up, Inc. issued a one-year, noninterest-bearing note with a face amount of $10,000 in exchange for equipment valued at $9,434.
What is the implicit interest rate on the note?
Present Value = Future value × PV Factor9,434.00$ = 10,000.00$ × PV Factor
0.9434 = PV Factor
From the Present Value table, we find that a PV factorof .9434 for 1 period represents an interest rate of 6%.
Noninterest-Bearing NotesNoninterest-Bearing NotesExampleExample
Noninterest-Bearing NotesNoninterest-Bearing NotesExampleExample
Scrip Dividends Payable
Accrued Liabilities
Advances and Returnable Deposits
Unearned Revenues
Short-Term LiabilitiesShort-Term Liabilities Short-Term LiabilitiesShort-Term Liabilities
Collected from customers on behalf of the state or local governments at the point of sale.
Requires a debit to cash and a credit to sales taxes payable.
Held in a liability account until time to make remittance to the taxing authority.
Requires a debit to sales taxes payable and a credit to cash.
Sales TaxesSales Taxes Sales TaxesSales Taxes
Selleroy Company sells merchandise for cash with a retail sales price of $50,000 on which a sales tax of 6% is levied. The company collects $53,000.
Selleroy Company sells merchandise for cash with a retail sales price of $50,000 on which a sales tax of 6% is levied. The company collects $53,000.
Cash 53,000 Sales
50,000 Sales Taxes Payable
3,000
Sales TaxesSales Taxes Sales TaxesSales Taxes
At the end of January the Sales account is adjusted to record the tax on all goods sold [$169,000 - ($169,000 ÷ 1.06)] = $9,600.
At the end of January the Sales account is adjusted to record the tax on all goods sold [$169,000 - ($169,000 ÷ 1.06)] = $9,600.
Cash 169,000 Sales
169,000
If the sales tax is included in the price charged to the customer
If the sales tax is included in the price charged to the customer
Sales 9,600 Sales Taxes Payable
9,600
Sales TaxesSales Taxes Sales TaxesSales Taxes
Withholdings from employee pay Employee’s portion of FICA
Employee Federal Income Tax Withholdings
Expenses deducted from income Employer portion of FICA
Federal Unemployment Tax (FUTA)
State Unemployment Tax (SUTA)
Payroll TaxesPayroll Taxes Payroll TaxesPayroll Taxes
Batter-Up, Inc. has 5 employees. Each employee receives a salary of $1,000 per week. The FICA rate is 7.65% and income tax is withheld at the rate of 20%.
Payroll Taxes - EmployeePayroll Taxes - EmployeeExamplecExamplec
Payroll Taxes - EmployeePayroll Taxes - EmployeeExamplecExamplec
Prepare the journal entry to record the payroll for Batter-Up for the week ending June 14, 2007.
GENERAL JOURNALPage: 15
Date Description PR Debit Credit
Payroll Taxes - EmployeePayroll Taxes - EmployeeExampleExample
Payroll Taxes - EmployeePayroll Taxes - EmployeeExampleExample
GENERAL JOURNALPage: 15
Date Description PR Debit Credit
14-Jun Salary Expense 5,000.00 FIT Withholding Payable 1,000.00 FICA Tax Payable 382.50 Cash 3,617.50 to record 6/14 payroll
Prepare the journal entry to record the payroll for Batter-Up for the week ending June 14, 2007.
Payroll Taxes - EmployeePayroll Taxes - EmployeeExampleExample
Payroll Taxes - EmployeePayroll Taxes - EmployeeExampleExample
GENERAL JOURNALPage: 15
Date Description PR Debit Credit
14-Jun Salary Expense 5,000.00 FIT Withholding Payable 1,000.00 FICA Tax Payable 382.50 Cash 3,617.50 to record 6/14 payroll
Note: The expense to the company is $5,000
while the actual payment to the employees is
$3,617.50.
Payroll Taxes - EmployeePayroll Taxes - EmployeeExampleExample
Payroll Taxes - EmployeePayroll Taxes - EmployeeExampleExample
GENERAL JOURNALPage: 15
Date Description PR Debit Credit
14-Jun Salary Expense 5,000.00 FIT Withholding Payable 1,000.00 FICA Tax Payable 382.50 Cash 3,617.50 to record 6/14 payroll
Note: The employer transfers the tax amounts
to the government on the employees’behalf.
Payroll Taxes - EmployeePayroll Taxes - EmployeeExampleExample
Payroll Taxes - EmployeePayroll Taxes - EmployeeExampleExample
Batter-Up, Inc. has also incurred FUTA of $50 and SUTA of $200.
Prepare Batter-Up’s journal entry for all of their taxes related to the June 16 payroll.
Payroll Taxes - EmployerPayroll Taxes - EmployerExampleExample
Payroll Taxes - EmployerPayroll Taxes - EmployerExampleExample
GENERAL JOURNALPage: 18
Date Description PR Debit Credit
14-Jun Payroll Tax Expense 632.50 FUTA Payable 50.00 SUTA Payable 200.00 FICA Payable, employer 382.50 to record payroll taxes for6/14 payroll
Payroll Taxes - EmployerPayroll Taxes - EmployerExampleExample
Payroll Taxes - EmployerPayroll Taxes - EmployerExampleExample
GENERAL JOURNALPage: 18
Date Description PR Debit Credit
14-Jun Payroll Tax Expense 632.50 FUTA Payable 50.00 SUTA Payable 200.00 FICA Payable, employer 382.50 to record payroll taxes for6/14 payroll
Note: The employer matchesmatches the FICA that was withheld
from the employees’paychecks. In effect, the total FICA
tax rate is 15.3%; half is paid by the employee (7.65%) and
half is paid by the employer (7.65%).
Note: The employer matchesmatches the FICA that was withheld
from the employees’paychecks. In effect, the total FICA
tax rate is 15.3%; half is paid by the employee (7.65%) and
half is paid by the employer (7.65%).
Payroll Taxes - EmployerPayroll Taxes - EmployerExampleExample
Payroll Taxes - EmployerPayroll Taxes - EmployerExampleExample
Ezzell Company closes its books annually each
December 31. The fiscal year for the town and county
in which the firm is located ends on June 30. The
estimated property taxes for the period July 1, 2007, to
June 30, 2008, are $7,200. The tax bill is mailed in
October with a requirement that the tax be paid before
December 31, 2007. The tax bill reported an actual tax
of $7,290, and the corporation pays this amount on
October 31, 2007.
Ezzell Company closes its books annually each
December 31. The fiscal year for the town and county
in which the firm is located ends on June 30. The
estimated property taxes for the period July 1, 2007, to
June 30, 2008, are $7,200. The tax bill is mailed in
October with a requirement that the tax be paid before
December 31, 2007. The tax bill reported an actual tax
of $7,290, and the corporation pays this amount on
October 31, 2007.
Property TaxesProperty Taxes Property TaxesProperty Taxes
Three Monthly Entries July 31-September 30, 2007
Property Tax Expense 600Property Taxes Payable 600
October 31, 2007: Payment of Property Taxes
Property Tax Payable 1,800Prepaid Property Taxes 5,490
Cash 7,290
Three Monthly Entries: October 31-Dec. 31, 2007
Property Tax Expense 610Prepaid Property Taxes 610
$7,200 ÷ 12
Property TaxesProperty Taxes Property TaxesProperty Taxes
Percentage of net income before the bonus-- Multiply the net income before the bonus by the
bonus percentage. Percentage of net income after the bonus
-- Algebraically expressed:
Bonus = % × (Net Income - Bonus)
Bonuses Based on IncomeBonuses Based on Income Bonuses Based on IncomeBonuses Based on Income
Linda Ball, Batter-Up’s CEO, Inc. gets a year-end bonus of 15% of net income after deducting her bonus. 2007 Net income is $250,000.
Compute Linda’s bonus for 2007.
BonusBonusExampleExample BonusBonus
ExampleExample
Linda Ball, Batter-Up’s CEO, Inc. gets a year-end bonus of 15% of net income after deducting her bonus. 2007 Net income is $250,000.
Compute Linda’s bonus for 2007.
Bonus = Bonus % × ( Net Income - Bonus ) = 15% × ( 250,000$ - Bonus ) = 37,500$ - ( .15Bonus )
1.15Bonus = 37,500$ Bonus = 37,500$ ÷ 1.15Bonus = 32,608.70$
BonusBonusExampleExample BonusBonus
ExampleExample
Occurs when unused vacation time is carried over to future years.
An expense/liability must be accrued if four criteria are met:
Absence relates to services already performed.
Benefits accumulate, or vest.
Payment is probable.
Amount can be reliably estimated.
Compensated-Absence LiabilityCompensated-Absence Liability Compensated-Absence LiabilityCompensated-Absence Liability
A vested right exists when an employer has an obligation to make payments to an employee that is not contingent on the employee’s future
services.
A vested right exists when an employer has an obligation to make payments to an employee that is not contingent on the employee’s future
services.
Compensated-Absence LiabilityCompensated-Absence Liability Compensated-Absence LiabilityCompensated-Absence Liability
Accumulated rights are those that can be carried forward by the employee to future periods if not taken in the
period in which they are earned.
Accumulated rights are those that can be carried forward by the employee to future periods if not taken in the
period in which they are earned.
Compensated-Absence LiabilityCompensated-Absence Liability Compensated-Absence LiabilityCompensated-Absence Liability
Milton Company has 100 employees who are paid an average
of $200 per day. Company policy allows each employee 12
days of paid vacation per year.
Milton Company has 100 employees who are paid an average
of $200 per day. Company policy allows each employee 12
days of paid vacation per year.
Sales Salaries Exp. Compensated Absences 30,000Office Salaries Exp. Compensated Absences 30,000 Liability for Employees’ Compensation for Future Absences (3/12 x $240,000) 60,000
March 31, 2008March 31, 2008March 31, 2008March 31, 2008
Compensated-Absence LiabilityCompensated-Absence Liability Compensated-Absence LiabilityCompensated-Absence Liability
The $200,000 April 30, 2008, payroll, including paid vacation time taken by the sales and office staff, is as follows:
The $200,000 April 30, 2008, payroll, including paid vacation time taken by the sales and office staff, is as follows:
Payroll for
Time Worked Vacation Taken
Sales staff $194,000 $6,000Office staff 193,000 7,000
ContinuedContinuedContinuedContinued
Compensated-Absence LiabilityCompensated-Absence Liability Compensated-Absence LiabilityCompensated-Absence Liability
Sales Salaries Expense 194,000Office Salaries Expense 193,000Liability for Employees’ Compen- sation for Future Absences 13,000
Cash 400,000
April 30, 2008April 30, 2008April 30, 2008April 30, 2008
Compensated-Absence LiabilityCompensated-Absence Liability Compensated-Absence LiabilityCompensated-Absence Liability
The portion of long-term debt maturing within the next fiscal year is reported as a current liabilit
Long-term debts should not be reported as current
liabilities if:
1. they are retired by assets not classified as
current assets
2. they are refinanced by new issues of debt
3. they are converted into capital stock.
Current Maturities of Long-Term DebtCurrent Maturities of Long-Term Debt Current Maturities of Long-Term DebtCurrent Maturities of Long-Term Debt
Obligations that are payable on demand or that will become payable on demand within the next operating cycle.
Long-term obligations that are callable by the creditor due to a violation of underlying terms.
Obligations That Are Callable by the CreditorObligations That Are Callable by the Creditor Obligations That Are Callable by the CreditorObligations That Are Callable by the Creditor
A current liability may be reclassified to a noncurrent status to improve the company’s working capital position.
Generally, this is allowed if the short-term liability is expected to be refinanced long-term.
Short-Term Obligations Expected to Be Short-Term Obligations Expected to Be RefinancedRefinanced
Short-Term Obligations Expected to Be Short-Term Obligations Expected to Be RefinancedRefinanced
The expected refinancing is evidenced by actual refinancing before the statement issue date. OR
The expected refinancing is evidenced by good faith entrance into a long-term, noncancelable refinancing agreement with a viable lender.
Criteria for Reclassifying Short-Term Criteria for Reclassifying Short-Term LiabilitiesLiabilities
Criteria for Reclassifying Short-Term Criteria for Reclassifying Short-Term LiabilitiesLiabilities
SFAS No. 6 requires:
1. The agreement must be noncancelable by all parties and must extend beyond one year.
2. The company must not be in violation of the agreement on the balance sheet or the issue date.
3. The lender must be financially capable of honoring the agreement.
Refinancing Agreement CriteriaRefinancing Agreement Criteria Refinancing Agreement CriteriaRefinancing Agreement Criteria
“An existing condition, situation, or set of circumstances involving uncertainty as to possible gain or a loss to an enterprise that ultimately will be resolved when one or more future events occur or fail to occur.”
SFAS No. 5
ContingenciesContingencies ContingenciesContingencies
CONDITIONS: Probable
The future event is likely to occur. Reasonably Possible
The chance of occurrence of the future event is more
than remote, but less than likely. Remote
The chance of occurrence of the future event is
slight.
ContingenciesContingencies ContingenciesContingencies
The Contingent Amount Can Be Amount Cannot BeEvent Is: Reasonably Estimated Reasonably Estimated
Accrue a loss and a Do not accrue. Report asProbable liability, and report in the a note in the financial
body of the statements. statements.Reasonably Do not accrue. Report as Do not accrue. Report as
Possible a note in the financial a note in the financialstatements. statements.
No accrual or note is No accrual or note isRemote required. A note required. A note
is permitted. is permitted.
Loss ContingenciesLoss ContingenciesAccounting TreatmentsAccounting Treatments Loss ContingenciesLoss Contingencies
Accounting TreatmentsAccounting Treatments
• A warranty is a promise (future cost) made by a seller to a
buyer to make good on a deficiency.
• Under the cash basis method, warranty costs are charged
to the period in which the costs are paid.
• Under the accrual basis method:
1. warranty costs (for warranties sold with the product) are
estimated and matched with revenue.
2. extended warranty revenues are deferred and
recognized over the life of the warranty contract.
Warranty ObligationsWarranty Obligations Warranty ObligationsWarranty Obligations
Cash or Accounts Receivable 1,200,000Sales 1,200,000
Warranty cost per machine is estimated at $150.Warranty cost per machine is estimated at $150.
Warranty Expense 30,000Estimated Liability under Warranties 30,000
Expense Warranty Accrual MethodExpense Warranty Accrual MethodExpense Warranty Accrual MethodExpense Warranty Accrual Method
Anglee Machinery Corporation begins production on a new machine in April 2007 and sells 200 of these machines at $6,000 each by December 31, 2007.
Anglee Machinery Corporation begins production on a new machine in April 2007 and sells 200 of these machines at $6,000 each by December 31, 2007.
Warranty ObligationsWarranty Obligations Warranty ObligationsWarranty Obligations
The corporation spent $5,000 in 2007 to fulfill warranty agreements for the 200 machines.
The corporation spent $5,000 in 2007 to fulfill warranty agreements for the 200 machines.
Estimated Liability under Warranties 5,000Cash (or other assets) 5,000
The corporation spent $25,150 in 2008 to fulfill warranty agreements for the 200 machines.
The corporation spent $25,150 in 2008 to fulfill warranty agreements for the 200 machines.
Estimated Liability under Warranties 25,000Warranty Expense 150
Cash (or other assets) 25,150
Warranty ObligationsWarranty Obligations Warranty ObligationsWarranty Obligations
Anglee Machinery Corporation sells 200 machines for $6,000. This amount includes a service contract sale of $150 and a machine sale of $5,850.
Anglee Machinery Corporation sells 200 machines for $6,000. This amount includes a service contract sale of $150 and a machine sale of $5,850.
Cash or Accounts Receivable 1,200,000Sales ($5,850 x 200) 1,170,000Unearned Warranty Revenue 30,000
Sales Warranty Accrual MethodSales Warranty Accrual MethodSales Warranty Accrual MethodSales Warranty Accrual Method
ContinuedContinuedContinuedContinued
Warranty ObligationsWarranty Obligations Warranty ObligationsWarranty Obligations
Recognition of warranty expense for period, April-December, 2007.
Recognition of warranty expense for period, April-December, 2007.
Warranty Expense 5,000Cash (or other assets) 5,000
Recognition of warranty revenue for period, April-December, 2007.
Recognition of warranty revenue for period, April-December, 2007.
Unearned Warranty Revenue 5,000Warranty Revenue 5,000
ContinuedContinuedContinuedContinued
Warranty ObligationsWarranty Obligations Warranty ObligationsWarranty Obligations
Recognition of warranty expense during 2008.Recognition of warranty expense during 2008.
Warranty Expense 25,150Cash (or other assets) 25,150
Recognition of warranty revenue during 2008.Recognition of warranty revenue during 2008.
Unearned Warranty Revenue 25,000Warranty Revenue 25,000
Warranty ObligationsWarranty Obligations Warranty ObligationsWarranty Obligations
On October 1, 2007, the American Meatball Corporation
began offering to customers a serving disk in return for 30
meatball can labels. The offer expires on April 1, 2008.
The cost of each premium serving disk is $2. It is estimated
that 60% of the labels will be redeemed.
Premium and Coupon ObligationsPremium and Coupon Obligations Premium and Coupon ObligationsPremium and Coupon Obligations
Purchased 12,000 serving dishes at $2 each.
Inventory of Premium Serving Dishes 24,000
Cash (or Accounts Payable) 24,000
Sold 300,000 cans of meatball at $1.80 each...
Cash (or Accounts Receivable) 540,000
Sales 540,000
ContinuedContinuedContinuedContinued
Premium and Coupon ObligationsPremium and Coupon Obligations Premium and Coupon ObligationsPremium and Coupon Obligations
Received 105,000 labels from customers:.
Premium Expense 7,000
Inventory of Premium Serving Dishes 7,000
Estimated that 75,000 labels will be submitted next year:
Premium Expense 5,000
Estimated Premium Claims Outstanding 5,000
Estimated labels that will be redeemed (300,000 x .60)Estimated labels that will be redeemed (300,000 x .60) 180,000180,000Deduct labels redeemed during 2007Deduct labels redeemed during 2007 (105,000(105,000))Estimated number of future label redemptionsEstimated number of future label redemptions 75,00075,000
Premium expense for estimated future redemptions:Premium expense for estimated future redemptions:
(75,000 ÷ 30) x $2(75,000 ÷ 30) x $2 $5,000$5,000
Premium expense for estimated future redemptions:Premium expense for estimated future redemptions:
(75,000 ÷ 30) x $2(75,000 ÷ 30) x $2 $5,000$5,000
(105,000 ÷ 30)(105,000 ÷ 30) x $2x $2
Premium and Coupon ObligationsPremium and Coupon Obligations Premium and Coupon ObligationsPremium and Coupon Obligations
To determine whether a liability should be recorded,
evaluate:
1. The time period in which the underlying cause of action occurred
2. The probability of an unfavorable outcome
3. The ability to make a reasonable estimate of loss
Litigation, Claims and AssessmentsLitigation, Claims and Assessments Litigation, Claims and AssessmentsLitigation, Claims and Assessments
You said that I will owe you
$1,000,000 if I miss the next
putt.
So does that mean I have to
disclose a contingent loss
on my personal financial
statement?
Obligations that extend beyond one year or the operating cycle, whichever is longer
Long-term LiabilitiesLong-term Liabilities Long-term LiabilitiesLong-term Liabilities
1. Debt financing may be the only available
source of funds.
2. Debt financing may have a lower cost.
3. Debt financing offers the opportunity for
leverage.
4. Debt financing offers an income tax advantage.
5. The voting privilege is not shared.
Reasons for Issuance of Long-Term LiabilitiesReasons for Issuance of Long-Term Liabilities Reasons for Issuance of Long-Term LiabilitiesReasons for Issuance of Long-Term Liabilities
Record long-term liabilities at the fair value of the goods or services received.
Interest expense is based on the market interest rate on the date of the debt issuance and the beginning balance of the liability.
Book value is the present value of all future cash payments, discounted at the market interest rate at issuance.
Long-term LiabilitiesLong-term LiabilitiesMeasurement and ValuationMeasurement and Valuation
Long-term LiabilitiesLong-term LiabilitiesMeasurement and ValuationMeasurement and Valuation
Company Issuing Bonds
Investor Buying Bonds
Bond Selling Price
Bond Certificate
At Bond Issuance Date
Bonds PayableBonds PayableCash FlowCash Flow
Bonds PayableBonds PayableCash FlowCash Flow
Company Issuing Bonds
Investor Buying Bonds
Face Value Payment at End of Bond Term
Interest Payments Over Bond Term
Bonds PayableBonds PayableCash FlowCash Flow
Bonds PayableBonds PayableCash FlowCash Flow
Issuing Entity
Collateral
Purpose of Issue
Payment of Interest
Maturity
Bonds PayableBonds PayableClassificationClassification
Bonds PayableBonds PayableClassificationClassification
Issuing EntityIndustrial Bonds
Municipal Bonds
CollateralSecured Bonds
- Mortgage Bonds
- Guaranteed Bonds
Debenture Bonds
Bonds PayableBonds PayableClassificationClassification
Bonds PayableBonds PayableClassificationClassification
Purpose of InterestPurchase Money Bonds
Refunding Bonds
Consolidated Bonds
Payment of InterestOrdinary Bonds
Income Bonds
Registered Bonds
Bearer Bonds
Bonds PayableBonds PayableClassificationClassification
Bonds PayableBonds PayableClassificationClassification
MaturityTerms Bonds
Serial Bonds
Callable Bonds
Redeemable Bonds
Convertible Bonds
Bonds PayableBonds PayableClassificationClassification
Bonds PayableBonds PayableClassificationClassification
BOND PAYABLE
Face Value $1,000 Interest 10%
6/30 & 12/31
Maturity Date 1/1/X5Bond Date 1/1/X0
1. Face Value = Maturity or Par Value2. Maturity Date3. Stated Interest Rate 4. Interest Payment Dates5. Bond Date
Bonds PayableBonds Payable Bonds PayableBonds Payable
BOND PAYABLE
Face Value $1,000 Interest 10%
6/30 & 12/31
Maturity Date 1/1/X5Bond Date 1/1/X0
1. Face Value = Maturity or Par Value2. Maturity Date3. Stated Interest Rate 4. Interest Payment Dates5. Bond Date
Other Factors:6. Market Interest Rate7. Issue Date
Bonds PayableBonds Payable Bonds PayableBonds Payable
Market rate = stated rateBonds sell at face or par value.
Market rate > stated rateBonds sell at a discount (below face value).
Market rate < stated rateBonds sell at a premium (above face value).
Bonds PricesBonds Prices Bonds PricesBonds Prices
On 12/31/X0 Graphics Inc. issues 10 bonds at face value. The market interest rate is 10%. The bonds have the following terms:
Face Value = $1,000
Maturity Date = 12/31/X5 (5 years)
Stated Interest Rate = 10%
Interest Dates = 6/30 & 12/31
Bond Date = 12/31/X0
Bonds Issued at Face Value on Bond DateBonds Issued at Face Value on Bond Date Bonds Issued at Face Value on Bond DateBonds Issued at Face Value on Bond Date
Prepare the journal entry to record the issuance of the bonds on 12/31/X0.
Bonds Issued at Face Value on Bond DateBonds Issued at Face Value on Bond Date Bonds Issued at Face Value on Bond DateBonds Issued at Face Value on Bond Date
Prepare the journal entry to record the issuance of the bonds on 12/31/X0.
Long-term Liability
Bonds Issued at Face Value on Bond DateBonds Issued at Face Value on Bond Date Bonds Issued at Face Value on Bond DateBonds Issued at Face Value on Bond Date
Prepare the journal entry required every 6/30 and 12/31 to pay interest.
Bonds Issued at Face Value on Bond DateBonds Issued at Face Value on Bond Date Bonds Issued at Face Value on Bond DateBonds Issued at Face Value on Bond Date
Prepare the journal entry required every 6/30 and 12/31 to pay interest.
Bonds Issued at Face Value on Bond DateBonds Issued at Face Value on Bond Date Bonds Issued at Face Value on Bond DateBonds Issued at Face Value on Bond Date
Prepare the journal entry to record the maturity of the bond on 12/31/X5.
Bonds Issued at Face Value on Bond DateBonds Issued at Face Value on Bond Date Bonds Issued at Face Value on Bond DateBonds Issued at Face Value on Bond Date
Prepare the journal entry to record the maturity of the bond on 12/31/X5.
Bonds Issued at Face Value on Bond DateBonds Issued at Face Value on Bond Date Bonds Issued at Face Value on Bond DateBonds Issued at Face Value on Bond Date
What happens when the market interest rates are different from the bond’s stated interest rate?
For example, the market is earning 8%. Would you want to invest in Graphics Inc.’s 10% bond?
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
What happens when the market interest rates are different from the bond’s stated interest rate?
For example, the market is earning 8%. Would you want to invest in Graphics Inc.’s 10% bond?
YES!
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
If the bond is paying 10% interest and the market is
paying 8% interest, Graphics Inc. would:
Sell the bond above face value--at a premium
BUT
Pay interest on only the face value
AND
Repay only the face value at maturity.
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
This arrangement will decrease the effective interest rate of Graphics Inc. bonds to the market rate.
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
On 12/31/X0 Graphics Inc. sells 1,000 bonds at 108.1105. The market interest rate is 8%. The bonds have the following terms:
Face Value = $1,000
Maturity Date = 12/31/X5 (5 years)
Stated Interest Rate = 10%
Interest Dates = 6/30 & 12/31
Bond Date = 12/31/X0
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
How much cash is Graphics Inc. going to receive for the entire bond issue?
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
How much cash is Graphics Inc. going to receive for the entire bond issue?
$1,000 face value ×1,000 sold = $1,000,000
$1,000,000 × 108.1105% = $1,081,105 cash
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
Graphics Inc. agrees to repay the full face value at maturity.
$1,000 face value × 1,000 sold = $1,000,000
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
The difference between the face value of the bonds and the cash received is the premium.
$1,081,105 - $1,000,000 = $81,105
The premium is a reduction in the interest factor for Graphics Inc. The premium will be amortized to Interest Expense.
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
Prepare the journal entry to record the issue of the bonds on 12/31/X0.
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
Prepare the journal entry to record the issue of the bonds on 12/31/X0.
Adjunct-LiabilityAccount
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
Book Value
Partial Balance Sheet at 12/31/X0
Long-term Liabilities: Bonds Payable 1,000,000$ Add: Premium on Bonds Payable 81,105 1,081,105$
Maturity Value
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
Prepare the journal entries required every 6/30 and 12/31. Use straight-line amortization of the premium.
(The interest method will be discussed later in the lecture.)
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
In addition to the interest payment entry, we also need to amortize the premium to
Interest Expense.
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
Premium on Bonds Payable
81,105
8,111
72,994
As the premium account is amortized, the book value of the bonds payable decreases toward the maturity value.
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
Book Value
Partial Balance Sheet at 6/30/X1
Long-term Liabilities: Bonds Payable 1,000,000$ Add: Premium on Bonds Payable 72,994 1,072,994$
Maturity Value
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
Now, let’s calculate how Graphics, Inc.
determined the selling price of the
bond.
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
Face Value 1,000,000$ Stated Interest Rate 10%Number of Periods (5 yrs. × 2) 10
Market Interest Rate 8%
Present Value of Bond on Issuance Date Principal 1,000,000$ PV $1, 10 periods, 4% .67556 PV of Principal 675,560$
Interest Payments 50,000$ PVA $1, 10 periods, 4% 8.11090 PV of Interest Payments 405,545
Selling Price of Bond 1,081,105$
Face Value 1,000,000$ Stated Interest Rate 10%Number of Periods (5 yrs. × 2) 10
Market Interest Rate 8%
Present Value of Bond on Issuance Date Principal 1,000,000$ PV $1, 10 periods, 4% .67556 PV of Principal 675,560$
Interest Payments 50,000$ PVA $1, 10 periods, 4% 8.11090 PV of Interest Payments 405,545
Selling Price of Bond 1,081,105$
Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date Bonds Issued Above Face Value on Bond DateBonds Issued Above Face Value on Bond Date
Interest Expense for each period is calculated as follows:
Book Value of Bond at Beginning of Period
×Market Interest Rate at Date of Bond Issuance
Interest Expense The amortization for the discount or premium is
calculated as follows:
Cash Payment for Interest
- Interest Expense
Amortization Amount
Interest MethodInterest Method Interest MethodInterest Method
Interest MethodInterest Method Amortization TableAmortization Table
Interest MethodInterest Method Amortization TableAmortization Table
*
* Rounded
Interest MethodInterest Method Amortization TableAmortization Table
Interest MethodInterest Method Amortization TableAmortization Table
What happens when the market interest rates are different from the bond’s stated interest rate?
For example, the market is earning 12%. Would you want to invest in Graphics Inc.’s 10% bond?
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
What happens when the market interest rates are different from the bond’s stated interest rate?
For example, the market is earning 12%. Would you want to invest in Graphics Inc.’s 10% bond?
NO!
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
If the bond is paying 10% interest and the market is paying 12% interest, Graphics Inc. would:
Sell the bond below face value--at a discount
BUT
Pay interest on the full face value
AND
Repay the full face value at maturity.
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
This arrangement will increase the effective interest rate of Graphics Inc. bonds to the market rate.
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
On 12/31/X0 Graphics Inc. sells 1,000 bonds at 92.6395. The market interest rate is 12%. The bonds have the following terms:
Face Value = $1,000
Maturity Date = 12/31/X5 (5 years)
Stated Interest Rate = 10%
Interest Dates = 6/30 & 12/31
Bond Date = 12/31/X0
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
How much cash is Graphics Inc. going to receive for the entire bond issue?
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
How much cash is Graphics Inc. going to receive for the entire bond issue?
$1,000 face value × 1,000 sold = $1,000,000
$1,000,000 × 92.6395% = $926,395 cash
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
Graphics Inc. agrees to repay the full face value at maturity.
$1,000 face value × 1,000 sold = $1,000,000
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
The difference between the face value of the bonds and the cash received is the discount.
$1,000,000 - $926,395 = $73,605
The discount is an additional interest factor for Graphics Inc. The discount will be amortized to Interest Expense.
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
Prepare the journal entry to record the issue of the bonds on 12/31/X0.
GENERAL JOURNAL Page 77
Date DescriptionPost. Ref. Debit Credit
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
Prepare the journal entry to record the issue of the bonds on 12/31/X0.
GENERAL JOURNAL Page 77
Date DescriptionPost. Ref. Debit Credit
Dec 31 Cash 926,395
Discount on Bonds Payable 73,605
Bonds Payable 1,000,000
To record bond issue at discount
Contra-LiabilityAccount
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
Book Value
Partial Balance Sheet at 12/31/X0
Long-term Liabilities: Bonds Payable 1,000,000$ Less: Discount on Bonds Payable 73,605 926,395$
Maturity Value
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
Prepare the journal entries required every 6/30 and 12/31. Use straight-line amortization of the discount.
(The interest method will be discussed later in the lecture.)
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
In addition to the interest payment entry, we also need to amortize the discount to
Interest Expense.
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
Discount on Bonds Payable
73,605
7,360
66,245
As the discount account is amortized, the book value of
the bonds payable increases toward the maturity value.
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
Book Value
Partial Balance Sheet at 6/30/X1
Long-term Liabilities: Bonds Payable 1,000,000$ Less: Discount on Bonds Payable 66,245 933,755$
Maturity Value
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
Calculate how Graphics, Inc.
determined the selling price of the
bond.
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
Face Value 1,000,000$ Stated Interest Rate 10%Number of Periods (5 yrs. × 2) 10
Market Interest Rate 12%
Present Value of Bond on Issuance Date Principal 1,000,000$ PV $1, 10 periods, 6% .55839 PV of Principal 558,390.00$
Interest Payments 50,000$ PVA $1, 10 periods, 6% 7.36009 PV of Interest Payments 368,004.50 Selling Price of Bond 926,394.50$
Face Value 1,000,000$ Stated Interest Rate 10%Number of Periods (5 yrs. × 2) 10
Market Interest Rate 12%
Present Value of Bond on Issuance Date Principal 1,000,000$ PV $1, 10 periods, 6% .55839 PV of Principal 558,390.00$
Interest Payments 50,000$ PVA $1, 10 periods, 6% 7.36009 PV of Interest Payments 368,004.50 Selling Price of Bond 926,394.50$
Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date Bonds Issued Below Face Value on Bond DateBonds Issued Below Face Value on Bond Date
Interest MethodInterest Method Amortization TableAmortization Table
Interest MethodInterest Method Amortization TableAmortization Table
*
* Rounded
Interest MethodInterest Method Amortization TableAmortization Table
Interest MethodInterest Method Amortization TableAmortization Table
On 1/1/X1 Graphics Inc. issued $1,000,000, 10%, 5-year bonds at a discount of 92.6395. The bonds pay interest semiannually. The market interest rate was 12%. Using the effective interest method, what would be the interest expense for the first 6 months?
a. $60,000.00
b. $55,583.70
c. $73,605.00
d. $46,319.75
Interest MethodInterest Method QuestionQuestion
Interest MethodInterest Method QuestionQuestion
On 1/1/X1 Graphics Inc. issued $1,000,000, 10%, 5-year bonds at a discount of 92.6395. The bonds pay interest semiannually. The market interest rate was 12%. Using the effective interest method, what would be the interest expense for the first 6 months?
a. $60,000.00
b. $55,583.70
c. $73,605.00
d. $46,319.75
Face Value 1,000,000.00$ Discount 92.6395%
Book Value 926,395.00 Market Rate (12% × 2) 6%
6 Month Expense 55,583.70$
Interest MethodInterest Method QuestionQuestion
Interest MethodInterest Method QuestionQuestion
Using the effective interest method, determine the amortization for the discount for the first 6 months?
a. $5,583.70
b. $55,583.70
c. $50,000.00
d. $9,664.99
Interest MethodInterest Method QuestionQuestion
Interest MethodInterest Method QuestionQuestion
Using the effective interest method, determine the amortization for the discount for the first 6 months?
a. $5,583.70
b. $55,583.70
c. $50,000.00
d. $9,664.99
Interest Expense $55,583.70
Cash Payment - 50,000.00
Discount Amortized $ 5,583.70
Interest MethodInterest Method QuestionQuestion
Interest MethodInterest Method QuestionQuestion
Legal
Accounting
Underwriting
Commission
Engraving
Printing
Registration
Promotion
Bond Issue CostsBond Issue Costs Bond Issue CostsBond Issue Costs
On January 1, 2007, Bergen Company issues 10-year bonds
with a face value of $500,000 at 104. Expenditures connected
with the issue totaled $8,000.
On January 1, 2007, Bergen Company issues 10-year bonds
with a face value of $500,000 at 104. Expenditures connected
with the issue totaled $8,000.
Cash ($520,000 - $8,000) 512,000
Deferred Bond Issue Costs 8,000
Bonds Payable 500,000
Premium on Bonds Payable 20,000
0.04 0.04 x $500,000x $500,000
Bond Issue CostsBond Issue Costs Bond Issue CostsBond Issue Costs
Each year for the ten years Deferred Bond Issue Costs is amortized on a straight-line
basis by charging Bond Interest Expense for $800.
Each year for the ten years Deferred Bond Issue Costs is amortized on a straight-line
basis by charging Bond Interest Expense for $800.
However, the FASB is planning to change GAAP, so that all debt issue costs are expensed as incurred.
However, the FASB is planning to change GAAP, so that all debt issue costs are expensed as incurred.
Bond Issue CostsBond Issue Costs Bond Issue CostsBond Issue Costs
In the previous examples, the bonds were sold on the bond date.
But this is not always the case.
Are you ready to see what happens when we sell bonds between the bond’s interest dates?
When bonds are sold between the interest dates, the bond issuer collects cash for:
The cash (or selling) price of the bonds
AND
The accrued interest since the last interest payment date.
Bonds Issued Between Interest DatesBonds Issued Between Interest Dates Bonds Issued Between Interest DatesBonds Issued Between Interest Dates
The 6 month interest payment to the bondholders is composed of:
Repayment of the accrued interest received from the bondholders when the bonds were originally sold
AND
Interest earned by the bondholders since the bonds were purchased.
Bonds Issued Between Interest DatesBonds Issued Between Interest Dates Bonds Issued Between Interest DatesBonds Issued Between Interest Dates
On 4/1/X1 Graphics Inc. issues 1,000 bonds at face value. The market interest rate was 12%. The bonds have the following terms:
Face Value = $1,000
Maturity Date = 1/1/X6 (5 years)
Stated Interest Rate = 10%
Interest Dates = 6/30 & 12/31
Bond Date = 1/1/X1
Bonds Issued Between Interest DatesBonds Issued Between Interest Dates Bonds Issued Between Interest DatesBonds Issued Between Interest Dates
Selling Price of BondsPV of Bonds at 1/1/X1 Principal (PV of $1, 10, 6%) 558,390$ Interest (PVA of $1, 10, 6%) 368,005
Total PV 926,395 Growth in PV 1/1/X1-4/1/X1 ($926,395 ×12% ×3/12) 27,792 Accrued Interest ($1,000,000 ×10% ×3/12) (25,000)
Selling Price of Bond 929,187
Selling Price of BondsPV of Bonds at 1/1/X1 Principal (PV of $1, 10, 6%) 558,390$ Interest (PVA of $1, 10, 6%) 368,005
Total PV 926,395 Growth in PV 1/1/X1-4/1/X1 ($926,395 ×12% ×3/12) 27,792 Accrued Interest ($1,000,000 ×10% ×3/12) (25,000)
Selling Price of Bond 929,187
Bonds Issued Between Interest DatesBonds Issued Between Interest Dates Bonds Issued Between Interest DatesBonds Issued Between Interest Dates
Cash Price of Bonds
Accrued Interest
How much cash is Graphics Inc. going to receive for the entire issue of the bonds?
Bonds Issued Between Interest DatesBonds Issued Between Interest Dates Bonds Issued Between Interest DatesBonds Issued Between Interest Dates
How much cash is Graphics Inc. going to receive for the entire issue of the bonds?
Cash Price of Bonds 929,187$
Accrued Interest$1,000,000 ×10% ×3/12 = 25,000
Total Cash Received 954,187$
Bonds Issued Between Interest DatesBonds Issued Between Interest Dates Bonds Issued Between Interest DatesBonds Issued Between Interest Dates
What does the $25,000 in accrued interest represent for Graphics Inc.?
Bonds Issued Between Interest DatesBonds Issued Between Interest Dates Bonds Issued Between Interest DatesBonds Issued Between Interest Dates
What does the $25,000 in accrued interest represent for Graphics Inc.?
Interest
Payable
Bonds Issued Between Interest DatesBonds Issued Between Interest Dates Bonds Issued Between Interest DatesBonds Issued Between Interest Dates
Prepare the journal entry to record the bond issue on 4/1/X1.
GENERAL JOURNAL Page 77
Date DescriptionPost. Ref. Debit Credit
Bonds Issued Between Interest DatesBonds Issued Between Interest Dates Bonds Issued Between Interest DatesBonds Issued Between Interest Dates
Prepare the journal entry to record the bond issue on 4/1/X1.
GENERAL JOURNAL Page 77
Date DescriptionPost. Ref. Debit Credit
Apr 1 Cash 954,187
Discount on Bonds Payable 70,813
Interest Payable 25,000
Bonds Payable 1,000,000
To record issue of bonds
Bonds Issued Between Interest DatesBonds Issued Between Interest Dates Bonds Issued Between Interest DatesBonds Issued Between Interest Dates
Prepare the journal entry to record the bond interest payment on 6/30/X1. Use the straight-line method for amortization.
GENERAL JOURNAL Page 77
Date DescriptionPost. Ref. Debit Credit
Bonds Issued Between Interest DatesBonds Issued Between Interest Dates Bonds Issued Between Interest DatesBonds Issued Between Interest Dates
Prepare the journal entry to record the bond interest payment on 6/30/X1. Use the straight-line method for amortization.
GENERAL JOURNAL Page 77
Date DescriptionPost.Ref. Debit Credit
Jun 30 Interest Expense 28,726
Interest Payable 25,000
Discount on Bonds Payable 3,726
Cash 50,000
To record bond interest payment
$70,814 ÷ 57 months = $1,242
$1,242 × 3 months = $3,726
Bonds Issued Between Interest DatesBonds Issued Between Interest Dates Bonds Issued Between Interest DatesBonds Issued Between Interest Dates
Prepare the journal entry to record the bond interest payment on 6/30/X1. Use the straight-line method for amortization.
GENERAL JOURNAL Page 77
Date DescriptionPost.Ref. Debit Credit
Jun 30 Interest Expense 28,726
Interest Payable 25,000
Discount on Bonds Payable 3,726
Cash 50,000
To record bond interest payment
$1,242 × 3 months = $3,726
The discount is amortized over the bond term of 4 years and 9 months
(57 months).
Bonds Issued Between Interest DatesBonds Issued Between Interest Dates Bonds Issued Between Interest DatesBonds Issued Between Interest Dates
Provide investors with opportunity to become a shareholder and participate in stock appreciation in addition to the principal and interest payments.
-- Nonconvertible bonds with detachable stock
warrants
-- Convertible bonds
Debt Securities With Equity RightsDebt Securities With Equity Rights Debt Securities With Equity RightsDebt Securities With Equity Rights
Some bonds are issued with rights, warrants, to acquire capital stock.
Stock warrants provide the option to purchase a specified number of shares of common stock at a designated price per share within a stated period.
A portion of the selling price of the bonds is allocated to the detachable stock warrants.
Credit Additional Paid-in Capital-Detachable Stock Warrants
Bonds Issued with Detachable Stock WarrantsBonds Issued with Detachable Stock Warrants Bonds Issued with Detachable Stock WarrantsBonds Issued with Detachable Stock Warrants
Some bonds are issued with rights, warrants, to acquire capital stock. If the warrants are detachable, a portion of the proceeds from selling the bonds must be allocated to the warrants.
Proportional method
Incremental method
Some bonds are issued with rights, warrants, to acquire capital stock. If the warrants are detachable, a portion of the proceeds from selling the bonds must be allocated to the warrants.
Proportional method
Incremental method
Bonds with Equity CharacteristicsBonds with Equity Characteristics Bonds with Equity CharacteristicsBonds with Equity Characteristics
Amount Assigned to
Bonds=
Market Value of Bonds Without Warrants
Market Value of Bonds Without Warrants
+ Market Value of Warrants
Issuance Price
x
Amount Assigned to Warrants
=Market Value of Warrants
Market Value of Bonds Without Warrants
+ Market Value of Warrants
Issuance Price
x
Bonds Issued with Detachable Stock WarrantsBonds Issued with Detachable Stock Warrants Bonds Issued with Detachable Stock WarrantsBonds Issued with Detachable Stock Warrants
Paul Company sold $800,000 of
12% bonds at 101 ($808,000).
Each bond carried 10 warrants,
and each warrant allows the holder
to acquire one share of $5 par
common stock for $25 per share.
The bonds are quoted at 99 ex
rights and the warrants at $3 each.
Paul Company sold $800,000 of
12% bonds at 101 ($808,000).
Each bond carried 10 warrants,
and each warrant allows the holder
to acquire one share of $5 par
common stock for $25 per share.
The bonds are quoted at 99 ex
rights and the warrants at $3 each.
Bonds Issued with Detachable Stock WarrantsBonds Issued with Detachable Stock Warrants Bonds Issued with Detachable Stock WarrantsBonds Issued with Detachable Stock Warrants
Amount Assigned to
Bonds=
Market Value of Bonds Without Warrants
Market Value of Bonds Without Warrants
+ Market Value of Warrants
Issuance Price
x
Amount Assigned to
Bonds=
$990 per bond x 800 bonds
($990 x 800) + ($3 x 800 x 10)$808,000x
Amount Assigned to
Bonds= $784,235.29
Bonds Issued with Detachable Stock WarrantsBonds Issued with Detachable Stock Warrants Bonds Issued with Detachable Stock WarrantsBonds Issued with Detachable Stock Warrants
Amount Assigned to Warrants
=Market Value of Warrants
Market Value of Bonds Without Warrants
+ Market Value of Warrants
Issuance Price
x
Amount Assigned to Warrants
=$3 x 10 warrants x 800 bonds
($990 x 800) + ($3 x 800 x 10)$808,000x
Amount Assigned to Warrants
= $23,764.71
Bonds Issued with Detachable Stock WarrantsBonds Issued with Detachable Stock Warrants Bonds Issued with Detachable Stock WarrantsBonds Issued with Detachable Stock Warrants
Cash 808,000.00Discount on Bonds Payable 15,764.71 Bonds Payable 800,000.00 Common Stock Warrants 23,764.71
From last slideFrom last slide
$800,000.00 - $784,235.29$800,000.00 - $784,235.29
Bonds Issued with Detachable Stock WarrantsBonds Issued with Detachable Stock Warrants Bonds Issued with Detachable Stock WarrantsBonds Issued with Detachable Stock Warrants
Cash 12,500.00Common Stock Warrants 1,485.50 Common Stock 2,500.00 Additional Paid-in Capital on Common Stock 11,485.50
Later, 500 warrants are exercised at $25 each. Later, 500 warrants are exercised at $25 each.
($23,765.71 ÷ 8,000) ($23,765.71 ÷ 8,000) x 500x 500
Common Stock Warrants 22,279.21 Additional Paid-in Capital from Expired Warrants 22,279.21
The remaining warrants expire.The remaining warrants expire. $23,764.71 - $1,485.50$23,764.71 - $1,485.50
Bonds Issued with Detachable Stock WarrantsBonds Issued with Detachable Stock Warrants Bonds Issued with Detachable Stock WarrantsBonds Issued with Detachable Stock Warrants
If only the detachable stock warrants have a readily determinable market value, the bonds are valued at the difference between the selling price and the market value of the warrants (incremental method).
Bonds with Detachable Stock WarrantsBonds with Detachable Stock Warrants Bonds with Detachable Stock WarrantsBonds with Detachable Stock Warrants
Bond is exchangeable for capital stock of Bond is exchangeable for capital stock of
the issuer at the the issuer at the option of the investor.option of the investor.
Convertible BondsConvertible Bonds Convertible BondsConvertible Bonds
Why issue convertible
bonds?
Why issue convertible
bonds?
Convertible BondsConvertible Bonds Convertible BondsConvertible Bonds
1. Avoid the downward price pressures on its stock that placing a large new issue of common stock on the market would cause.
2. Avoid the direct sale of common stock when it believes its stock currently is undervalued in the market.
3. Penetrate that segment of the capital market that is unwilling or unable to participate in a direct common stock issue.
4. Minimize the costs associated with selling securities.
Convertible BondsConvertible Bonds Convertible BondsConvertible Bonds
APB Opinion No. 14 specifies that convertible bonds be recorded as debt.
Accounting for interest expense and amortization of discount or premium is not affected by convertibility.
Convertible BondsConvertible Bonds Convertible BondsConvertible Bonds
When the bonds are converted, the issuer updates interest expense and amortization of discount or premium to the date of conversion.
Convertible BondsConvertible Bonds Convertible BondsConvertible Bonds
Book value method Record new stock at the book value of the
convertible bonds. Recognize neither gain nor loss.
Market value method Record new stock at the market value of stock
or debt. Recognize gain or loss (Mkt. Value - Book Value)
Convertible BondsConvertible Bonds Convertible BondsConvertible Bonds
Shannon Corporation has outstanding convertible bonds with a face value of $10,000 and a book value of $10,500. Each bond is convertible into 40 shares of $20 par common stock. The market price is $26.50 per share when the shares are converted.
Shannon Corporation has outstanding convertible bonds with a face value of $10,000 and a book value of $10,500. Each bond is convertible into 40 shares of $20 par common stock. The market price is $26.50 per share when the shares are converted.
Convertible BondsConvertible Bonds Convertible BondsConvertible Bonds
Book Value Method- The market price is not considered.Bonds Payable 10,000Premium on Bonds Payable 500
Common Stock 8,000Additional-Paid-in Capital-plug 2,500
Book Value Method- The market price is not considered.Bonds Payable 10,000Premium on Bonds Payable 500
Common Stock 8,000Additional-Paid-in Capital-plug 2,500
Market Value Method-Equity accounts equal market price.Bonds Payable 10,000Premium on Bonds Payable 500Loss on Conversion 100
Common Stock 8,000Additional-Paid-in Capital 2,600
Market Value Method-Equity accounts equal market price.Bonds Payable 10,000Premium on Bonds Payable 500Loss on Conversion 100
Common Stock 8,000Additional-Paid-in Capital 2,600
Convertible BondsConvertible Bonds Convertible BondsConvertible Bonds
A company that has convertible bonds may desire bondholders to convert the bonds to common stock.
A company that has convertible bonds may desire bondholders to convert the bonds to common stock.
To induce conversion, the company may add a “sweetener” to the convertible bond.
To induce conversion, the company may add a “sweetener” to the convertible bond.
The debtor recognizes an expense equal to the fair value
of the “sweetener” and is measured on the date the offer is accepted by the
bondholders.
The debtor recognizes an expense equal to the fair value
of the “sweetener” and is measured on the date the offer is accepted by the
bondholders.
Induced ConversionsInduced Conversions Induced ConversionsInduced Conversions
Assume that Harmon Company had $10,000 of outstanding
convertible bonds, which had been issued at par. The original
terms of issuance allowed each bond to be converted into 40
shares of no-par common stock. To induce conversion, the
terms were changed to offer 50 shares per bond. All shares
were converted when the market price was $30 per share.
Bonds Payable 10,000
Bond Conversion Expense 3,000
Common Stock, no par 13,000
Induced ConversionsInduced Conversions Induced ConversionsInduced Conversions
A liability is extinguished if one of the following criteria is met:
Debtor pays the creditor and is
relieved its obligation. Debtor is legally
released from being the primary obligor under the liability,
either judicially or by the creditor.
OR
Debt ExtinguishmentDebt Extinguishment SFAS No. 140SFAS No. 140
Debt ExtinguishmentDebt Extinguishment SFAS No. 140SFAS No. 140
Whether bonds are recalled, retired, or refunded prior to maturity, any gain or loss is reported as a component of
income from continuing operations in the current period.
Whether bonds are recalled, retired, or refunded prior to maturity, any gain or loss is reported as a component of
income from continuing operations in the current period.
Debt ExtinguishmentDebt Extinguishment Debt ExtinguishmentDebt Extinguishment
Update interest expense, amortization, and related issue costs to retirement date.
Remove liability accounts.
Record the transfer of cash, other resources, or debt securities.
Accounting for Debt ExtinguishmentAccounting for Debt Extinguishment Accounting for Debt ExtinguishmentAccounting for Debt Extinguishment
Channing Corporation originally issued $100,000 of 12%
bonds at 97 on January 1, 2002. The bonds have a 10-year
life, pay interest on January 1 and July 1, and are callable at
105 plus accrued interest. The company amortizes the
discount by the straight-line method.
Channing Corporation originally issued $100,000 of 12%
bonds at 97 on January 1, 2002. The bonds have a 10-year
life, pay interest on January 1 and July 1, and are callable at
105 plus accrued interest. The company amortizes the
discount by the straight-line method.
ContinuedContinuedContinuedContinued
On June 30, 2007, the company recalls the bonds.On June 30, 2007, the company recalls the bonds.
Bonds Retired Prior to MaturityBonds Retired Prior to Maturity Bonds Retired Prior to MaturityBonds Retired Prior to Maturity
Interest Expense 6,150
Discount on Bonds Payable 150
Interest Payable 6,000
First, Channing records the current interest expense and
liability, including the amortization of the discount that
expired since the last interest payment.
First, Channing records the current interest expense and
liability, including the amortization of the discount that
expired since the last interest payment.
($3,000 ÷ 10) ($3,000 ÷ 10) x 1/2x 1/2
$100,000 $100,000 x 0.12 x 1/2x 0.12 x 1/2
Bonds Retired Prior to MaturityBonds Retired Prior to Maturity Bonds Retired Prior to MaturityBonds Retired Prior to Maturity
Bonds Payable 100,000
Interest Payable 6,000
Loss on Bond Redemption 6,350
Discount on Bonds Payable 1,350
Cash 111,000
Channing then records the reacquisition of the bonds at
105 plus accrued interest of $6,000.
Channing then records the reacquisition of the bonds at
105 plus accrued interest of $6,000.
Original discountOriginal discount $ 3,000 $ 3,000 Less: AmortizationLess: Amortization for 5 1/2 yearsfor 5 1/2 years ((1,650)1,650)Unamortized discountUnamortized discount $1,350 $1,350
Bonds Retired Prior to MaturityBonds Retired Prior to Maturity Bonds Retired Prior to MaturityBonds Retired Prior to Maturity
Present value techniques are used for valuation and interest recognition.
The procedures are similar to those we encountered with bonds.
Long-Term NotesLong-Term Notes Long-Term NotesLong-Term Notes
On January 1 of the current year, Johnson Company issues
a 3-year, non-interest-bearing note with a face value of
$8,000 and receives $5,694.24 in exchange.
On January 1 of the current year, Johnson Company issues
a 3-year, non-interest-bearing note with a face value of
$8,000 and receives $5,694.24 in exchange.
Cash 5,694.24
Discount on Notes Payable 2,305.76
Notes Payable 8,000.00
Contra account Contra account to Notes Payableto Notes Payable
Contra account Contra account to Notes Payableto Notes Payable
Notes Payable Issued for CashNotes Payable Issued for Cash Notes Payable Issued for CashNotes Payable Issued for Cash
Johnson Company records the interest expense on
the note for the first year.
Johnson Company records the interest expense on
the note for the first year.
Interest Expense 683.31
Discount on Notes Payable 683.31
Notes payable $8,000.00 Less: Unamortized discount (2,305.76)Carrying value at beginning of year $5,694.24 x Effective interest rate 0.12 Entry amount $ 683.31
Notes Payable Issued for CashNotes Payable Issued for Cash Notes Payable Issued for CashNotes Payable Issued for Cash
Verna Company borrows $100,000 by issuing a 3-year, non-
interest-bearing note to a customer. In addition, Verna
Company agrees to sell inventory to the customer at a
reduced price over a 5-year period. The firm’s incremental
borrowing rate is 12%.
Verna Company borrows $100,000 by issuing a 3-year, non-
interest-bearing note to a customer. In addition, Verna
Company agrees to sell inventory to the customer at a
reduced price over a 5-year period. The firm’s incremental
borrowing rate is 12%.
Cash 100,000.00
Discount on Notes Payable 28,822.00
Notes Payable 100,000.00
Unearned Revenue 28,822.00
$100,000- ($100,000 $100,000- ($100,000 x 0.711789)x 0.711789)$100,000- ($100,000 $100,000- ($100,000 x 0.711789)x 0.711789)
Notes Payable Issued for Cash or Rights and Notes Payable Issued for Cash or Rights and PrivilegesPrivileges
Notes Payable Issued for Cash or Rights and Notes Payable Issued for Cash or Rights and PrivilegesPrivileges
$71,178 $71,178 x 0.12x 0.12
Interest Expense 8,541.36 Discount on Notes Payable 8,541.36Unearned Revenue 5,764.40 Sales Revenue 5,764.40
End of First Year
$28,822 ÷ 5$28,822 ÷ 5Interest Expense 9,566.32 Discount on Notes Payable 9,566.32Unearned Revenue 5,764.40 Sales Revenue 5,764.40
End of Second Year
($71,178 + $8,541.36) ($71,178 + $8,541.36) x 0.12x 0.12
Notes Payable Issued for Cash or Rights and Notes Payable Issued for Cash or Rights and PrivilegesPrivileges
Notes Payable Issued for Cash or Rights and Notes Payable Issued for Cash or Rights and PrivilegesPrivileges
1. No interest is stated, or
2. The stated rate of interest is clearly unreasonable, or
3. The face value of the note is materially different from the cash sales price of the property, goods, or services, or the fair value of the note at the date of the transaction.
APB Opinion No. 21 states that the stipulated rate of
interest should be presumed fair. This presumption can be
overcome only if--
Notes Payable Exchanged for Property, Goods Notes Payable Exchanged for Property, Goods or Servicesor Services
Notes Payable Exchanged for Property, Goods Notes Payable Exchanged for Property, Goods or Servicesor Services
A note payable is recorded at the fair value of the property, goods,
or services or the fair value of the note, whichever is more
reliable.
A note payable is recorded at the fair value of the property, goods,
or services or the fair value of the note, whichever is more
reliable.
Notes Payable Exchanged for Property, Goods Notes Payable Exchanged for Property, Goods or Servicesor Services
Notes Payable Exchanged for Property, Goods Notes Payable Exchanged for Property, Goods or Servicesor Services
On January 1, 2007, Marsden Company purchased used equipment from Joyce Company, issuing a 5 year, $10,000 non-interest-bearing note in exchange. Marsden’s incremental interest rate is 12%.
On January 1, 2007, Marsden Company purchased used equipment from Joyce Company, issuing a 5 year, $10,000 non-interest-bearing note in exchange. Marsden’s incremental interest rate is 12%.
Equipment 5,574.27
Discount on Notes Payable 4,325.73
Notes Payable 10,000.00
Present valuePresent value
Notes Payable Exchanged for Property, Goods Notes Payable Exchanged for Property, Goods or Servicesor Services
Notes Payable Exchanged for Property, Goods Notes Payable Exchanged for Property, Goods or Servicesor Services
Interest Expense 680.91 Discount on Notes Payable 680.91
December 31, 2007
($10,000 – $4,325.73) ($10,000 – $4,325.73) x 0.12x 0.12($10,000 – $4,325.73) ($10,000 – $4,325.73) x 0.12x 0.12
Interest Expense 762.62 Discount on Notes Payable 762.62
December 31, 2008
$10,000 – ($4,325.73 – $680.91) $10,000 – ($4,325.73 – $680.91) x 0.12x 0.12$10,000 – ($4,325.73 – $680.91) $10,000 – ($4,325.73 – $680.91) x 0.12x 0.12
Depreciation Expense 567.62 Accumulated Depreciation 567.43
Notes Payable Exchanged for Property, Goods Notes Payable Exchanged for Property, Goods or Servicesor Services
Notes Payable Exchanged for Property, Goods Notes Payable Exchanged for Property, Goods or Servicesor Services
On 1/1/X4 Dairy Farms Inc. issued a $100,000, 3-year, 6% note in exchange for equipment. Interest is paid every 12/31. The equipment does not have a ready market value. The appropriate rate of interest for notes of this type is 9%.
First, let’s determine the present value of the note and review the amortization table.
Long-Term NotesLong-Term NotesExampleExample
Long-Term NotesLong-Term NotesExampleExample
Present Value of Note Principal (PV $1, 3 periods, 9%) 77,218$ Interest ($6,000 year) (PVA $1, 3 periods, 9%) 15,188 PV of Note 92,406$
Present Value of Note Principal (PV $1, 3 periods, 9%) 77,218$ Interest ($6,000 year) (PVA $1, 3 periods, 9%) 15,188 PV of Note 92,406$
Long-Term NotesLong-Term NotesExampleExample
Long-Term NotesLong-Term NotesExampleExample
AMORTIZATION TABLE FOR NOTE PAYABLE
Interest Interest Discount Unamortized BookDate Payment Expense Amortization Discount Value1/1/X4 7,594$ 92,406$
12/31/X4 6,000$ 8,317$ 2,317$ 5,277 94,723 12/31/X5 6,000 8,525 2,525 2,752 97,248 12/31/X6 6,000 8,752 2,752 0 100,000
AMORTIZATION TABLE FOR NOTE PAYABLE
Interest Interest Discount Unamortized BookDate Payment Expense Amortization Discount Value1/1/X4 7,594$ 92,406$
12/31/X4 6,000$ 8,317$ 2,317$ 5,277 94,723 12/31/X5 6,000 8,525 2,525 2,752 97,248 12/31/X6 6,000 8,752 2,752 0 100,000
Long-Term NotesLong-Term NotesExampleExample
Long-Term NotesLong-Term NotesExampleExample
GENERAL JOURNAL Page 77
Date DescriptionPost. Ref. Debit Credit
Jan 1 Equipment 92,406
Discount on Notes Payable 7,594
Notes Payable 100,000
To record purchase of equipment
Prepare the journal entry to record issuance of the note on January 1, X4.
Long-Term NotesLong-Term NotesExampleExample
Long-Term NotesLong-Term NotesExampleExample
GENERAL JOURNAL Page 77
Date DescriptionPost.Ref. Debit Credit
Dec 31 Interest Expense 8,317
Discount on Notes Payable 2,317
Cash 6,000
To record interest payment
$92,406 ×9% = $8,317
$8,317 - $6,000 = $2,317
Prepare the journal entry for December 31, X4.
Long-Term NotesLong-Term NotesExampleExample
Long-Term NotesLong-Term NotesExampleExample
GENERAL JOURNAL Page 77
Date DescriptionPost. Ref. Debit Credit
Dec 31 Notes Payable 100,000
Interest Expense 8,752
Notes PayableDiscount on Notes Payable 2,752
Cash 106,000
To record maturity of note
Prepare the journal entries for December 31, X6.
Long-Term NotesLong-Term NotesExampleExample
Long-Term NotesLong-Term NotesExampleExample
Unconditional purchase obligations
Exchangeable debenture
Interest rate swap
Off-Balance Sheet FinancingOff-Balance Sheet Financing Off-Balance Sheet FinancingOff-Balance Sheet Financing
Market value
Interest rates
Maturity dates
Debt restrictions
Call provisions
Conversion privileges
Collateral
Sinking-fund requirements for next 5 years
Long-Term LiabilitiesLong-Term LiabilitiesDisclosuresDisclosures
Long-Term LiabilitiesLong-Term LiabilitiesDisclosuresDisclosures
Chapter7
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