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Chapter_14-students - Chapter 14 Long­Term Liabilities...

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Unformatted text preview: Chapter 14 Long­Term Liabilities Financing Corporations Two different sources of financing: Corporations go through complex considerations to determine the appropriate mixture for them – One consideration is the impact to earnings per share (EPS) (Net Income – Preferred Dividends)/ number of common – – Debt Equity – Demands on cash and income tax implications shares outstanding Bonds One of the focuses of the chapter Bond issues are debts – often broken down into smaller, more manageable pieces – Face value (principal) of each bond is often $1,000 or a multiple of $1,000 – This can help the company to receive a favorable rate Bonds differ as to the face value, interest rates, interest payment dates, and maturity dates – Semiannual interest payment dates are common Difficult to find a lender that is able and willing to lend the entire amount without charging a premium Bonds, continued Terminology surrounding bonds – Bond indenture – the contract between the company issuing the bonds and the bondholders – Convertible bonds – Callable bonds – likely on the large bond workout problem on midterm three – Debenture bonds Bonds, cont. Factors to determine the money that a company will receive when issuing a bond – Face amount (amount due at maturity date) – Interest rate on bonds often $1,000 or multiple of $1,000 – Market rate of interest Stated rate of interest Contract rate Interest is paid on the face amount Also called effective rate of interest Determined from sales of similar bonds with similar risk and maturity Semiannual payments are very common – Frequency of interest payments Bonds, cont Because there is market information available, bonds with a stated interest rate that is lower than market rate will be issued at a discount (selling price less than face amount) If stated interest rate > market rate, bonds will be issued at a premium (selling price greater than face value) If the two rates equal, selling price will equal face value Accounting for B/P When bonds are issued at face value Issuance Cash dr Bonds Payable (B/P) cr. Payment of interest Interest Expense dr Cash Maturity date Bonds Payable dr Cash cr Note: Adjusting entries would be required if the financial statement date cuts off between payment Accounting for B/P Bonds issued at a discount (stated interest rate is lower than market) Issuance Cash dr. Discount on B/P dr. B/P cr. – – – – – – – discount on B/P is a contra account to B/P Will be amortized over the life of the bond B/P less discount on B/P is called the carrying value of the B/P Two methods to amortize the discount Required to know both methods Effective interest rate method is where you will receive the most points on the exam Straight line (in body of book chapter) Effective interest rate method (appendix 2) Straight line amortization is only allowed if there are immaterial differences exist Required by GAAP Bonds with Discounts, etc. Interest payment dates (if entry for amortization of discount is combined with entry for payment of interest) Interest expense dr. discount on B/P cr. Cash (stated interest x principal) cr. Amortization of discount might occur as an annual adjusting entry Interest Expense dr. Discount on B/P cr. Bonds Issued at a Premium Issuance Cash dr Premium on B/P cr. B/P cr. interest payment *assuming entry for amortization is combined with entry for interest payments Interest expense dr. Premium on B/P dr. Cash cr. – Premium on B/P has a normal balance of a credit. It increases the carrying value of the B/P Bond Redemption Call or redeem Often will be for a price that differs from the carrying value of the B/P – Carrying value (carrying amount) is the face value less any unamortized discount (if a discount) – Carrying value would be the face value plus any unamortized premium (if a premium exists) – Gain results if price to redemption is less than carrying value – Loss results if cost to redeem is greater than carrying value Bond Redemption In case of a gain B/P dr Premium on B/P***dr gain on redemption cr cash cr ***if there was a discount on the bond in question, this would be a credit to discount on B/P Bond Redemptions, cont In case of a loss on redemption B/P dr Premium on B/P*** dr Loss on redemption dr cash cr ***if there was a discount on the B/P this would be a credit to discount on B/P Gains/losses on redemptions are reported in the other income section of the income statement Installment Notes An installment note is a debt that requires the borrower to make equal periodic payments to the lender for the term of the note. Unlike bonds, a note payment consists of payment of a portion of the amount initially borrowed (the principal) and payment of interest on the outstanding balance – Ex 14­11 Appendix material Time Value of Money – The time value of money concept recognizes that an amount of cash to be received today is worth more than the same amount of cash to be received in the future. – Present value – the value today of a certain sum to be received in the future – Concept related to present value is future value – the value of an amount today at some point in the future (the $1,100 above is future value of $1,000 today) – You can manually calculate or use tables If you felt that you can receive 10% return on investments (compounded annually), you would be indifferent between receiving $1,000 today or $1,100 tomorrow The appendix at the end of the book has longer tables than what is presented in the appendix in chapter 14 Appendix Materials Annuity­ a series of EQUAL cash receipts at fixed intervals. Bonds have two types of payments to consider – The interest payments over the life of the bond (cash payments are seen as an annuity) – The face value received at the end of the bond’s life (PV of an amount) – This requires two calculations ...
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