ACCT 2113 1st Edition Lecture 9 Outline of Last Lecture II Current Liabilities A Current vs long term liabilities B Account for notes payable and interest expense C Example III Measuring Interest A Example IV Line of Credit A Employee employer payroll liabilities B Employee employer costs V Current portion of long term debt A Deferred taxes VI Contingencies A Litigations and other causes B Contingent liabilities C Accounting treatment D Warranties E Contingent gains VII Assessing liquidity Outline of Current Lecture II Financing alternatives A Debt financing B Equity financing III Bond A Definition of private placement B Characteristics C Secured unsecured term serial callable convertible IV Pricing and recording a bond A Face amount discount premium V Amortization schedules for bonds VI Retirement of bonds VII Other long term liabilities A Installment notes 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 VIII B Leases Long term liability ratios A Debt to equity ratio B Times interest earned ratio Current Lecture Chapter 9 Long term Liabilities Financing alternatives Financing options Debt financing borrowing money liabilities Equity financing obtaining additional investment from stockholders stockholders equity Capital Structure is the mixture of liabilities and stockholders equity used by a business Accounting Equation What is a bond Bonds are very similar to notes Bonds though usually are issued to many lenders while notes most often are issued to a single lender such as a bank Traditionally interest on bonds is paid twice a year semi annually on designated interest dates beginning six months after the original bond issue date Bonds provide a way to borrow the money needed from many community members each willing to lend a small amount In return those investing in the bonds receive interest over the life of the bonds say 20 years and repayment of the principal amount at the end of the bonds life o A formal debt instrument that obligates the borrower to repay a stated amount referred to as the principal or face amount at a specified maturity date o In return the borrower agrees to pay interest over the life of the bond o Similar to notes payable except bonds are usually issued to many lenders at the same time o Traditionally interest on bonds is paid twice a year semi annually o Bonds are sold or underwritten by investment houses like JPMorgan Citibank and Bank of America o The borrower pays a fee for underwriting services Other costs include legal accounting registration and printing fees o To keep costs lower the issuing company may choose to sell the debt securities directly to a single investor This is referred to as a Private placement o Issue costs are lower because privately placed securities are not subject to the costly and lengthy process of registering with the SEC that is required of all public offerings A company that borrows by issuing bonds is effectively by passing the bank and borrowing directly from the investing public usually at a lower interest rate than it would in a bank loan However issuing bonds entails significant bond issue costs that can exceed 5 of the amount borrowed For smaller loans the additional bond issuance costs exceed the savings from a lower interest rate making it more economical to borrow from a bank For loans of 20 million or more the interest rate savings often exceed the additional bond issuance costs making a bond issue more attractive A bond issue in effect breaks down a large debt into manageable parts usually 1 000 units This avoids the necessity of finding a single investor who is both willing and able to loan a large amount of money at a reasonable interest rate Characteristics of bonds A bond indenture is a contract between a firm issuing bonds to borrow money the issuer and the corporations or individuals who purchase the bonds as investments the investors For any particular bond the bond may be secured or unsecured term or serial callable or convertible Secured and Unsecured Bonds o o Secured Bonds supported by specific assets the issuer has pledged as collateral o Mortgage bonds are backed by specific real estate assets o If the borrower defaults on the payments the lender is entitled to the real estate pledged as collateral Unsecured bonds referred to as debentures are not backed by a specific asset o Secured only by the full faith and credit of the borrower When you buy a house and finance your purchase with a bank loan you sign a mortgage agreement assigning your house as collateral If later you are unable to make the payments the bank is entitled to take your house Secured bonds are similar They are supported by specific assets the issuer has pledged as collateral For instance mortgage bonds are backed by specific real estate assets If the borrower defaults on the payments the lender is entitled to the real estate pledged as collateral However most bonds are unsecured Unsecured bonds also referred to as debentures are not backed by a specific asset These bonds are secured only by the full faith and credit of the borrower Term and Serial Bonds o Term bonds require payment of the full principal amount of the bond at a single maturity date o Most bonds have this characteristic o To ensure that sufficient funds are available to repay the amount at maturity the borrower sets aside money in a sinking fund o o A sinking fund is an investment fund used to set aside money to pay the outstanding debt as it comes due Serial bonds require payments in instalments over a series of years o It makes it easier for the borrower to meet its bond obligations as they become due Term bonds require payment of the full principal amount of the bond at a single maturity date Most bonds have this characteristic Borrowers often plan ahead for the repayment by setting aside funds throughout the term to maturity For example let s say a city borrows 20 million to build a new sports park by issuing 7 term bonds due in 12 years To ensure that sufficient funds are available to pay the 20 million 12 years later the borrower sets aside money in a sinking fund A sinking fund is a designated fund to which an organization makes payments each year over the life of its outstanding debt The city might save 2 million each year for 12 years in a sinking fund so that 20 million is available to pay the bonds when they become due Serial bonds require payments in