Learning Objectives
• Understand the Business
– LO1 Explain the role of liabilities in financing a
business.
• Study the accounting methods
– LO2 Explain how to account for common types of
current liabilities.
– LO3 Analyze and record bond liability transactions.
– LO4 Describe how to account for contingent liabilities.
• Evaluate the results
– LO5 Calculate and interpret the quick ratio and the
times interest earned ratio.
• Review the chapter
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1
Long-Term Liabilities
Bonds
• Bonds are financial instruments that outline the
future payments a company promises to make in
exchange for receiving a sum of money now.
Face Value
Maturity Date
The amount payable on a
bond’s maturity date.
The date on which a bond is
due to be paid in full.
Stated Interest Rate
The rate stated on the face of
the bond, which is used to
compute interest payments.
LO3
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2
Bond Pricing
• Issue Price is the amount of money the company
receives when a bond is issued. The amount may
be equal to face value ($1,000), or the amount may
be higher or lower than face value.
• Present Value is a mathematical calculation to
determine how much future payments are worth
today.
LO3
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3
Accounting for a Bond Issue
Bonds Issued at Face Value
General Mills receives $100,000 cash in exchange for issuing
100 bonds at their $1,000 face value.
1 Analyze
2 Record
LO3
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4
Bonds Issued at a Premium
A Premium is the amount by which a bond’s issue price
exceeds its face value.
General Mills receives $107,260 cash in exchange for issuing
100 bonds at their $1,000 face value.
The bond price is 107.26.
$100,000 is the face value and $7,260 is a premium.
1 Analyze
2 Record
LO3
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5
Bonds Issued at a Discount
A Discount is the amount by which a bond’s issue price is less
than its face value.
General Mills receives $93,376 cash in exchange for issuing
100 bonds at their $1,000 face value.
The bond price is 93.376.
$100,000 is the face value and $6,624 is a discount.
1 Analyze
2 Record
Discount on Bonds Payable is a contra-liability.
LO3
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6
Relationships between Interest Rates and Bond Pricing
6%
Stated Interest
Rate on Bond
4%
Market
Interest Rate
Investors will
pay more than
face value
6%
Market
Interest Rate
Investors will
pay face value
Bond Issued at
Face Value
8%
Market
Interest Rate
Investors will
pay less than
face value
Bond Issued at
a Discount
Bond Issued at
a Premium
Market Interest Rate is the rate that investors demand from a bond.
Balance Sheet Reporting of Bond Liabilities
LO3
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7
Interest Expense
Interest on Bonds Issued at Face Value
General Mills issued $100,000 6% bonds January 2, 2012.
After one month, on January 31, 2012, interest expense will
be $100,000 x 6% x 1/12 = $500
1 Analyze
2 Record
LO3
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8
Interest on Bonds Issued at a Premium
General Mills issued $100,000 6% bonds January 2, 2012 and
received $107,260. General Mills received $107,260, but must pay
back only $100,000 at maturity.
The premium, $7,260, is a reduction in the cost of borrowing.
Bond Amortization will reduce the interest expense.
Bond Amortization is explained in the Supplements at the end of this chapter.
LO3
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9
Interest on Bonds Issued at a Discount
General Mills issued $100,000 6% bonds January 2, 2012 and
received $93,376. General Mills received $93,376, but must pay
back only $100,000 at maturity.
The discount, $6,624, is an increase in the cost of borrowing.
Bond Amortization will increase the interest expense.
Bond Amortization is explained in the Supplements at the end of this chapter.
LO3
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10
Bond Retirements
Retirement at Maturity
Most bonds are retired (paid off) at maturity.
General Mills pays $100,000 cash to retire bonds at maturity.
1 Analyze
2 Record
LO3
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11
Early Retirement
Bonds may be retired early, sometimes to reduce future
interest expense, especially if interest rates have fallen.
If bonds are retired early, a gain will arise if the cash paid to retire the
bonds is less than the carrying value; a loss will arise if the cash paid is
more than the carrying value.
General Mills pays $103,000 cash to retire bonds early.
1 Analyze
2 Record
LO3
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12