Accounting

Accounting for
for Bond
Bond Issues
Issues
Question
The rate of interest investors demand for loaning funds to
a corporation is the:
a. contractual interest rate.
b. face value rate.
c. market interest rate.
d. stated interest rate.

Slide
10-1
SO 4 Explain why bonds are issued, and identify the types of bonds.
 Accounting
Accounting for
for Bond
Bond Issues
Issues
Question
Karson Inc. issues 10-year bonds with a maturity value of
$200,000. If the bonds are issued at a premium, this
indicates that:
a. the contractual interest rate exceeds the market
interest rate.
b. the market interest rate exceeds the contractual
interest rate.
c. the contractual interest rate and the market interest
rate are the same.
d. no relationship exists between the two rates.

Slide
10-2
SO 4 Explain why bonds are issued, and identify the types of bonds.
 Accounting
Accounting for
for Bond
Bond Issues
Issues

Issuing Bonds at Face Value

Illustration: On January 1, 2011, Candlestick

Corporation issues $100,000, five-year, 10% bonds at 100
(100% of face value). The entry to record the sale is:

Jan. 1 Cash 100,000

Bonds payable 100,000

Slide
10-3
SO 4 Explain why bonds are issued, and identify the types of bonds.
 Issuing
Issuing Bonds
Bonds at
at Face
Face Value
Value

Illustration: On January 1, 2011, Candlestick

Corporation issues $100,000, five-year, 10% bonds at 100
(100% of face value). Assume that interest is
payable semiannually on January 1 and July 1. Prepare
the entry to record the payment of interest on July 1, 2011,
assume no previous accrual.

July 1 Bond interest expense 5,000

Cash 5,000

Slide
10-4
SO 4 Explain why bonds are issued, and identify the types of bonds.
 Issuing
Issuing Bonds
Bonds at
at Face
Face Value
Value

Illustration: On January 1, 2011, Candlestick

Corporation issues $100,000, five-year, 10% bonds at 100
(100% of face value). Assume that interest is
payable semiannually on January 1 and July 1. Prepare
the entry to record the accrual of interest on December 31,
2011, assume no previous accrual.

Dec. 31 Bond interest expense 5,000

Bond interest payable 5,000

Slide
10-5
SO 4 Explain why bonds are issued, and identify the types of bonds.
 Accounting
Accounting for
for Bond
Bond Issues
Issues
Assume Contractual Rate of 8%

Market Interest Bonds Sold At

6% Premium

8% Face Value

10% Discount

Slide
10-6
SO 5 Prepare the entries for the issuance of bonds and interest expense.
 Accounting
Accounting for
for Bond
Bond Issues
Issues

Issuing Bonds at a Discount

Illustration: On January 1, 2011, Candlestick, Inc. sells
$100,000, five-year, 10% bonds for $92,639 (92.639% of
face value). Interest is payable on July 1 and January 1.
The entry to record the issuance is:

Jan. 1 Cash 92,639

Bond payable 92,639

Slide
10-7
SO 5 Prepare the entries for the issuance of bonds and interest expense.
 Issuing
Issuing Bonds
Bonds at
at aa Discount
Discount

Statement Presentation Illustration 10-11

Statement presentation of
bonds issued at a discount

Slide
10-8
SO 5 Prepare the entries for the issuance of bonds and interest expense.
 Issuing
Issuing Bonds
Bonds at
at aa Discount
Discount
Total Cost of Borrowing
Illustration 10-12

Illustration 10-13

Slide
10-9
SO 5 Prepare the entries for the issuance of bonds and interest expense.
 Issuing
Issuing Bonds
Bonds at
at aa Discount
Discount
Question

Discount on Bonds Payable:

a. has a credit balance.
b. is a contra account.
c. is added to bonds payable on the statement of
financial position.
d. increases over the term of the bonds.

Slide
10-10
SO 5 Prepare the entries for the issuance of bonds and interest expense.
 Accounting
Accounting for
for Bond
Bond Issues
Issues

Issuing Bonds at a Premium

Illustration: On January 1, 2011, Candlestick, Inc. sells
$100,000, five-year, 10% bonds for $108,111 (108.111%
of face value). Interest is payable on July 1 and January 1.
The entry to record the issuance is:

Jan. 1 Cash 108,111

Bonds payable 108,111

Slide
10-11
SO 5 Prepare the entries for the issuance of bonds and interest expense.
 Issuing
Issuing Bonds
Bonds at
at aa Premium
Premium

Statement Presentation Illustration 10-14

Statement presentation of
bonds issued at a premium

Issuing bonds at an amount different from face value is quite

common. By the time a company prints the bond certificates and
markets the bonds, it will be a coincidence if the market rate and the
contractual rate are the same.

Slide
10-12
SO 5 Prepare the entries for the issuance of bonds and interest expense.
 Issuing
Issuing Bonds
Bonds at
at aa Premium
Premium
Total Cost of Borrowing
Illustration 10-15

Illustration 10-16

Slide
10-13
SO 5 Prepare the entries for the issuance of bonds and interest expense.
 Accounting
Accounting for
for Bond
Bond Retirements
Retirements

Redeeming Bonds at Maturity

Assuming that the company pays and records separately
the interest for the last interest period, Candlestick records
the redemption of its bonds at maturity as follows:

Bond payable 100,000

Cash 100,000

Slide
10-14
SO 6 Describe the entries when bonds are redeemed.
 Accounting
Accounting for
for Bond
Bond Retirements
Retirements

Redeeming Bonds before Maturity

When retiring bonds before maturity, it is necessary to:
1. eliminate the carrying value of the bonds at the redemption
date;
2. record the cash paid; and
3. recognize the gain or loss on redemption.

The carrying value of the bonds is the face value of the bonds less
unamortized bond discount or plus unamortized bond premium at the
redemption date.
Slide
10-15
SO 6 Describe the entries when bonds are redeemed.
 Accounting
Accounting for
for Bond
Bond Retirements
Retirements
Question
When bonds are redeemed before maturity, the gain or
loss on redemption is the difference between the cash
paid and the:
a. carrying value of the bonds.
b. face value of the bonds.
c. original selling price of the bonds.
d. maturity value of the bonds.

Slide
10-16
SO 6 Describe the entries when bonds are redeemed.
 Accounting
Accounting for
for Bond
Bond Retirements
Retirements
Illustration: Assume Candlestick, Inc. has sold its bonds at a
premium. At the end of the eighth period, Candlestick retires
these bonds at 103 after paying the semiannual interest. The
carrying value of the bonds at the redemption date is $101,623.
Candlestick makes the following entry to record the redemption
at the end of the eighth interest period (January 1, 2015):

Bonds payable 101,623

Loss on redemption 1,377
Cash 103,000

Slide
10-17
SO 6 Describe the entries when bonds are redeemed.
 Accounting
Accounting for
for Long-Term
Long-Term Notes
Notes Payable
Payable

Long-Term Notes Payable

May be secured by a mortgage that pledges title to
specific assets as security for a loan.

Typically, terms require the borrower to make installment

payments over the term of the loan. Payment consists of
1. interest on the unpaid balance of the loan and
2. a reduction of loan principal.

Companies initially record mortgage notes payable at

face value.

Slide
10-18
SO 7 Describe the accounting for long-term notes payable.
 Accounting
Accounting for
for Long-Term
Long-Term Notes
Notes Payable
Payable
Illustration: Porter Technology Inc. issues a $500,000, 12%, 20-
year mortgage note on December 31, 2011. The terms provide for
semiannual installment payments of $33,231 (not including real
estate taxes and insurance). The installment payment schedule for
the first two years is as follows.
Illustration 10-17

Slide
10-19
SO 7 Describe the accounting for long-term notes payable.
 Accounting
Accounting for
for Long-Term
Long-Term Notes
Notes Payable
Payable
Illustration: Porter Technology Inc. issues a $500,000, 12%, 20-
year mortgage note on December 31, 2011. The terms provide for
semiannual installment payments of $33,231 (not including real
estate taxes and insurance). The installment payment schedule for
the first two years is as follows.

Dec. 31 Cash 500,000

Mortgage notes payable 500,000

Jun. 30 Interest expense 30,000

Mortgage notes payable 3,231
Cash 33,231

Slide
10-20
SO 7 Describe the accounting for long-term notes payable.
 Accounting
Accounting for
for Long-Term
Long-Term Notes
Notes Payable
Payable
Question

Each payment on a mortgage note payable consists of:

a. interest on the original balance of the loan.
b. reduction of loan principal only.
c. interest on the original balance of the loan and
reduction of loan principal.
d. interest on the unpaid balance of the loan and
reduction of loan principal.

Slide
10-21
SO 7 Describe the accounting for long-term notes payable.
Slide
10-22
 Statement
Statement Presentation
Presentation and
and Analysis
Analysis

Presentation
Illustration 10-18

Slide SO 8 Identify the methods for the presentation and

10-23 analysis of non-current liabilities.
 Statement
Statement Presentation
Presentation and
and Analysis
Analysis

Analysis
Two ratios that provide information about debt-paying
ability and long-run solvency are:

1. Debt to total Total debt

=
assets
Total assets

The higher the percentage of debt to total assets, the

greater the risk that the company may be unable to meet
its maturing obligations.

Slide SO 8 Identify the methods for the presentation and

10-24 analysis of non-current liabilities.
 Statement
Statement Presentation
Presentation and
and Analysis
Analysis

Analysis

Income before income taxes

2. Times
and interest expense
Interest =
Earned Interest expense

Indicates the company’s ability to meet interest payments

as they come due.

Slide SO 8 Identify the methods for the presentation and

10-25 analysis of non-current liabilities.
 Statement
Statement Presentation
Presentation and
and Analysis
Analysis

Analysis
Illustrate: LG’s (KOR) had total liabilities of W39,048
billion, total assets of W64,782 billion, interest expense of
W778 billion, income taxes of W1,092 billion, and net
income of W2,967 billion.
Illustration 10-19

Slide SO 8 Identify the methods for the presentation and

10-26 analysis of non-current liabilities.
Slide
10-27
 Understanding
Understanding U.S.
U.S. GAAP
GAAP

Key Differences Liabilities

IFRS reserves the use of the term contingent liability to refer

only to possible obligations that are not recognized in the
financial statements but may be disclosed if certain criteria are
met. Under GAAP, contingent liabilities are recorded in the
financial statements if they are both probable and can be
reasonably estimated. If only one of these criteria is met, then
the item is disclosed in the notes.

IFRS uses the term provisions to refer to liabilities of uncertain

timing or amount. Examples of provisions would be provisions
for warranties, employee vacation pay, or anticipated losses.
Under GAAP, these are considered recordable contingent
Slide liabilities.
10-28
 Understanding
Understanding U.S.
U.S. GAAP
GAAP

Key Differences Liabilities

Both GAAP and IFRS classify liabilities industries where a

presentation based on liquidity would be considered to provide
more useful information (such as financial institutions) can use
that format instead.

Under IFRS, companies sometimes show liabilities before

assets. Also, they will sometimes show non-current liabilities
before current liabilities. Neither of these presentations is used
under GAAP.

Under IFRS, companies sometimes will net current liabilities

against current assets to show working capital on the face of
the statement of financial position. This practice is not used
Slide
10-29
under GAAP.
 Understanding
Understanding U.S.
U.S. GAAP
GAAP

Key Differences Liabilities

IFRS requires the effective-interest method for amortization of

bond discounts and premiums. GAAP allows use of the
straight-line method where the difference is not material.

GAAP often uses a separate Discount or Premium account to

account for bonds payable. IFRS records discounts or
premiums as direct increases or decreases to Bonds Payable.

The GAAP accounting for leases is much more “rules-based,”

with specific bright-line criteria (such as the “90% of fair value”
test) to determine if a lease arrangement transfers the risks and
rewards of ownership; IFRS is more conceptual in its
provisions.
Slide
10-30
 Understanding
Understanding U.S.
U.S. GAAP
GAAP

Looking to the Future Liabilities

The FASB and IASB are currently involved in two projects that
have implications for the accounting for liabilities. The FASB
and IASB have identified leasing as one of the most
problematic areas of accounting. The joint project will initially
focus primarily on lessee accounting. One of the first areas to
be studied is, “What are the assets and liabilities to be
recognized related to a lease contract?” The main issue is
whether the focus should remain on the leased item or should
instead focus on the right to use the leased item. Finally, the
two standard-setting bodies are involved in a far-reaching
project to significantly change the approach used to account
for pensions.
Slide
10-31
 Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing

Present Value of Face Value Appendix 10A

To illustrate present value concepts, assume that you are

willing to invest a sum of money that will yield $1,000 at the
end of one year, and you can earn 10% on your money.
What is the $1,000 worth today?
To compute the answer,
 divide the future amount by 1 plus the interest rate
($1,000/1.10 = $909.09 OR
 use a Present Value of 1 table. ($1,000 X .90909) =
$909.09 (10% per period, one period from now).

Slide
10-32 SO 9 Compute the market price of a bond.
 Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing

Present Value of Face Value

To compute the answer,

 divide the future amount by 1 plus the interest rate
($1,000/1.10 = $909.09.
Illustration 10A-1

Slide
10-33 SO 9 Compute the market price of a bond.
 Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing

Present Value of Face Value

To compute the answer,
 use a Present Value of 1 table. ($1,000 X .90909) =
$909.09 (10% per period, one period from now).
TABLE 10A-1

Slide
10-34 SO 9 Compute the market price of a bond.
 Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing

Present Value of Face Value

The future amount ($1,000), the interest rate (10%), and the
number of periods (1) are known
Illustration 10A-2

Slide
10-35 SO 9 Compute the market price of a bond.
 Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing

Present Value of Face Value

If you are to receive the single future amount of $1,000 in

two years, discounted at 10%, its present value is $826.45
[($1,000 1.10) 1.10].
Illustration 10A-3

Slide
10-36 SO 9 Compute the market price of a bond.
 Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing

Present Value of Face Value

To compute the answer using a Present Value of 1 table.
($1,000 X .82645) = $826.45 (10% per period, two periods
from now).
TABLE 10A-1

Slide
10-37 SO 9 Compute the market price of a bond.
 Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing

Present Value of Interest Payments (Annuities)

In addition to receiving the face value of a bond at maturity,
an investor also receives periodic interest payments
(annuities) over the life of the bonds.

To compute the present value of an annuity, we need to

know:

1) interest rate,

2) number of interest periods, and

3) amount of the periodic receipts or payments.

Slide
10-38 SO 9 Compute the market price of a bond.
 Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing

Present Value of Interest Payments (Annuities)

Assume that you will receive $1,000 cash annually for three
years and the interest rate is 10%.
Illustration 10A-5

Slide
10-39 SO 9 Compute the market price of a bond.
 Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing

Present Value of Interest Payments (Annuities)

Assume that you will receive $1,000 cash annually for three
years and the interest rate is 10%.
Illustration 10A-6

Slide
10-40 SO 9 Compute the market price of a bond.
 Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing

Present Value of Interest Payments (Annuities)

Assume that you will receive $1,000 cash annually for three
years and the interest rate is 10%.

TABLE 10A-2

$1,000 annual payment x 2.48685 = $2,486.85

Slide
10-41 SO 9 Compute the market price of a bond.
 Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing

Computing the Present Value of a Bond

The selling price of a bond is equal to the sum of:

1) The present value of the face value of the bond
discounted at the investor’s required rate of return
PLUS
2) The present value of the periodic interest payments
discounted at the investor’s required rate of return

Slide
10-42 SO 9 Compute the market price of a bond.
 Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing

Assume a bond issue of 10%, five-year bonds with a face

value of $100,000 with interest payable semiannually on
January 1 and July 1.
Illustration 10A-8

Slide
10-43 SO 9 Compute the market price of a bond.
 Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing

Assume a bond issue of 10%, five-year bonds with a face

value of $100,000 with interest payable semiannually on
January 1 and July 1.
Illustration 10A-9

Contractual Rate = Discount Rate Issued at Face Value

Slide
10-44 SO 9 Compute the market price of a bond.
 Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing

Assume a bond issue of 10%, five-year bonds with a face

value of $100,000 with interest payable semiannually on
January 1 and July 1.
Illustration 10A-10

Contractual Rate < Discount Rate Issued at a Discount

Slide
10-45 SO 9 Compute the market price of a bond.
 Present
Present Value
Value Concepts
Concepts Related
Related to
to Bond
Bond Pricing
Pricing

Assume a bond issue of 10%, five-year bonds with a face

value of $100,000 with interest payable semiannually on
January 1 and July 1.
Illustration 10A-11

Contractual Rate > Discount Rate Issued at a Premium

Slide
10-46 SO 9 Compute the market price of a bond.
 Effective-Interest
Effective-Interest Method
Method of
of Bond
Bond Amortization
Amortization
Appendix 10B

Under the effective-interest method, the amortization of

bond discount or bond premium results in period interest
expense equal to a constant percentage of the carrying value
of the bonds.

Required steps:

1. Compute the bond interest expense.

2. Compute the bond interest paid or accrued.

3. Compute the amortization amount.

Slide SO 10 Apply the effective-interest method of amortizing

10-47 bond discount and bond premium.
 Effective-Interest
Effective-Interest Method
Method of
of Bond
Bond Amortization
Amortization

Amortizing Bond Discount

Assume Candlestick, Inc. issues $100,000 of 10%, five-year bonds
on January 1, 2011, for $92,639, with interest payable each July 1
and January 1. Illustration 10B-2

Slide
10-48 SO 10
 Effective-Interest
Effective-Interest Method
Method of
of Bond
Bond Amortization
Amortization

Amortizing Bond Discount

Assume Candlestick, Inc. issues $100,000 of 10%, five-year bonds
on January 1, 2011, for $92,639, with interest payable each July 1
and January 1.

Journal entry on July 1, 2011, to record the interest payment and

amortization of discount is as follows:

July 1 Interest Expense 5,558

Cash 5,000
Bonds Payable 558

Slide SO 10 Apply the effective-interest method of amortizing

10-49 bond discount and bond premium.
 Effective-Interest
Effective-Interest Method
Method of
of Bond
Bond Amortization
Amortization

Amortizing Bond Premium

Assume Candlestick, Inc. issues $100,000 of 10%, five-year bonds
on January 1, 2011, for $108,111, with interest payable each July 1
and January 1. Illustration 10B-4

Slide
10-50 SO 10
 Effective-Interest
Effective-Interest Method
Method of
of Bond
Bond Amortization
Amortization

Amortizing Bond Premium

Assume Candlestick, Inc. issues $100,000 of 10%, five-year bonds
on January 1, 2011, for $108,111, with interest payable each July 1
and January 1.
Journal entry on July 1, 2011, to record the interest payment and
amortization of premium is as follows:

July 1 Interest Expense 4,324

Bonds Payable 676
Cash 5,000

Slide SO 10 Apply the effective-interest method of amortizing

10-51 bond discount and bond premium.
 Straight-Line
Straight-Line Amortization
Amortization
Appendix 10C
Amortizing Bond Discount
Candlestick, Inc., sold $100,000, five-year, 10% bonds on January
1, 2011, for $92,639 (discount of $7,361). Interest is payable on
July 1 and January 1. Illustration 10C-2

Slide
10-52
SO 11
 Straight-Line
Straight-Line Amortization
Amortization
Amortizing Bond Discount
Candlestick, Inc., sold $100,000, five-year, 10% bonds on January
1, 2011, for $92,639 (discount of $7,361). Interest is payable on
July 1 and January 1. The bond discount amortization for each
interest period is $736 ($7,361/10).

Journal entry on July 1, 2011, to record the interest payment and

amortization of discount is as follows:

July 1 Interest Expense 5,736

Bonds Payable 736
Cash 5,000

Slide SO 11 Apply the straight-line method of amortizing

10-53 bond discount and bond premium.
 Straight-Line
Straight-Line Amortization
Amortization
Amortizing Bond Premium
Candlestick, Inc., sold $100,000, five-year, 10% bonds on January
1, 2011, for $108,111. Interest is payable on July 1 and January 1.
Illustration 10C-4

Slide
10-54
SO 11
 Straight-Line
Straight-Line Amortization
Amortization
Amortizing Bond Premium
Candlestick, Inc., sold $100,000, five-year, 10% bonds on January
1, 2011, for $108,111 (premium of $8,111). Interest is payable on
July 1 and January 1. The bond discount amortization for each
interest period is $811 ($8,111/10).

Journal entry on July 1, 2011, to record the interest payment and

amortization of discount is as follows:

July 1 Interest Expense 4,189

Bonds Payable 811
Cash 5,000

Slide SO 11 Apply the straight-line method of amortizing

10-55 bond discount and bond premium.
 Payroll-Related
Payroll-Related Liabilities
Liabilities
Appendix 10D
Payroll and Payroll Taxes Payable

The term “payroll” pertains to both:

Salaries - managerial, administrative, and sales personnel
(monthly or yearly rate).
Wages - store clerks, factory employees, and manual
laborers (rate per hour).

Determining the payroll involves computing three amounts:

(1) gross earnings, (2) payroll deductions, and (3) net pay.

Slide
10-56 SO 12 Prepare entries for payroll and payroll taxes under U.S. law.
 Payroll-Related
Payroll-Related Liabilities
Liabilities

Illustration: Assume a corporation records its payroll for the

week of March 7 as follows:

Mar. 7 Salaries and wages expense 100,000

FICA tax payable
Federal income tax payable 7,650
State income tax payable 21,864 2,922
Salaries and wages payable 67,564

Record the payment of this payroll on March 11.

Mar. 11 Salaries and wages payable 67,564
Cash
Slide
10-57 67,564
SO 12 Prepare entries for payroll and payroll taxes under U.S. law.
 Payroll-Related
Payroll-Related Liabilities
Liabilities

Payroll tax expense results from three taxes that

governmental agencies levy on employers.

These taxes are:

FICA tax
Federal unemployment tax
State unemployment tax

Slide
10-58 SO 12 Prepare entries for payroll and payroll taxes under U.S. law.
 Payroll-Related
Payroll-Related Liabilities
Liabilities

Illustration: Based on the corporation’s $100,000 payroll,

the company would record the employer’s expense and
liability for these payroll taxes as follows.

Payroll tax expense 13,850

FICA tax payable
7,650
Federal unemployment tax payable800
State unemployment tax payable
5,400

Slide
10-59 SO 12 Prepare entries for payroll and payroll taxes under U.S. law.
 Payroll-Related
Payroll-Related Liabilities
Liabilities

Question

Employer payroll taxes do not include:

a. Federal unemployment taxes.
b. State unemployment taxes.
c. Federal income taxes.
d. FICA taxes.

Slide
10-60 SO 12 Prepare entries for payroll and payroll taxes under U.S. law.
 Copyright
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Slide
10-61