Chapter 9 - ACC210 Spring 2011 Long Term Liabilities...

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ACC210 – Spring 2011 “Long Term Liabilities” Chapter 9 Christopher T. McKittrick CPA, MBA, CFE
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Chapter 9 – Objectives Describe the advantages/disadvantages of issuing debt instruments over equity instruments Describe long-term notes Record notes payable transactions Describe bonds payable Define callable and convertible bonds Calculate the issuance price of bonds payable Describe the relationship between the market interest rate and market value of bonds payable Record bonds payable transactions Amortize bonds payable using the effective interest method Calculate and interpret the debt-to-equity, financial leverage and times interest earned ratios
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Long-Term Liabilities • LT Liabilities are generally those obligations that extend beyond one year • Often used to finance and expand operations – Higher in industries that use property, plant, and equipment to generate revenues • Increasing long-term debt causes: – increased interest expense – the need for cash to cover periodic interest payments – cash to repay the principal 3
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Debt vs. Equity Financing Financial Leverage Borrowed money must return more than the interest expense Remember the TVM applications we covered? Risk Can the borrower pay it back? Control Creditors do not share in profits of the company Creditors cannot “vote” Taxation Interest expense Is tax deductible interest to the borrower And what about dividends?
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Pros and Cons of Financing Debt Interest expense on debt is deductible – Taxable income is less than it is without the interest on the debt Fixed amount of compensation to the lender Leverage – Is our use of borrowed capital producing more income than needed to pay the interest on the debt? In periods of inflation, debt permits borrowers to repay the lender in dollars that have declined in purchasing power! Con … – Inflexibility of the payment schedule 5
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Types of Notes Non-interest Bearing Note Non-installment Interest Bearing Note Non-installment Installment
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Nature of Notes Note Payable Mortgage Payable Installment loan Bonds Payable
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Notes Payable and Bonds Payable Note: a formal agreement or contract Bonds: a type of note Requires issuing entity to pay the face value of the bond to the holder when it matures Pay interest periodically at a specified rate Accounting for the liability of Notes Payable and Bonds Payable is identical Only difference is account title 8
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Notes Payable Journal Entries Issuance dr. Cash (A) x,xxx cr. Notes Payable (L) x,xxx Interest dr. Interest Expense (SE) x,xxx cr. Cash (A) or Accrued Int. Exp (L) x,xxx Retirement dr. Notes Payable (L) x,xxx cr. Cash (A) x,xxx
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Bond Terminology Face Value/Par Value/Principal The amount of money borrower agrees to repay at maturity Maturity Date Date on which the borrower agrees to pay the creditor the face value (par value, principal) 10
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Chapter 9 - ACC210 Spring 2011 Long Term Liabilities...

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