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Chapter 14. Long-Term Liabilities. Bond Financing. A1. Advantages. Disadvantages. Bonds do not affect owner control. Bonds require payment of both periodic interest and par value at maturity. Interest on bonds is tax deductible. Bonds can decrease return on equity. - PowerPoint PPT Presentation
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PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Chapter 14
LONG-TERM LIABILITIES
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BOND FINANCING
Bonds do not affect owner control.
Bonds do not affect owner control.
Interest on bonds is tax deductible.
Interest on bonds is tax deductible.
Bonds can increase return on equity.
Bonds can increase return on equity.
AdvantagesAdvantages
Bonds require Bonds require payment of both payment of both
periodic interest and periodic interest and par value at maturity.par value at maturity.
Bonds require Bonds require payment of both payment of both
periodic interest and periodic interest and par value at maturity.par value at maturity.
Bonds can decrease Bonds can decrease return on equity.return on equity.
Bonds can decrease Bonds can decrease return on equity.return on equity.
DisadvantagesDisadvantages
A1
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ISSUING BONDS AT PAR
On Jan. 1, 2011, a company issued the following bonds:Par Value: $800,000
Stated Interest Rate: 9%Interest Dates: 6/30 and 12/31
Maturity Date = Dec. 31, 2030 (20 years)
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$800,000 × 9% × ½ year = $36,000$800,000 × 9% × ½ year = $36,000
ISSUING BONDS AT PAR
On June 30, 2011, the issuer of the bond pays the first semiannual interest payment of $36,000.
On June 30, 2011, the issuer of the bond pays the first semiannual interest payment of $36,000.
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This entry is made every six months until the bonds mature.This entry is made every six months until the bonds mature.
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ISSUING BONDS AT PAR
On December 31, 2030, the bonds mature and the issuer of the bond pays face value of $800,000 to the
bondholders.
On December 31, 2030, the bonds mature and the issuer of the bond pays face value of $800,000 to the
bondholders.
P1
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Fila issues bonds with the following provisions: Fila issues bonds with the following provisions:
Par Value: $100,000Par Value: $100,000
Issue Price: 96.454% of par valueIssue Price: 96.454% of par value
Stated Interest Rate: 8%Stated Interest Rate: 8%
Market Interest Rate: 10%Market Interest Rate: 10%
Interest Dates: 6/30 and 12/31Interest Dates: 6/30 and 12/31
Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011
Maturity Date: Dec. 31, 2013 (2 years)Maturity Date: Dec. 31, 2013 (2 years)
Fila issues bonds with the following provisions: Fila issues bonds with the following provisions:
Par Value: $100,000Par Value: $100,000
Issue Price: 96.454% of par valueIssue Price: 96.454% of par value
Stated Interest Rate: 8%Stated Interest Rate: 8%
Market Interest Rate: 10%Market Interest Rate: 10%
Interest Dates: 6/30 and 12/31Interest Dates: 6/30 and 12/31
Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011
Maturity Date: Dec. 31, 2013 (2 years)Maturity Date: Dec. 31, 2013 (2 years)
ISSUING BONDS AT A DISCOUNT
}} Bond will sell at a discount.
P2
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On Dec. 31, 2011, Fila should record the bond issue.On Dec. 31, 2011, Fila should record the bond issue.On Dec. 31, 2011, Fila should record the bond issue.On Dec. 31, 2011, Fila should record the bond issue.
ISSUING BONDS AT A DISCOUNT
Par value $ 100,000 Cash proceeds 96,454 Discount $ 3,546 *$100,000 x 96.454%
Contra-LiabilityContra-LiabilityAccountAccount
Contra-LiabilityContra-LiabilityAccountAccount
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Long-term Liabilities: Bonds Payable 100,000 Less: Discount on Bonds Payable 3,546 96,454
Partial Balance Sheet as of Dec. 31, 2011
Long-term Liabilities: Bonds Payable 100,000 Less: Discount on Bonds Payable 3,546 96,454
Partial Balance Sheet as of Dec. 31, 2011
Maturity ValueMaturity ValueMaturity ValueMaturity Value
Carrying ValueCarrying ValueCarrying ValueCarrying Value
ISSUING BONDS AT A DISCOUNT
Amortizing a Bond DiscountAmortizing a Bond DiscountUsing the Using the straight-line methodstraight-line method, the discount amortization will , the discount amortization will
be $887 be $887 (rounded) (rounded) every six months. every six months.
$3,546 ÷ 4 periods = $887 $3,546 ÷ 4 periods = $887 (rounded)(rounded)
Amortizing a Bond DiscountAmortizing a Bond DiscountUsing the Using the straight-line methodstraight-line method, the discount amortization will , the discount amortization will
be $887 be $887 (rounded) (rounded) every six months. every six months.
$3,546 ÷ 4 periods = $887 $3,546 ÷ 4 periods = $887 (rounded)(rounded)
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$3,546 ÷ 4 periods = $887 (rounded)
$100,000 × 8% × ½ = $4,000
$3,546 ÷ 4 periods = $887 (rounded)
$100,000 × 8% × ½ = $4,000
Fila will make the following entry every six Fila will make the following entry every six months to record the cash interest payment and months to record the cash interest payment and
the amortization of the discount.the amortization of the discount.
Fila will make the following entry every six Fila will make the following entry every six months to record the cash interest payment and months to record the cash interest payment and
the amortization of the discount.the amortization of the discount.
AMORTIZING A BOND DISCOUNT
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Adidas issues bonds with the following provisions: Adidas issues bonds with the following provisions:
Par Value: $100,000Par Value: $100,000
Issue Price: 103.546% of par valueIssue Price: 103.546% of par value
Stated Interest Rate: 12%Stated Interest Rate: 12%
Market Interest Rate: 10%Market Interest Rate: 10%
Interest Dates: 6/30 and 12/31Interest Dates: 6/30 and 12/31
Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011
Maturity Date: Dec. 31, 2013 (2 years)Maturity Date: Dec. 31, 2013 (2 years)
Adidas issues bonds with the following provisions: Adidas issues bonds with the following provisions:
Par Value: $100,000Par Value: $100,000
Issue Price: 103.546% of par valueIssue Price: 103.546% of par value
Stated Interest Rate: 12%Stated Interest Rate: 12%
Market Interest Rate: 10%Market Interest Rate: 10%
Interest Dates: 6/30 and 12/31Interest Dates: 6/30 and 12/31
Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011
Maturity Date: Dec. 31, 2013 (2 years)Maturity Date: Dec. 31, 2013 (2 years)
ISSUING BONDS AT A PREMIUM
}} Bond will sell at a premium.
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ISSUING BONDS AT A PREMIUM
Par value $ 100,000 Cash proceeds 103,546 *Premium $ 3,546 *$100,000 x 103.546%
Adjunct-LiabilityAdjunct-LiabilityAccountAccount
Adjunct-LiabilityAdjunct-LiabilityAccountAccount
On Dec. 31, 2011, Adidas will record the bond issue as:On Dec. 31, 2011, Adidas will record the bond issue as:On Dec. 31, 2011, Adidas will record the bond issue as:On Dec. 31, 2011, Adidas will record the bond issue as:
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ISSUING BONDS AT A PREMIUM
Long-term Liabilities: Bonds Payable 100,000 Plus: Premum on Bonds Payable 3,546 103,546
Partial Balance Sheet as of Dec. 31, 2011
Long-term Liabilities: Bonds Payable 100,000 Plus: Premum on Bonds Payable 3,546 103,546
Partial Balance Sheet as of Dec. 31, 2011
Maturity ValueMaturity ValueMaturity ValueMaturity Value
Carrying ValueCarrying ValueCarrying ValueCarrying Value
Amortizing a Bond PremiumAmortizing a Bond PremiumUsing the Using the straight-line methodstraight-line method, the premium amortization will , the premium amortization will
be $887 be $887 (rounded) (rounded) every six months. every six months.
$3,546 ÷ 4 periods = $887 $3,546 ÷ 4 periods = $887 (rounded)(rounded)
Amortizing a Bond PremiumAmortizing a Bond PremiumUsing the Using the straight-line methodstraight-line method, the premium amortization will , the premium amortization will
be $887 be $887 (rounded) (rounded) every six months. every six months.
$3,546 ÷ 4 periods = $887 $3,546 ÷ 4 periods = $887 (rounded)(rounded)
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AMORTIZING A BOND PREMIUM
$3,546 ÷ 4 periods = $887 (rounded)
$100,000 × 12% × ½ = $6,000
$3,546 ÷ 4 periods = $887 (rounded)
$100,000 × 12% × ½ = $6,000
Adidas will make the following entry every six Adidas will make the following entry every six months to record the cash interest payment and months to record the cash interest payment and
the amortization of the discount.the amortization of the discount.
Adidas will make the following entry every six Adidas will make the following entry every six months to record the cash interest payment and months to record the cash interest payment and
the amortization of the discount.the amortization of the discount.
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Fila issues bonds with the following provisions: Fila issues bonds with the following provisions:
Par Value: $100,000Par Value: $100,000
Issue Price: ?Issue Price: ?
Stated Interest Rate: 8% Stated Interest Rate: 8%
Market Interest Rate: 10%Market Interest Rate: 10%
Interest Dates: 6/30 and 12/31Interest Dates: 6/30 and 12/31
Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011
Maturity Date: Dec. 31, 2013 (2 years)Maturity Date: Dec. 31, 2013 (2 years)
Fila issues bonds with the following provisions: Fila issues bonds with the following provisions:
Par Value: $100,000Par Value: $100,000
Issue Price: ?Issue Price: ?
Stated Interest Rate: 8% Stated Interest Rate: 8%
Market Interest Rate: 10%Market Interest Rate: 10%
Interest Dates: 6/30 and 12/31Interest Dates: 6/30 and 12/31
Bond Date: Dec. 31, 2011 Bond Date: Dec. 31, 2011
Maturity Date: Dec. 31, 2013 (2 years)Maturity Date: Dec. 31, 2013 (2 years)
ISSUING BONDS AT A DISCOUNTP2
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PRESENT VALUE OF A DISCOUNT BOND
To calculate Present Value, we need relevant interest rate To calculate Present Value, we need relevant interest rate and number of periods.and number of periods.
Semiannual rate = 5% (Market rate 10% ÷ 2)Semiannual rate = 5% (Market rate 10% ÷ 2)Semiannual periods = 4 (Bond life 2 years × 2)Semiannual periods = 4 (Bond life 2 years × 2)
To calculate Present Value, we need relevant interest rate To calculate Present Value, we need relevant interest rate and number of periods.and number of periods.
Semiannual rate = 5% (Market rate 10% ÷ 2)Semiannual rate = 5% (Market rate 10% ÷ 2)Semiannual periods = 4 (Bond life 2 years × 2)Semiannual periods = 4 (Bond life 2 years × 2)
$100,000 × 8% × ½ = $4,000$100,000 × 8% × ½ = $4,000$100,000 × 8% × ½ = $4,000$100,000 × 8% × ½ = $4,000
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This ratio helps investors determine the risk of investing This ratio helps investors determine the risk of investing in a company by dividing its total liabilities by total equity.in a company by dividing its total liabilities by total equity.This ratio helps investors determine the risk of investing This ratio helps investors determine the risk of investing in a company by dividing its total liabilities by total equity.in a company by dividing its total liabilities by total equity.
DEBT-TO-EQUITY RATIO
Debt-to-
Equity Ratio
Total Liabilities
Total Equity=
A3