Chap 7 Outline

# Interest expense each time loan balance interest rate

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Interest expense each time = LOAN balance * interest rate * time Example: Jones company buys equipment for \$50,000. Agrees to make 4 equal payments at December 31 of \$14,429.57. The interest rate is 6% Year Bal beg yr Cash pymt Interest pymt A Prin.repaymen t B Bal 12/31 1 50,000 .00 14,429 .57 3,000.00 11,429.57 38,570.43 2 38,570.43 14,429.57 2,314.23 12,115.34 26,455.09 3 26,455.09 14,429.57 1,587.31 12,842.26 13,612.83 4 13,612.83 14,429.57 816.74 13,612.83** 0.00 A = loan balance (50,000) * (.06) = 3000 B = total payment (14,429.57) – interest (3000) = 11429.57 paid off on the debt Loan balance changes from 50,000 – 11,429.57 = 38,570.43 Second year interest: 38,570.43 * .06 = 2314.23 Second year principle payment = 14,426.57 – 2,314.23 = 12,115.34 Show how year one transaction is recorded: Asset Liability Equity cash Note payable Retained earnings -14,429.57 -11,429.57 -3000 interest expense Line of credit. Businesses frequently use lines of credit to meet fluctuating borrowing needs 7-3

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Chapter 07 - Accounting for Liabilities They are, therefore, a convenient source of short-term credit. Borrowers pay for this convenience with relatively high interest rates that fluctuate with market conditions. Each time you borrow on the line, it is an asset source transaction. They must repay the loan and regularly pay interest on the line of credit A business does not have to borrow on the line of credit but can when it needs to and then only pays interest if it borrows on it. Bond Liability Companies issue bond to the public (investors) to borrow larger sums of money than one financial institution would lend. Bonds are sold in \$1000 increments Bond certificates state the interest rate, how often interest is paid and when the debt/bond will be paid off. Advantages of Bonds 1. This type of debt is more long term. It allows for more strategic planning for repayment. 2. Bond interest rates are usually lower than bank interest rates. Bonds are issued At face value – where the market rate is the same as the contract rate At a discount – where it is sold below face value At a premium- where it is sold above face value 3 transactions related to bonds 1. Issue the bond (borrow money) (asset source transaction) 2. Accrue interest (claims exchange) (most are semi annual interest payments) 3. Pay interest (asset use) Asset Liability Equity 1. Cash + bond payable + 2 Interest payable+ Retained earnings - Interest expense 3 Cash - Interest payable - How to issue at bond at a discount (95) of \$100,000 Bond is issued at 95% of the face value (.95 * face value 100,000 = 95,000 of cash) Asset Liability Equity 1. Cash + 95,000 bond payable + 100,000 Bond Discount -5,000 7-4
Chapter 07 - Accounting for Liabilities

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• Fall '12
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