ACCT 209 1nd Edition Lecture 11 Outline of Last Lecture I Long lived assets a Acquisition I Example b Use over multiple years I Methods II Example II Disposal a Example III Natural resources a Example IV Intangible assets V Current Liabilities Overview VI Short Term notes payable a Examples VII Discounted Notes Payable VIII Commitments IX Contingent Liabilities a Example X Quick Ratio XI Compound Interest XII Compound interest and present value of an annuity XIII Debt financing Vs Equity financing Borrowing Vs Ownership Outline of Current Lecture a Example XIV Bonds a Example XV Pricing Bonds Payable a Example b Second Example Current Lecture Example 5 Installment loan These 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 731 854 2 What amount should Parker record as interest expense for 2013 37 911 3 What amount should Parker record as the outstanding liability on the loan on December 31 2013 after the first payment is made 519 765 Pvoa 15 000 4 2136 631 854 n 5 I 6 Cost 100 000 631 854 731 854 150 000 5 750 000 Total to repay 631 854 118 146 Total interest expense Date Payment Interest expense Amortization schedule Amount to reduce loan balance 1 2 2013 Loan balance Appears on balance sheet 631 854 12 31 201 3 150 000 37 911 112 089 519 765 12 31 201 4 150 000 31 186 118 814 400 951 12 31 201 5 150 000 24 057 125 943 275 008 12 31 201 6 150 000 16 500 133 500 141 509 12 31 201 7 150 000 8 491 141 509 1 118 145 X Y Z Define Note payable negotiated contract between two parties Bond payable contract to borrow created by an entity then issued or sold to numerous lenders Bond 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 lender Term bonds all bonds in the bond issue mature at same time Serial 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 payment Secured bonds have specific assets of issuing company pledged as collateral Debentures unsecured bonds backed only by general credit worthiness of issuing company Convertible bonds bond holder lender may exchange bond for shares of issuing company s stock Callable bonds issuer may call repay bonds before maturity Stated 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 bonds Zero 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 maturity BOND BASICS Generally 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 maturity Zero coupon bond pays no interest instead pays only face value at maturity Example 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 up Bond payment goes up 100 000 Every Dec 31 Intrest expense goes up Net income goes down For five years Cash goes down 1000 000 10 10 000 At end of five years Cash goes down Bond payment does down 100 000 Pricing 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 issues and how debt is priced Contract also coupon stated face rate determines cash interest payments Market 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 market rate 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 issue b report the appropriate liability on the balance sheet each year of the bond issue Example 7 Bond issued at a discount On 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 the market 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 for 5 years b Repay 100 000 at end of 5 years pvoa 4000 7 72173 30 887 pva 100 000 0 61391 61 391 30 837 61 391 91 278 What is the total amount of cash that must be repaid over the life of the bonds Given that total interest is the difference between the amount borrowed and the amount repaid how much interest expense should Longhorn report over the life of the bond issue Pay back 4000 2 5 100 000 140 000 borrowed