TAX 4001 Essay

CHAPTER 14 – LONG-TERM LIABILITIES [pages 782-840`]

LEARNING OBJECTIVES

1. Describe the formal procedures associated with issuing long-term debt. 2. Identify various types of bond issues. 3. Describe the accounting valuation for bonds at date of issuance. 4. Apply the methods of bond discount and premium amortization. 5. Describe the accounting for the extinguishment of non-current liabilities. 6. Explain the accounting for long-term notes payable. 7. Describe the accounting for the fair value option 8. Explain the reporting of off-balance-sheet financing arrangements. 9. Indicate how to present and analyze long-term debt. *10. Describe the accounting for a debt restructuring.
*Material covered in Appendix

I. Overview – Long-term Liabilities (Bonds and Notes Payable)

A. What is long-term debt?
1. probable future sacrifices of economic benefit

2. payable in the future, normally beyond one year or operating cycle whichever is longer

3. Examples: bonds payable, long-term notes payable, mortgage notes payable (topics of this chapter), pension liabilities and lease obligations.

B. Why issue long-term debt (as opposed to equity)?
1. May be only source of funds

2. Lower cost

3. Interest payments are tax deductible

4. Creditors have no right to vote

5. Takes advantage of financial leverage

II. Bonds Payable
A. Contract (obligation) called a bond indenture 1. to pay a sum of money 2. at a designated maturity date plus periodic interest 3. at a specified rate on the face value.

4. Repay principal at maturity B. Types of Bonds: term, serial, secured and unsecured, convertible, commodity-backed, deep discount, registered and coupon bonds.

C. Issuing of Bonds
1. Can be through an underwriter (investment banker or brokerage firm)

2. Private placement – usually to a large financial institution

D. Valuation of Bonds
1. The denomination of a bond is called the face value, par value, principal, maturity value and face amount.

2. Bonds are issued in multiples of $1,000 (i.e. the face of one bond is $1,000)

3. Selling prices are quoted as a percentage of par value (102% = $1020)
a. determined by the interaction of the stated interest rate and the market rate b. stated rate ( coupon, nominal, contract rate) is the interest rate appearing on the bond certificate
c. market rate (effective or yield rate) is the rate actually earned.

E. Premium or Discount on Bonds Payable 1. Discounts and premiums recorded at the time the bonds are sold.

2. Discounts or premiums are amortized each time bond interest is paid.

3. The time period for amortizing equals the period the bonds are outstanding

4. Amortization of bond premiums decreases the recorded amount of bond interest expense,

5. Amortization of bond discounts increases the recorded amount of bond interest expense

III. Accounting for Bonds

A. Valuation

1. Price of a bond determined by the interaction between the bonds’s stated interest rate and its market rate.

2. Price is equal to the sum of the present value of the principle and the present value of the periodic interest.
a. Stated rate = the market rate, the bond sells at par.
b. Stated rate < the market rate, the bond sells at a discount.
c. Stated rate > the market rate, the bond sell at a premium.

B. Issuance 1. Face value always recorded in the bond payable account.

2. If a bond sells at a discount, the difference between the sales price and the face value is debited to Discount on Bonds Payable. (contra-account to Bonds Payable). Cash xxx Discount on Bonds Payable xxx Bonds Payable xxx 3. If a bond sells at a premium, the difference between the sales price and the face value is credited to Premium on Bonds Payable (an adjunct account to Bonds Payable). Cash xxx Premium on Bonds Payable xxx Bonds Payable xxx 4. Bonds sold

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