Bonds

15-1
Current Liabilities
Current liability is debt with two key features:

1. Company expects to pay the debt from existing
current assets or through the creation of other current
liabilities.
2. Company will pay the debt within one year or the
operating cycle, whichever is longer.
Current liabilities include notes payable, accounts payable, unearned

revenues, and accrued liabilities such as taxes payable, salaries payable,
and interest payable.
15-2
Current Liabilities
Illustration: First National Bank agrees to lend $100,000 on

September 1, 2014, if Cole Williams Co. signs a $100,000,
12%, four-month note maturing on January 1.
Instructions
a) Prepare the entry on September 1.
b) Prepare the adjusting entry on December 31, assuming

monthly adjusting entries have not been made.
c) Prepare the entry at maturity (January 1, 2015).
15-3 LO 2 Describe the accounting for notes payable.

Current Liabilities

a) Prepare the entry on September 1.
Cash 100,000
Notes payable 100,000
b) Prepare the adjusting entry on Dec. 31.
Interest expense 4,000

Interest payable 4,000
$100,000 x 12% x 4/12 = $4,000

Current Liabilities

c) Prepare the entry at maturity (January 1, 2015).
Notes payable 100,000

Cash 104,000

Current Liabilities
Sales Tax Payable

 Sales taxes are expressed as a stated percentage of
the sales price.
 Either rung up separately or included in total receipts.
 Retailer collects tax from the customer.
 Retailer remits the collections to the state’s department

of revenue.
15-6 LO 3 Explain the accounting for other current liabilities.

Current Liabilities
Illustration: The March 25 cash register reading for Cooley

Grocery shows sales of $10,000 and sales taxes of $600 (sales
tax rate of 6%), the journal entry is:
Cash 10,600
Sales revenue 10,000
Sales tax payable 600

Current Liabilities
Payroll and Payroll Taxes Payable

The term “payroll” pertains to both:
Salaries - managerial, administrative, and sales
personnel (monthly or yearly rate).
Wages - store clerks, factory employees, and manual
laborers (rate per hour).
Determining the payroll involves computing three amounts: (1)

gross earnings, (2) payroll deductions, and (3) net pay.

Current Liabilities
Illustration: Assume a corporation records its payroll for the

week of March 7 as follows:
Mar. 7 Salaries and wages expense 100,000

Withholding Tax Payable 1,650
Salaries and wages payable 98,350
Record the payment of this payroll on March 11.
Mar. 11 Salaries and wages payable 98,350
Cash 98,350
15-9
Current Liabilities
Unearned Revenue
Revenues that are received before the company delivers goods
or provides services.
1. Company debits Cash, and credits

a current liability account
(unearned revenue).
2. When the company earns the

revenue, it debits the
Unearned Revenue account, and
credits a revenue account.
15-10
Current Liabilities
Illustration: Assume that Superior University sells 10,000

season football tickets at $50 each for its five-game home
schedule. The university makes the following entry for the sale
of season tickets:
Aug. 6 Cash 500,000
Unearned revenue 500,000
As the school completes each of the five home games, it would

record the revenue earned.
Sept. 7 Unearned revenue 100,000

Ticket revenue 100,000
15-11
Current Liabilities
Current Maturities of Long-Term Debt

 Portion of long-term debt that comes due in the
current year.
 No adjusting entry required.

Statement Presentation and Analysis
15-13
Analysis
Illustration 10-6
Liquidity refers to the
ability to pay maturing
obligations and meet
unexpected needs for
cash.
The current ratio Illustration 10-7

permits us to compare
the liquidity of different-
sized companies and of
a single company at
different times.

Long-Term Liabilities
Bond Basics
 A form of interest-bearing notes payable.
 To obtain large amounts of long-term capital.
Three advantages over common stock:
1. Stockholder control is not affected.
2. Tax savings result.
3. Earnings per share may be higher.
15-15 LO 4 Explain why bonds are issued, and identify the types of bonds.
Bond Basics
Effects on earnings per share—stocks vs. bonds.
Illustration 10-9
15-16
Alternative Financing Plans – $800,000 Earnings
Plan 1 Plan 2 Plan 3
12 % bonds — — $2,000,000
Preferred 9% stock, $50 par — $2,000,000 1,000,000
Common stock, $10 par $4,000,000 2,000,000 1,000,000
Total $4,000,000 $4,000,000 $4,000,000
Earnings before interest
and income tax $ 800,000 $ 800,000 $ 800,000
Deduct interest on bonds — — 240,000
Income before income tax $ 800,000 $ 800,000 $ 560,000
Deduct income tax 320,000 320,000 224,000
Net income $ 480,000 $ 480,000 $ 336,000
Dividends on preferred stock — 180,000 90,000
Available for dividends $ 480,000 $ 300,000 $ 246,000
Shares of common stock ÷400,000 ÷200,000 ÷100,000
Earnings per share $ 1.20 $ 1.50 $ 2.46
15-17
Bond Basics
♦ Secured and Unsecured (debenture) bonds.

 Have specific assets of issuer pledged as collateral for the bonds.
♦ Term and Serial bonds.

 Bonds that mature at a single specified future date.
♦ Registered and Bearer (or coupon) bonds.

 Bonds issued in the name of the owner.
♦ Convertible and Callable bonds.

 Bonds that can be converted into common stock at the
bondholder’s option.
15-18
Bond Basics
Types of Bonds
15-19 LO 4
Bond Basics
Issuing Procedures
 State laws grant corporations the power to issue bonds.
 Board of directors and stockholders must approve bond

issues.
 Board of directors must stipulate number of bonds to be

authorized, total face value, and contractual interest rate.
 Bond contract known as a bond indenture.
 Paper certificate, typically a $1,000 face value.
15-20
Bond Basics
Issuing Procedures
 Represents a promise to pay:
► sum of money at designated maturity date, plus
► periodic interest at a contractual (stated) rate on the

maturity amount (face value).
 Interest payments usually made semiannually.
 Generally issued when the amount of capital needed is

too large for one lender to supply.
15-21
Bond Basics
Issuer of
Bonds Illustration 10-10
2017
Maturity
Date
DUE 2017 DUE 2017
Contractual
Interest
Rate
Face or
15-22 Par Value
Bond Basics
Determining the Market Value of Bonds

Market value is a function of the three factors that determine
present value:
1. dollar amounts to be received,
2. length of time until the amounts are received, and
3. market rate of interest.
The features of a bond (callable, convertible, and so on) affect the

market rate of the bond.
15-23
Accounting for Bond Issues
Corporation records bond transactions when it

 issues (sells),
 retires (buys back) bonds and
 when bondholders convert bonds into common stock.
NOTE: If bondholders sell their bond investments to other investors,

the issuing firm receives no further money on the transaction, nor
does the issuing corporation journalize the transaction.
15-24 LO 5 Prepare the entries for the issuance of bonds and interest expense.
Issue at Par, Discount, or Premium?

Illustration 10-12
Bond
Contractual
Interest Rate
of 10%
15-25
Issuing Bonds at Face Value

Illustration: On January 1, 2014, Candlestick Corporation
issues $100,000, five-year, 10% bonds at 100 (100% of face
value). The entry to record the sale is:
Jan. 1 Cash 100,000
Bonds payable 100,000
15-26

value). Assume that interest is payable semiannually on
January 1 and July 1. Prepare the entry to record the payment
of interest on July 1, 2014, assume no previous accrual.
July 1 Interest expense 5,000
Cash 5,000
15-27

value). Assume that interest is payable semiannually on
January 1 and July 1. Prepare the entry to record the accrual
of interest on December 31, 2014, assume no previous
accrual.
Dec. 31 Interest expense 5,000
15-28
Issuing Bonds at a Discount

Illustration: On January 1, 2014, Candlestick, Inc. sells
$100,000, five-year, 10% bonds for $92,639 (92.639% of face
value). Interest is payable on July 1 and January 1. The entry
to record the issuance is:
Jan. 1 Cash 92,639
Discount on bonds payable 7,361
Bond payable 100,000
15-29
Statement Presentation
Illustration 10-13
Carrying value or
book value
Sale of bonds below face value causes the total cost of borrowing to
be more than the bond interest paid.
The reason: Borrower is required to pay the bond discount at the

maturity date. Thus, the bond discount is considered to be a
increase in the cost of borrowing.
15-30
Total Cost of Borrowing
Illustration 10-14
Illustration 10-15
15-31
Issuing Bonds at a Premium

Illustration: On January 1, 2014, Candlestick, Inc. sells
$100,000, five-year, 10% bonds for $108,111 (108.111% of
face value). Interest is payable on July 1 and January 1. The
entry to record the issuance is:
Jan. 1 Cash 108,111
Premium on bond payable 8,111
15-32
Statement Presentation
Illustration 10-16
Sale of bonds above face value causes the total cost of borrowing
to be less than the bond interest paid.
The reason: The borrower is not required to pay the bond premium at
the maturity date of the bonds. Thus, the bond premium is
considered to be a reduction in the cost of borrowing.
15-33
Total Cost of Borrowing

Illustration 10-17
Illustration 10-18
15-34
Accounting for Bond Retirements
Redeeming Bonds at Maturity

Assuming that the company pays and records separately the
interest for the last interest period, Candlestick records the
redemption of its bonds at maturity as follows:
Bond payable 100,000
Cash 100,000
15-35
Redeeming Bonds before Maturity

When bonds are retired before maturity, it is necessary to:
1. eliminate carrying value of bonds at redemption date;
2. record cash paid; and
3. recognize gain or loss on redemption.
The carrying value of the bonds is the face value of the bonds less
unamortized bond discount or plus unamortized bond premium at the
redemption date.
15-36
Illustration: Assume Candlestick, Inc. has sold its bonds at a

premium. At the end of the eighth period, Candlestick retires
these bonds at 103 after paying the semiannual interest. The
carrying value of the bonds at the redemption date is $101,623.
Candlestick makes the following entry to record the redemption
at the end of the eighth interest period (January 1, 2018):

Premium on bonds payable 1,623
Loss on bond redemption 1,377
Cash 103,000
15-37
Converting Bonds into Common Stock

Until conversion, the bondholder receives interest on the
bond.
For the issuer, the bonds sell at a higher price and pay a
lower rate of interest than comparable debt securities without
the conversion option.
Upon conversion, the company transfers the carrying value of
the bonds to paid-in capital accounts. No gain or loss is
recognized.
15-38
Illustration: On July 1 Saunders Associates converts

$100,000 bonds sold at face value into 2,000 shares of $10 par
value common stock. Both the bonds and the common stock
have a market value of $130,000. Saunders makes the
following entry to record the conversion:

Common stock (2,000 x $10) 20,000
Paid-in capital in excess of par value 80,000
15-39
Accounting for Long-Term Notes Payable
May be secured by a mortgage that pledges title to specific

assets as security for a loan.
Typically, terms require borrower to make installment

payments over the term of the loan. Each payment consists of
 interest on the unpaid balance of the loan and
 a reduction of loan principal.
Companies initially record mortgage notes payable at face

value.
15-40
Accounting for Other Long-Term Liabilities
Illustration: Porter Technology Inc. issues a $500,000, 12%, 20-

year mortgage note on December 31, 2014. The terms provide for
semiannual installment payments of $33,231 (not including real
estate taxes and insurance). The installment payment schedule for
the first two years is as follows.
Illustration 10-19
15-41
Accounting for Other Long-Term Liabilities
Illustration: Porter Technology Inc. issues a $500,000, 12%, 20-

year mortgage note on December 31, 2014. The terms provide for
semiannual installment payments of $33,231 (not including real
estate taxes and insurance). The installment payment schedule for
the first two years is as follows.
Dec. 31 Cash 500,000

Mortgage payable 500,000
Jun. 30 Interest expense 30,000

Mortgage payable 3,231
Cash 33,231
15-42
Presentation
Illustration 10-20
LO 8 Identify the methods for the presentation

15-43
and analysis of long-term liabilities.
Analysis
Two ratios that provide information about debt-paying
ability and long-run solvency are:
 Debt to Total Assets Ratio
 Times Interest Earned Ratio
LO 8 Identify the methods for the presentation

15-44
and analysis of long-term liabilities.
Analysis
Illustration: Kellogg had total liabilities of $8,925 million, total assets
of $11,200 million, interest expense of $295 million, income taxes of
$476 million, and net income of $1,208 million.
The higher the percentage of debt to total assets, the greater the risk
that the company may be unable to meet its maturing obligations.
15-45
LO 8
Analysis
Illustration: Kellogg had total liabilities of $8,925 million, total assets
of $11,200 million, interest expense of $295 million, income taxes of
$476 million, and net income of $1,208 million.
Times interest earned indicates the company’s ability to meet interest

payments as they come due.
15-46
LO 8
APPENDIX 10A PRESENT VALUE CONCEPTS RELATED TO BOND PRICING
Present Value of Face Value

Illustration: Assume that you are willing to invest a sum of
money that will yield $1,000 at the end of one year, and you can
earn 10% on your money. What is the $1,000 worth today?
To compute the answer,
1. divide the future amount by 1 plus the interest rate

($1,000/1.10 = $909.09 OR
2. use a Present Value of 1 table. ($1,000 X .90909) = $909.09

(10% per period, one period from now).
15-47
1. divide the future amount by 1 plus the interest rate

($1,000/1.10 = $909.09.
Illustration 10A-1
15-48
2. use a Present Value of 1 table. ($1,000 X .90909) =

$909.09 (10% per period, one period from now).
15-49
The future amount ($1,000), the interest rate (10%), and the
number of periods (1) are known
Illustration 10A-2
15-50
If you are to receive the single future amount of $1,000 in

two years, discounted at 10%, its present value is $826.45
[($1,000 1.10) 1.10].
Illustration 10A-3
15-51
To compute the answer using a Present Value of 1 table.

($1,000 X .82645) = $826.45 (10% per period, two periods
from now).
15-52
Present Value of Interest Payments (Annuities)
In addition to receiving the face value of a bond at maturity,

an investor also receives periodic interest payments
(annuities) over the life of the bonds.
To compute the present value of an annuity, we need to

know:
1) interest rate,
2) number of interest periods, and
3) amount of the periodic receipts or payments.
15-53
Assume that you will receive $1,000 cash annually for three
years and the interest rate is 10%.
Illustration 10A-5
15-54
Illustration 10A-6
15-55
$1,000 annual payment x 2.48685 = $2,486.85

15-56
Computing the Present Value of a Bond
Selling price of a bond is equal to the sum of:

 Present value of the face value of the bond discounted
at the investor’s required rate of return
PLUS
 Present value of the periodic interest payments

discounted at the investor’s required rate of return
15-57
Assume a bond issue of 10%, five-year bonds with a face value

of $100,000 with interest payable semiannually on January 1
and July 1.
Illustration 10A-8
15-58

and July 1.
Illustration 10A-9
15-59

and July 1.
Illustration 10A-10
15-60

and July 1.
Illustration 10A-11
15-61
APPENDIX 10B EFFECTIVE-INTEREST METHOD OF BOND AMORTIZATION
Under the effective-interest method, the amortization of

bond discount or bond premium results in period interest
expense equal to a constant percentage of the carrying value
of the bonds.
Required steps:
1. Compute the bond interest expense.
2. Compute the bond interest paid or accrued.
3. Compute the amortization amount.
15-62
Effective-Interest Method of Bond Amortization
Amortizing Bond Discount

Illustration: Candlestick, Inc. issues $100,000 of 10%, five-year
bonds on January 1, 2014, for $92,639, with interest payable each
July 1 and January 1. This results in a discount of $7,361.
Illustration 10B-2
15-63

July 1 and January 1. This results in a discount of $7,361.
Journal entry on July 1, 2014, to record the interest payment and

amortization of discount is as follows:
July 1 Interest Expense 5,558

Cash 5,000
Discount on Bonds Payable 558
15-64
Amortizing Bond Premium

July 1 and January 1. This results in a premium of $8,111.
Illustration 10B-4
15-65

July 1 and January 1. This results in a premium of $8,111.

amortization of premium is as follows:

Premium on Bonds Payable 676
Cash 5,000
15-66
APPENDIX 10B STRAIGHT-LINE AMORTIZATION

Illustration: Candlestick, Inc., sold $100,000, five-year, 10%
bonds on January 1, 2014, for $92,639 (discount of $7,361).
Interest is payable on July 1 and January 1.
Illustration 10C-2
15-67

bonds on January 1, 2014, for $92,639 (discount of $7,361).
Interest is payable on July 1 and January 1. The bond discount
amortization for each interest period is $736 ($7,361/10).

amortization of discount is as follows:

Discount on Bonds Payable 736
Cash 5,000
15-68

bonds on January 1, 2014, for $108,111 (premium of $8,111).
Interest is payable on July 1 and January 1.
Illustration 10C-4
15-69

bonds on January 1, 2014, for $108,111 (premium of $8,111).
Interest is payable on July 1 and January 1. The bond premium
amortization for each interest period is $811 ($8,111/10).

amortization of premium is as follows:

Premium on Bonds Payable 811
Cash 5,000
15-70

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15-1

Current liability is debt with two key features:

Current liabilities include notes payable, accounts payable, unearned

Illustration: First National Bank agrees to lend $100,000 on

a) Prepare the entry on September 1.

b) Prepare the adjusting entry on December 31, assuming

c) Prepare the entry at maturity (January 1, 2015).

15-3 LO 2 Describe the accounting for notes payable.

Illustration: First National Bank agrees to lend $100,000 on

b) Prepare the adjusting entry on Dec. 31.

Interest expense 4,000

15-4 LO 2 Describe the accounting for notes payable.

Illustration: First National Bank agrees to lend $100,000 on

Notes payable 100,000

15-5 LO 2 Describe the accounting for notes payable.

Sales Tax Payable

 Either rung up separately or included in total receipts.

 Retailer collects tax from the customer.

 Retailer remits the collections to the state’s department

15-6 LO 3 Explain the accounting for other current liabilities.

Illustration: The March 25 cash register reading for Cooley

15-7 LO 3 Explain the accounting for other current liabilities.

Payroll and Payroll Taxes Payable

Determining the payroll involves computing three amounts: (1)

15-8 LO 3 Explain the accounting for other current liabilities.

Illustration: Assume a corporation records its payroll for the

Mar. 7 Salaries and wages expense 100,000

1. Company debits Cash, and credits

2. When the company earns the

Illustration: Assume that Superior University sells 10,000

As the school completes each of the five home games, it would

Sept. 7 Unearned revenue 100,000

Current Maturities of Long-Term Debt

 No adjusting entry required.

15-12 LO 3 Explain the accounting for other current liabilities.

The current ratio Illustration 10-7

15-14 LO 3 Explain the accounting for other current liabilities.

 To obtain large amounts of long-term capital.

Three advantages over common stock:

1. Stockholder control is not affected.

2. Tax savings result.

3. Earnings per share may be higher.

Effects on earnings per share—stocks vs. bonds.

Earnings per share $ 1.20 $ 1.50 $ 2.46

♦ Secured and Unsecured (debenture) bonds.

♦ Term and Serial bonds.

♦ Registered and Bearer (or coupon) bonds.

♦ Convertible and Callable bonds.

 Board of directors and stockholders must approve bond

 Board of directors must stipulate number of bonds to be

 Bond contract known as a bond indenture.

 Paper certificate, typically a $1,000 face value.

► sum of money at designated maturity date, plus

► periodic interest at a contractual (stated) rate on the

 Interest payments usually made semiannually.

 Generally issued when the amount of capital needed is

DUE 2017 DUE 2017

Determining the Market Value of Bonds

1. dollar amounts to be received,

2. length of time until the amounts are received, and

3. market rate of interest.

The features of a bond (callable, convertible, and so on) affect the

Corporation records bond transactions when it

 retires (buys back) bonds and