Transcript Chapter 10
Chapter 10
Long-Term Liabilities Skyline College Lecture Notes
Funding Growth
Growth usually requires investment in long term assets and research and development
How do companies raise long-term funds?
Issuance of capital stock Copyright © Houghton Mifflin Company. All rights reserved .
Issuance of long-term debt Take on long-term debt? How much debt to carry? What types of debt to incur? 10–2
Deciding to Issue Long-Term Debt
Advantages to consider Disadvantages to consider
No loss of stockholder control as when issuing stock A high level of debt exposes a company to financial risk The interest on debt is tax deductible If earnings on funds borrowed exceed interest on debt,
financial leverage
is gained If earnings on funds borrowed do not exceed interest on debt,
negative financial leverage
is experienced Copyright © Houghton Mifflin Company. All rights reserved .
10–3
Average Debt to Equity for Selected Industries
Copyright © Houghton Mifflin Company. All rights reserved .
10–4
Evaluating Long-Term Debt
Many companies use the debt to equity ratio when assessing how much debt to carry Debt to Equity Ratio Total Total Liabilitie Stockholde rs’ s Equity McDonald’ s Debt to Equity Ratio $3,520.5
$10,115.5
$14,201.5
1 .
0 McDonald’s also has long-term leases that do not appear on the balance sheet, called
off-balance sheet financing
. Copyright © Houghton Mifflin Company. All rights reserved .
10–5
Interest Coverage Ratio
Measures how much risk a company is undertaking with its long-term debt Interest Coverage Ratio Income Before Income Taxes Interest Interest Expense Expense Measures the degree of protection a company has from default on interest payments Copyright © Houghton Mifflin Company. All rights reserved .
10–6
Interest Coverage Ratio Illustrated
McDonald’s 2004 annual report shows that the company had income before income taxes of $3,202.4 million and interest expense of $358.4 million.
Interest Coverage Ratio Income Before Taxes Interest Interest Expense Expense $ 3 , 202 .
4 $358.4
$358.4
9 .
9 times McDonald’s interest expense was covered 9.9 times in 2004. However, management will add the company’s off-the-balance sheet rent expense of $1,003.2 to its interest expense. This procedure decreases the coverage ratio to 3.4 times, still adequate to cover interest payments.
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10–7
Types of Long-Term Debt
Bonds payable Notes payable Mortgages payable Long-term leases Pensions Other postretirement benefits Deferred income taxes Copyright © Houghton Mifflin Company. All rights reserved .
10–8
Long-Term Debt
Bonds Payable Most common type of long-term debt May be convertible to common stock Involves a debt to many creditors Notes Payable Represents a loan from a bank or other creditor Deutsche Telekom International Finance recently raised $14.6 billion by issuing a series of long-term notes denominated in dollars, Euros, pounds, and yen.
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10–9
Mortgages Payable
Long-term debt secured by real property. Usually repaid in equal monthly installments that include interest on the debt and a reduction in the initial debt. Illustration: Monthly Payment Schedule on a $50,000, 12% mortgage Payment Date 6/1 7/1 8/1 9/1 Unpaid Bal. At Beg. of Period $50,000 49,700 49,397 M onthly Payment $800 800 800 Interest for 1 M onth at 1% on Unpaid Bal.
$500 497 494 Reduction in Debt $300 303 306 Unpaid Bal. At End of Period $50,000 49,700 49,397 49,091 Copyright © Houghton Mifflin Company. All rights reserved .
10–10
Leases
• Companies may obtain an operating asset in three ways: Borrow the money and buy the asset Rent the asset on a short-term lease (operating lease; payments are treated as rent expense) Obtain the asset on a long-term lease (may be structured as a capital lease or an operating lease) Copyright © Houghton Mifflin Company. All rights reserved .
10–11
Capital Leases
Accounting standards require that a lease be treated as a capital lease if the lease:
Cannot be cancelled Has about the same duration as the useful life of the asset Stipulates that the lessee has the option to buy the asset at a nominal price at the end of the lease
Accounting for a Capital Lease
The lessee should: 1) Record the asset 2) Record depreciation on the asset 3) Record a liability equal to the present value of the total lease payments during the lease term Copyright © Houghton Mifflin Company. All rights reserved .
10–12
Capital Lease Illustrated
Glenellen Manufacturing Company enters into a long-term lease for a machine. The lease terms call for an annual payment of $4,000 for six years, which approximates the useful life of the machine. At the end of the lease period, the title to the machine passes to Glenellen.
Use present value techniques to place a value on the asset and on the corresponding liability. Assume that the interest cost on the unpaid part of the obligation is 16 percent.
$4,000 x 3.685 = $14,740 Capital Lease Equipment Capital Lease Obligations To record capital lease on machinery Copyright © Houghton Mifflin Company. All rights reserved .
14,740 14,740 10–13
Capital Lease Illustrated
(cont’d)
Each year, Glenellen must record depreciation on the leased asset. Assume the company uses the straight-line method and no salvage value. Depreciation Expense, Capital Lease Equipment Accum. Depreciation, Capital Lease Equip. To record depr. Expense on capital lease machinery 2,457 2,457 Glenellen must also record interest expense for the lease. The interest expense for each year is computed by multiplying the interest rate by the amount of remaining lease obligation. Interest Expense Capital Lease Obligations Cash Made payment on capital lease $14,740 x 16% = $2,358 Copyright © Houghton Mifflin Company. All rights reserved .
2,358 1,642 4,000 10–14
Off-Balance Sheet Financing
A legal way of structuring a lease commitment so that it does not have to be included on the balance sheet as a liability Financial statement users should review the notes to the financial statements for information about any leases that may have the effect of long-term liabilities Copyright © Houghton Mifflin Company. All rights reserved .
10–15
Discussion: Ethics on the Job
Cardle Industries plans to apply for a large loan from United Bank in 20x8. In 20x6, the controller recommends that the company renegotiate the duration of its leases so that the company may categorize them as operating leases. This will improve the company’s debt to equity ratio.
Q. Do you think this recommendation is ethical?
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10–16
Pension Liabilities
Pension plans Require a company to pay benefits to employees after they retire Employer contributions Some companies pay full cost of pension plan Employee contributions Pension Fund Employees often share the cost of pension plans Pension benefits paid to retired employees Copyright © Houghton Mifflin Company. All rights reserved .
10–17
Pension Plans
Defined Contribution Plan Defined Benefit Plan
Employer makes fixed, agreed upon, annual contribution Retirement payments depend on how much the fund earns Employer makes variable payments required to fund the estimated future liability Employees usually control their own accounts and can transfer funds if they leave the firm Retirement benefits are fixed More complex accounting required Examples: 401(K) plans, profit-sharing plans, and ESOPs Copyright © Houghton Mifflin Company. All rights reserved .
10–18
Other Postretirement Benefits
Retired employees may also be provided health care benefits and other postretirement benefits Recent accounting standards hold postretirement benefits should be estimated and expensed during the time that employees are working in accordance with the matching rule. Estimates should account for retirement age, mortality, future trends in health care Future benefits should be discounted to the current period Copyright © Houghton Mifflin Company. All rights reserved .
10–19
Deferred Income Taxes
Results from using different accounting methods to calculate income taxes on the income statement and income tax liability on the income tax return A company might use straight-line depreciation for financial reporting and an accelerated method for income tax purposes.
The difference in taxes resulting from the two methods is listed as a long-term liability.
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10–20
Bonds
A security, usually long term, representing money that a corporation borrows from the investing public Governments and foreign countries also issue bonds to raise money Must be repaid at a specified time and require periodic payments of interest at a specified rate at specified times Copyright © Houghton Mifflin Company. All rights reserved .
10–21
What Is a Bond Issue?
A bond issue is the total value of bonds issued at one time For example, a $1,000,000 bond issue could consist of one thousand, $1,000 bonds
Prices of Bonds
• Stated in terms of a percentage of face value • Bonds selling at 100 • Sell at face or par value • Bonds selling above 100 • Sell at a premium • Bonds selling below 100 • Sell at a discount Copyright © Houghton Mifflin Company. All rights reserved .
10–22
Selling Price of Bond Illustrated
A bond issue is quoted at 103 ½ What is the selling price of a $1,000 bond?
A bond issue quoted at 103 ½ means that the bond sells at 103.5 percent of its face value Bond Selling Price Face Value Quoted Percentage of Face Value $1,000 1.035
$1,035 This bond sells at a premium and would cost the buyer $1,035 Copyright © Houghton Mifflin Company. All rights reserved .
10–23
Interest Rates
Face Interest Rate
Fixed rate of interest paid to bondholders based on the face value of the bonds
Market Interest Rate
Rate of interest paid in the market on bonds of similar risk, also called the
effective interest rate
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10–24
Discounts and Premiums
Discount
• Equals the excess of the face value over the issue price. • The issue price will be less than the face value when:
Market > Face Premium
• Equals the excess of the issue price over the face value. • The issue price will be more than the face value when
Market < Face
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10–25
Bond Characteristics
Unsecured Secured Term Serial Callable Convertible Registered Coupon Issued on the basis of a firm’s general credit Carry a pledge of certain corporate assets as a guarantee of repayment All bonds of an issue mature at the same time Bonds of an issue mature on different dates Gives issuer the right to buy back and retire the bonds before maturity at a specified call price Allows bondholder to exchange a bond for a specified number of shares of common stock Issued to a specific bondholder Not registered with the organization Copyright © Houghton Mifflin Company. All rights reserved .
10–26
Issuing Bonds Payable
The board of directors must submit the appropriate legal documents to the Securities and Exchange Commission (SEC) for approval to issue bonds No journal entry is required for the authorization of the bond issue (most companies disclose in the notes to the financial statements) Copyright © Houghton Mifflin Company. All rights reserved .
10–27
Bonds Issued at Face Value
Katakis Corporation issues $100,000 of 9 percent, 5-year bonds on January 1, 20x4 and sells them on the same date for their face value. The bond indenture states that interest is to be paid on January 1 and July 1 of each year. Jan. 1 Cash Bonds Payable Sold $100,000 of 9%, 5-year bonds at face value 100,000 100,000 Bond Interest Expense Cash (Interest Payable) Paid (or accrued) semiannual interest to bondholders of 9%, 5 year bonds Copyright © Houghton Mifflin Company. All rights reserved .
Interest Principal 4,500 Rate Time $100,000 $4,500 .09
6/12 year 4,500 10–28
Bonds Issued at a Discount
Katakis Corporation issues $100,000 of 9 percent, 5-year bonds at 96.149 on January 1, 20x4, when the market rate is 10 percent.
Record the issuance of the bonds at a discount: 20x4 Jan. 1 Cash Unamortized Bond Discount Bonds Payable Sold $100,000 of 9%, 5-year bonds at 96.149 Less purchase price of bonds ($100,000 x .96149) Unamortized bond discount 96,149 3,851 $100,000 96,149 $ 3,851 100,000 Unamortized Bond Discount is a contra-liability account Carrying Value of Bonds = Face Value – Unamortized Bond Discount Copyright © Houghton Mifflin Company. All rights reserved .
10–29
Bonds Issued at a Premium
Katakis Corporation issues $100,000 of 9 percent, 5-year bonds for $104,100 on January 1, 20x4, when the market rate is 8 percent.
Record the issuance of the bonds at a premium: 20x4 Jan. 1 Cash Unamortized Bond Premium Bonds Payable Sold $100,000 of 9%, 5-year bonds at 104.1 ($100,000 x 1.041) Less face amount of bonds Unamortized bond premium $104,100 100,000 $ 4,100 104,100 4,100 100,000 Carrying Value of Bonds = Face Value + Unamortized Bond Premium = $100,000 + $4,100 = $104,100 Copyright © Houghton Mifflin Company. All rights reserved .
10–30
Bond Issue Costs
Can amount to as much as 5 percent of a bond issue Establish a long-term prepaid account for these costs and amortize over life of bonds or issue costs can be subtracted from the proceeds making the discount bigger or the premium smaller Copyright © Houghton Mifflin Company. All rights reserved .
10–31
Influence of the Market Interest Rate on Bonds
The market interest rate varies from day to day and therefore what investors are willing to pay changes as well If current market interest rate > face interest investors are willing to pay less If current market interest rate < face interest investors are willing to pay more Copyright © Houghton Mifflin Company. All rights reserved .
10–32
Case 1: Present Value
Market interest rate > Face interest rate
A bond has a face value of $10,000 and pays fixed interest of $450 every six months (a 9 percent annual rate). The bond is due in 5 years and the market interest rate is 12 percent.
What is the present value of the bond?
Determine the interest rate and number of periods to use in the present value tables • Divide the annual interest rate by the number of periods in the year 12% ÷ 2 = 6% • Multiply the number of periods in one year by the number of years 2 x 5 = 10 periods Present value of 10 periodic payments @ 6% Present value of a single payment at the end of 10 periods @ 6% Present value of $10,000 bond Copyright © Houghton Mifflin Company. All rights reserved .
Table 4 Table 3 $450 x 7.360 $10,000 x .558 $3,312.00 5,580.00 $8,892.00 10–33
Case 2: Present Value
Market interest rate < Face interest rate
A bond has a face value of $10,000 and pays fixed interest of $450 every six months (a 9 percent annual rate). The bond is due in 5 years and the market interest rate is 8 percent.
What is the present value of the bond?
Present value of 10 periodic payments @ 4% Present value of a single payment at the end of 10 periods @ 4% Present value of $10,000 bond Table 4 Table 3 $450 x 8.111 $10,000 x .676 $3,649.95 6,760.00 $10,409.95 Copyright © Houghton Mifflin Company. All rights reserved .
10–34
Bond Discounts or Premiums
Amount by which the total interest cost is higher or lower than the total interest payments Amortized over the life of the bonds Use straight-line or effective interest method Copyright © Houghton Mifflin Company. All rights reserved .
10–35
Total Interest Cost Illustrated
Katakis Corporation issues $100,000 of 9 percent, 5-year bonds at 96.149 when the market rate is 10 percent. The bonds sold for $96,149 resulting in an unamortized bond discount of $3,851.
The bonds were issued at a discount: Although the company does not receive the full face value of the bonds on issue, it still must pay back the full face value at maturity Interest Cost to Company Stated Interest Payments Amount of Bond Discount Copyright © Houghton Mifflin Company. All rights reserved .
10–36
Calculating Total Interest Cost
Katakis Corporation issues $100,000 of 9 %, 5-year bonds at 96.149 when the market rate is 10 percent. The bonds sold for $96,149, resulting in an unamortized bond discount of $3,851.
Cash to be paid to bondholders Face value at maturity Interest payments ($100,000 x .09 x 5 years) Total cash paid to bondholders Less cash received from bondholders Total interest cost
Or, alternately
Interest payments ($100,000 x .09 x 5 years) Bond discount Total interest cost $100,000 45,000 $145,000 96,149 $ 48,851 $45,000 3,851 $ 48,851 The bond discount increases the interest paid on the bonds from the stated interest rate to the effective interest rate.
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10–37
Accounting for Total Interest Cost
Effective Interest Rate = Stated Rate + Discount
Amortization of the bond discount Must be allocated over the remaining life of the bonds as an increase in the interest expense each period Interest expense for each period will exceed the actual payment of interest by the amount of the bond discount amortized over the period Copyright © Houghton Mifflin Company. All rights reserved .
10–38
Zero Coupon Bonds
Do not require periodic interest payments Represent a promise to pay a fixed amount at the maturity date Zero coupon bonds are issued by some companies and governmental units Copyright © Houghton Mifflin Company. All rights reserved .
10–39
Straight-Line Method
Equal amortization of the bond discount for each interest period
Face value = $100,000 Face interest rate = 9% Life of bond = 5 years Interest payments = Semiannual Bond discount = $3,851
Step 1: Determine the total number of interest payments
Total Interest Payments Interest Payments per Year Life of Bonds 2 5 10 periods
Step 2: Determine the amount of bond discount to amortize each interest period
Amortizati on of Bond Discount per Period Bond Discount Total Interest Payments 10 $3,851 periods $385 (rounded) Copyright © Houghton Mifflin Company. All rights reserved .
10–40
Straight-Line Method
(cont’d) Step 3: Determine the cash interest payment amount
Cash Interest Payment Face Value $100,000 Face Interest .09
6 12 Rate Time $4,500
Step 4: Determine the total interest expense per interest period
Interest Expense per Period Interest Payment Amortizati $4,500 $385 $4,885 on of Bond Discount
Record first semiannual interest payment and amortization of bond discount
20x4 July 1 Bond Interest Expense Unamortized Bond Discount Cash (or Interest Payable) Paid (or accrued) semiannual interest to bondholders and amortized discount on 9%, 5-year bonds .
4,885 385 4,500 10–41
Weaknesses of the Straight-Line Method
When used to amortize a discount, the carrying value goes up each period, but the bond interest expense stays the same; thus, the rate of interest falls over time. When used to amortize a premium, the rate of interest rises over time. used only when it does not lead to a material difference from the effective interest method Copyright © Houghton Mifflin Company. All rights reserved .
10–42
Effective Interest Method
Applies a constant interest rate to the carrying value of bonds at the beginning of the interest period Rate equals the market, or effective, rate at the time the bonds were issued.
Amount amortized is the difference between interest computed and actual interest paid to bondholders Copyright © Houghton Mifflin Company. All rights reserved .
10–43
Interest and Amortization of a Bond Discount: Effective Interest Method
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10–44
Bond Amortization – Effective Interest Method
Face value = $100,000 Face Interest rate = 9% Life of bond = 5 years Interest payments = Semiannual Bond discount = $3,851 Column A Carrying value = Face value – Unamortized bond discount
Semiannual Interest Period
0 1
A Carrying Value at Beginning of Period
$96,149 Column B – Use market interest rate ($96,149 x .10 x 6/12 = $4,807) Column C – Use face interest rate on bond ($100,00 x .09 x 6/12 = $4,500)
B Semiannual Interest Expense at 10% to be Recorded (5% x A)
$4,807
C Semiannual Interest to be Paid to Bondholders (4.5% x $100,000)
$4,500
D Amortization of Bond Discount (B – C) E Unamortized Bond Discount at End of Period (E – D)
$3,851
F Carrying Value at End of Period (A + D)
$96,149 Copyright © Houghton Mifflin Company. All rights reserved .
10–45
Bond Amortization – Effective Interest Method
(cont’d)
Column D Discount amortized = Effective interest expense – Actual interest payment to bondholders ($4,807 – $4,500 = $307)
Semiannual Interest Period
0 1
A Carrying Value at Beginning of Period
$96,149
B Semiannual Interest Expense at 10% to be Recorded (5% x A)
$4,807
C Semiannual Interest to be Paid to Bondholders (4.5% x $100,000)
$4,500 Column F Carrying value at beg. of period + Amort. during the period ($96,149 + $307 = $96,456)
D Amortization of Bond Discount (B – C)
$307
E Unamortized Bond Discount at End of Period (E – D)
$3,851 3,544
F Carrying Value at End of Period (A + D)
$96,149 96,456 Notice that the sum of the carrying value and the unamortized discount always equals the face value of the bonds Copyright © Houghton Mifflin Company. All rights reserved .
Column E Bond discount at beg. of period – Current pd amort. ($3,851 – $307 = $3,544) 10–46
Bond Amortization – Effective Interest Method
(cont’d) Record first semiannual interest payment and amortization of bond discount:
20x4 July 1 Bond Interest Expense Unamortized Bond Discount Cash (or Interest Payable) to bondholders and amortized discount on 9%, 5-year bonds Paid (or accrued) semiannual interest 4,807 It is not necessary to prepare an interest and amortization table to determine amortization of a discount for the period 307 4,500 Amount of Interest t o Amortize (Carrying Value Effective Interest Rate) – Interest Payment ($96,149 .05) – $4,500 $307 Copyright © Houghton Mifflin Company. All rights reserved .
10–47
Bond Premiums
Bondholders pay more than face value for bonds Premium is an amount that bondholders have prepaid their own interest over life of the issue Copyright © Houghton Mifflin Company. All rights reserved .
10–48
Total Interest Cost
Katakis Corporation issues $100,000 of 9 percent, 5-year bonds at 104.1 on January 1, 20x4, when the market rate is 8 percent. The bonds sold for $104,100 resulting in an unamortized bond premium of $4,100.
Cash to be paid to bondholders Face value at maturity Interest payments ($100,000 x .09 x 5 years) Total cash paid to bondholders Less cash received from bondholders Total interest cost $100,000 45,000 $145,000 104,100 $ 40,900 Or, alternately Interest payments ($100,000 x .09 x 5 years) Less bond premium Total interest cost $45,000 4,100 $ 40,900 The bond premium decreases the interest paid on the bonds from the stated interest rate to the effective interest rate.
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10–49
Interest and Amortization of a Bond Premium: Effective Interest Method
Copyright © Houghton Mifflin Company. All rights reserved .
10–50
Bond Amortization – Effective Interest Method
(cont’d) Record first semiannual interest payment and amortization of bond premium:
20x4 July 1 Bond Interest Expense Unamortized Bond Premium Cash (or Interest Payable) Paid (or accrued) semiannual interest 4,164 336 to bondholders and amortized premium on 9%, 5-year bonds 4,500 It is not necessary to prepare an interest and amortization table to determine amortization of a premium for the period Amount of Interest t o Amortize Interest Payment (Carrying Value Effective Interest Rate) $4,500 – ($104,100 .04) $336 Copyright © Houghton Mifflin Company. All rights reserved .
10–51
Calling Bonds
Why call bonds before their maturity date?
If bond interest rates drop, the company can call the bonds and reissue debt at a lower cost.
Company has earned enough to pay off the debt. The reason for having the debt no longer exists. The company wants to restructure its debt to equity ratio.
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10–52
Callable Bonds Illustrated
The issuer has the right to buy back and retire bonds at a specified call price Katakis Corporation can call or retire at 105 the $100,000 of bonds it issued at a premium (104.1). It decides to do so on July 1, 20x7. The entry for the required interest payment and amortization of the premium has already been made.
Record the retirement of the bonds:
20x7 July 1 Bonds Payable Unamortized Bond Premium Loss on Retirement of Bonds Cash Retired 9% bonds at 105 100,000 1,447 3,553 105,000 The loss occurs because the call price of the bonds is greater than the carrying value Copyright © Houghton Mifflin Company. All rights reserved .
10–53
Callable Bonds (Purchase)
Katakis Corporation can call or retire at 105 the $100,000 of bonds it issued at a premium (104.1). Because of a rise in interest rates, Katakis is able to purchase the $100,000 bond issue on the open market for 85. The entry for the required interest payment and amortization of the premium has already been made.
Record the purchase of the bonds:
20x7 July 1 Bonds Payable Unamortized Bond Premium Cash Gain on Retirement of Bonds Purchased and retired 9% bonds at 85 100,000 1,447 85,000 16,447 The gain occurs because the call price of the bonds is less than than the carrying value Copyright © Houghton Mifflin Company. All rights reserved .
10–54
Convertible Bonds Illustrated
Katakis Corporation issued $100,000 of convertible bonds on January 1, 20x4, that can be converted to 40 shares of common stock for each $1,000 bond. The bondholders decide to convert all the bonds to $8 par value common stock on July 1, 20x7.
Record the bond conversion:
20x7 July 1 Bonds Payable Unamortized Bond Premium Common Stock Additional Paid-in Capital 40 shares for each $1,000 bond Converted 9% bonds payable into $8 par value common stock at a rate of 100,000 1,447 32,000 69,447 No loss or gain is recorded because the bond liability and the associated unamortized discount or premium are written off the books.
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10–55
Sale of Bonds Between Interest Dates
When a company sells a bond between interest dates… it collects the interest that would have accrued for the partial period preceding the issue date, and… at the end of the first period, it pays the interest for the entire period. Copyright © Houghton Mifflin Company. All rights reserved .
10–56
Sale of Bonds Between Interest Dates Illustrated
Katakis Corporation sold $100,000 of 9 percent, 5-year bonds on May 1, 20x4 (after the January 1, 20x4 issue date).
Record the sale of the bonds:
20x4 May 1 Cash Bond Interest Expense Bonds Payable Sold 9%, 5-year bonds at face value plus 4 months’ accrued interest ($100,000 x .09 x 4/12 = $3,000) 103,000 Bondholder pays interest that would have accrued for the partial period from the issue date to the sale date Bal.
Bond Interest Expense
0 May 1 3,000 3,000 100,000 Copyright © Houghton Mifflin Company. All rights reserved .
10–57
Sale of Bonds Between Interest Dates Illustrated
(cont’d)
Katakis Corporation sold $100,000 of 9 percent, 5-year bonds on May 1, 20x4 (after the January 1, 20x4 issue date).
Record first semiannual interest payment:
20x4 July 1 Bond Interest Expense Cash (or Interest Payable) Paid (or accrued) semiannual interest 4,500 ($100,000 x .09 x 6/12 = $4,500) Corporation pays the bondholder interest for the entire period Bal.
July 1
Bond Interest Expense
0 4,500 May 1 3,000 Bal. 1,500 4,500 The bondholder is reimbursed for the partial interest payment made at time of sale ($3,000) plus paid interest for the partial period the bond was held ($1,500) Copyright © Houghton Mifflin Company. All rights reserved .
10–58
Year-End Accrual of Bond Interest Expense
Bond interest payment dates rarely correspond with a company’s fiscal year. A year-end adjustment is required.
Katakis Corporation issues $100,000 of 9 percent, 5-year bonds at 104.1 on January 1, 20x4. The company’s fiscal year ends September 31, 20x4 Interest and amortization were recorded on July 1, 20x4. Three months of interest has accrued since then.
Record the year-end accrual of bond interest expense:
20x4 Sept. 30 Bond Interest Expense Unamortized Bond Premium Interest Payable To record accrual of interest on 9% 2,075.50 174.50 bonds payable for 3 months and amortization of ½ of premium for the second interest payment period Copyright © Houghton Mifflin Company. All rights reserved .
2,250.00 10–59
Year-End Accrual of Bond Interest Expense
(cont’d) Record second semiannual interest payment and amortization of bond premium:
20x5 Jan. 1 Bond Interest Expense Interest Payable Unamortized Bond Premium Cash Paid semiannual interest, including interest previously accrued, and 2,075.50 2,250.00 174.50 amortized the premium for the period since the end of the fiscal year 4,500.00 Copyright © Houghton Mifflin Company. All rights reserved .
10–60