Date Payment Interest Loan Balance Reduction of Principal 365 50 367 33 369 16 25 500 00 25 134 50 24 767 17 24 398 01 Long term notes payable and mortgages are paid back in 2 parts Debt Financing Principal Interest Amortization Table Finds out how much of loan payment is principal and interest EXAMPLE 1 Annuity payments Present Value 25 500 is what Sandy needs right now 10 01 05 10 31 05 11 30 05 12 31 05 493 493 493 127 50 125 67 123 84 Interest at 10 31 05 25 500 x 06 x 1 12 127 50 Interest at 11 30 05 25 134 50 x 06 x 1 12 125 67 Interest at 12 31 05 24 767 17 x 06 x 1 12 123 84 Mortgages Special note payable borrowing from bank Secured by pledging certain assets usually real estate as collateral Widely used to purchase homes and plant assets Liability is initially recorded at face value Following entries are required and have reduction of both Interest Principal EXAMPLE 2 Date 09 01 Account Cash Mortgage Payable Debit 250 000 00 Credit 250 000 00 Income Statement No effect Balance Sheet Increase Assets Increase Liabilities Cash Flow Financing Inflow Date Payment Interest Loan Balance Reduction of Principal 1 790 00 1 790 00 1 790 00 1 790 00 7 160 00 1 250 00 1 247 30 1 244 59 1 241 86 4 983 75 540 542 70 545 41 548 14 2 176 25 250 000 00 249 460 00 248 917 30 248 371 89 247 823 75 09 01 04 09 30 04 10 31 04 11 30 04 12 31 04 Totals Interest 06 Time 1 12 As we make payments you credit cash and debit Interest expense and mortgage payable This is an operating outflow and financing outflow Lease Contract specifies terms which an owner of an asset agrees to transfer the right to use the asset to another party Lessee the party that is granted the right Lessor owner of the property rented 2 Types of Leases Operating Lease Off Balance Sheet Financing Lessee assumes no risk of ownership Each lease payment is classified as rent expense At end of lease term right to use property reverts back to lessor Companies prefer because they don t have to record liability o FASB issued SFAS No 13 sets criteria that if met requires leases to be recorded as capital Treated as if the lessee had purchased the asset Lessee assumes rights and risks of ownership Lessee records an asset on their balance sheet with related liability and depreciation leases Renting an apartment Capital Lease EXAMPLE 3 Betty Lessee Operating Lease Date 01 01 04 NO Every 12 31 ENTRY REQUIRED Rent Expense Cash Account Debit Credit 10 000 10 000 Capital Lease Treated as if lessee had purchased asset Lessee records a LEASED ASSET and a LEASE LIABILITY on their balance sheer equal to the PRESENT VALUE OF THE LEASE PAYMENTS The LEASED ASSET must be DEPRECIATED over the lease term The LEASE LIABILITY is AMORTIZED to separate the payment into interest and principal reduction Present value 10 000 x PVAF 31 699 Date Payment Interest 01 01 04 12 31 04 12 31 05 12 31 06 12 31 07 12 31 07 10 000 10 000 10 000 10 000 10 000 3 169 90 2 486 89 1 735 58 909 14 908 63 Interest 10 Time 12 12 Reduction of Principal 6 830 10 7 513 11 8 264 42 9 090 86 9 091 37 Loan Balance 31 699 24 868 90 17 355 79 9 091 37 Must be zero 0 There will always be a rounding error Make the reduction of principal equal to the lease balance and force out the interest Date 01 01 04 Every 12 31 12 31 Account Leased Asset Lease Liability Deprecation Expense Accumulated Depreciation To record annual depreciation 31 699 4 Debit 31 699 00 Credit 31 699 00 7 924 75 7 924 75 Interest Expense Lease Liability Cash To record first lease payment 3 169 90 6 830 10 10 000 OPERATING LEASE Rent Expense CAPITAL LEASE Depreciation Expense 2004 2005 2006 2007 10 000 10 000 10 000 10 000 7 924 75 7 924 75 7 924 75 7 924 75 TOTAL 40 000 40 000 Interest Expense 3 169 90 2 486 89 1 735 58 908 63 Debt Ratios Debt to Equity Liabilities Equity Measures percentage of funds being provided by creditors vs stockholders Ratio of 1 3 would indicate that liabilities are 30 larger than equity Ratio of 8 would indicate equity is 20 larger than debt Ratio of 1 would indicate liabilities and equity are equal How protected creditors are in the event the company is not able to pay its debts insolvency All things equal higher debt to equity ratio higher risk to creditors Higher likelihood an individual would not be paid in full Higher rate of interest charged by lenders to accommodate added risk Times to Interest Earned Ratio NI Inc Tax Exp Interest Exp Interest Expense Measures the companies ability to meet its interest payments as they are coming due Higher is better Thought of as Margin of Safety provided to creditors The more income our company has to pay its interest and less likely they are to default on payments