ACCT 209 1nd Edition Lecture 11 Outline of Last Lecture I. Long- lived assetsa. AcquisitionI. Exampleb. Use over multiple yearsI. MethodsII. ExampleII. Disposala. ExampleIII. Natural resourcesa. ExampleIV. Intangible assetsV. Current Liabilities OverviewVI. Short Term notes payablea. ExamplesVII. Discounted Notes PayableVIII. CommitmentsIX. Contingent Liabilitiesa. ExampleX. Quick RatioXI. Compound InterestXII. Compound interest and present value of an annuityXIII. Debt-financing Vs. Equity-financing (Borrowing Vs. Ownership)Outline of Current Lecture a. ExampleXIV.Bondsa. ExampleXV. Pricing Bonds Payablea. Exampleb. Second ExampleCurrent LectureExample #5 Installment loanThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.On January 2, 2013, Parker Company purchased a new warehouse. Parker paid $100,000 as a down payment and issued a long-term note to finance the balance. The note, which carries an interest rate of 6%, requires Parker to make annual payments of $150,000 for five years, with the first payment due on December 31, 2013. 1. What amount should Parker record as the cost of the new warehouse? $731,8542. What amount should Parker record as interest expense for 2013? $37,9113. What amount should Parker record as the outstanding liability on the loan on December 31, 2013 (after the first payment is made)? $519,765Pvoa = 15,000 * 4.2136 = 631,854n = 5, I = 6%Cost = 100,000 + 631,854 = 731,854150,000 * 5 = 750,000 (Total to repay) -631,854118,146 (Total interest expense)Date Payment Interest expense (Amortization schedule) Amount to reduce loan balanceLoan balance (Appears on balance sheet)1/2/2013 631,85412/31/2013150,000 37,911 112,089 519,76512/31/2014150,000 31,186 118,814 400,95112/31/2015150,000 24,057 125,943 275,00812/31/2016150,000 16,500 133,500 141,50912/31/2017150,000 8,491 141,509 -1118,145X - Y = ZDefine:Note payable – negotiated contract between two partiesBond payable – contract to borrow created by an entity then issued or sold to numerous lendersBond indenture – contract that sets out details, such as interest rate, interest payment dates) of bond issue (Some bond indentures include bond covenants)Bond covenant – promise; special provision in bond contract, usually included as protection to the lenderTerm bonds – all bonds in the bond issue mature at same timeSerial bonds – bonds in the bond issue have staggered maturity dates; since not all bonds mature at same time, allows issuing company to spread out re-paymentSecured bonds – have specific assets of issuing company pledged as collateralDebentures (unsecured bonds) – backed only by general credit-worthiness of issuing companyConvertible bonds – bond holder (lender) may exchange bond for shares of issuing company’s stockCallable bonds - issuer may “call” (repay) bonds before maturityStated rate (or coupon, contract, or face rate) - interest rate that determines the cash interest * payments that the bond issuer must pay* Market rate (or effective rate, or yield) – interest rate that is in effect at time of bond issue, determines actual interest cost of issuing bondsZero-coupon bonds – type of bond issue that includes no regular interest payments; bonds are sold at present value of face amount and pay full face amount at maturityBOND BASICSGenerally, when a company issues bonds, the borrowing company agrees to 1. Make regular interest payments over the life of the bond; Payments are based on face amount and stated interest rate; May be made annually, semi-annually (Most common), quarterly, ect.2. Repay Principle (Face amount) at maturityZero-coupon bond: pays no interest, instead pays only face value at maturityExample #6: A corporation issues 100, $1,000, 10%, 5-year bonds, with the interest paid annually. How will the bond issue, the regular interest payments and re-payment of principal affect the corporation’s financial statements?At issue: Cash goes upBond/ payment goes up 100,000Every Dec. 31: Intrest expense goes up => Net income goes downFor five years: Cash goes down1000,000 * .10 = 10,000At end of five years: Cash goes down Bond/ payment does down100,000Pricing bonds payable (determining issue price)The actual issue price (amount received by the borrower) may differ from the face amount (amount due at maturity). Two different interest rates are critical for understanding bond issuesand how debt is priced. Contract (also coupon, stated, face) rate: determines cash interest paymentsMarket (yield, effective) rate: Determines selling prices and actual expense If the market rate of interest is different from the bond’s stated rate, the bond will be issued for an amount other than the face amount.market rate > stated rate bond sells at a discount (less than face amount)market rate < stated rate bond sells at a premium (more than face amount)Selling price of bond = the present value of the cash to be received by the bondholder = present value of the interest payments (annuity)+ present value of the amount to be paid at maturity (face amount)Remember: The stated or face rate of interest is used to find the cash interest payments. The market rate of interest determines the selling price. Use the market interest rate to find the present value of the interest payments and the face amount. Subsequent changes in the marketrate of interest (changes after issue date) do not affect either the required cash interest payments or the interest expense the bond issuing company will record.Accounting for Bond issues Companies that issue bonds must a. account for interest expense over the life of the bond issueb. report the appropriate liability on the balance sheet each year of the bond issue.Example #7 Bond issued at a discountOn January 2, 2010, Longhorn Company issued 5-year, $100,000 bonds with a stated rate of 8%. The bonds pay interest semiannually on June 30 and December 31. At the time of the issue, themarket rate of interest was 10%. Longhorn Company uses the effective interest method to amortize any premium or discount.a. What is the selling price of the bonds?1) 2 promises of contract- Interest payments [100,000 * 0.03 * 1/2] * 2 per year => 4000 every 6 months for5 years- Repay 100,000 at end of 5 yearspvoa = 4000 * 7.72173 = 30,887 | pva = 100,000 * 0.61391 = 61,39130,837 + 61,391 = 91,278b. What is the total