14-1
PREVIEW OF CHAPTER 14
Intermediate Accounting
IFRS 2nd Edition
Kieso, Weygandt, and Warfield
14-2
BONDS PAYABLE
Non-current liabilities (long-term debt) consist of an
expected outflow of resources arising from present obligations
that are not payable within a year or the operating cycle of
the company, whichever is longer.
Examples:
► Bonds payable ► Pension liabilities
► Long-term notes payable ► Lease liabilities
► Mortgages payable
Long-term debt has various
covenants or restrictions.
14-3 LO 1
Issuing Bonds
◆ Bond contract known as a bond indenture.
◆ Represents a promise to pay:
(1) sum of money at designated maturity date, plus
(2) periodic interest at a specified rate on the maturity
amount (face value).
◆ Paper certificate, typically a €1,000 face value.
◆ Interest payments usually made semiannually.
◆ Used when the amount of capital needed is too large for
one lender to supply.
14-4 LO 1
Types and Ratings of Bonds
Common types found in practice:
◆ Secured and Unsecured (debenture) bonds.
◆ Term, Serial, and Callable bonds.
◆ Convertible, Commodity-Backed, Deep-Discount bonds.
◆ Registered and Bearer (Coupon) bonds.
◆ Income and Revenue bonds.
14-5 LO 2
Types and Ratings of Bonds
Corporate bond listing.
Company Price as a % of par
Name
Interest rate based on price
Interest rate paid as Creditworthiness
a % of par value
14-6 LO 2
Valuation of Bonds Payable
Issuance and marketing of bonds to the public:
◆ Usually takes weeks or months.
◆ Issuing company must
► Arrange for underwriters.
► Obtain regulatory approval of the bond issue, undergo
audits, and issue a prospectus.
► Have bond certificates printed.
14-7 LO 3
Valuation of Bonds Payable
Selling price of a bond issue is set by the
◆ supply and demand of buyers and sellers,
◆ relative risk,
◆ market conditions, and
◆ state of the economy.
Investment community values a bond at the present value of
its expected future cash flows, which consist of (1) interest and
(2) principal.
14-8 LO 3
Valuation of Bonds Payable
Interest Rate
◆ Stated, coupon, or nominal rate = Rate written in the
terms of the bond indenture.
► Bond issuer sets this rate.
► Stated as a percentage of bond face value (par).
◆ Market rate or effective yield = Rate that provides an
acceptable return commensurate with the issuer’s risk.
► Rate of interest actually earned by the bondholders.
14-9 LO 3
Valuation of Bonds Payable
How do you calculate the amount of interest that is actually paid
to the bondholder each period?
(Stated rate x Face Value of the bond)
How do you calculate the amount of interest that is actually
recorded as interest expense by the issuer of the bonds?
(Market rate x Carrying Value of the bond)
14-10 LO 3
Valuation of Bonds Payable
Assume Stated Rate of 8%
Market Interest Bonds Sold At
6% Premium
8% Par Value
10% Discount
14-11 LO 3
Bonds Issued at Par
Illustration: Santos Company issues R$100,000 in bonds
dated January 1, 2015, due in five years with 9 percent interest
payable annually on January 1. At the time of issue, the market
rate for such bonds is 9 percent.
ILLUSTRATION 14-1
Time Diagram for Bonds
Issued at Par
14-12 LO 3
Bonds Issued at Par ILLUSTRATION 14-1
Time Diagram for Bonds
Issued at Par
ILLUSTRATION 14-2
Present Value
Computation of
Bond Selling at Par
14-13 LO 3
Bonds Issued at Par
Journal entry on date of issue, Jan. 1, 2015.
Cash 100,000
Bonds payable 100,000
Journal entry to record accrued interest at Dec. 31, 2015.
Interest expense 9,000
Interest payable 9,000
Journal entry to record first payment on Jan. 1, 2016.
Interest payable 9,000
Cash 9,000
14-14 LO 3
Bonds Issued at a Discount
Illustration: Assuming now that Santos issues R$100,000
in bonds, due in five years with 9 percent interest payable
annually at year-end. At the time of issue, the market rate for
such bonds is 11 percent.
ILLUSTRATION 14-3
Time Diagram for Bonds
Issued at a Discount
14-15 LO 3
Bonds Issued at a Discount ILLUSTRATION 14-3
Time Diagram for Bonds
Issued at a Discount
ILLUSTRATION 14-4
Present Value
Computation of
Bond Selling at
Discount
14-16 LO 3
Bonds Issued at a Discount
Journal entry on date of issue, Jan. 1, 2015.
Cash 92,608
Bonds payable 92,608
Journal entry to record accrued interest at Dec. 31, 2015.
Interest expense ($92,608 x 11%) 10,187
Interest payable 9,000
Bonds payable 1,187
Journal entry to record first payment on Jan. 1, 2016.
Interest payable 9,000
Cash 9,000
14-17 LO 3
Bonds Issued at a Discount
When bonds sell at less than face value:
► Investors demand a rate of interest higher than stated rate.
► Usually occurs because investors can earn a higher rate
on alternative investments of equal risk.
► Cannot change stated rate so investors refuse to pay face
value for the bonds.
► Investors receive interest at the stated rate computed on
the face value, but they actually earn at an effective rate
because they paid less than face value for the bonds.
14-18 LO 3
14 Non-Current Liabilities
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Describe the formal procedures 5. Explain the accounting for long-term
associated with issuing long-term debt. notes payable.
2. Identify various types of bond issues. 6. Describe the accounting for the
3. Describe the accounting valuation for extinguishment of non-current liabilities.
bonds at date of issuance. 7. Describe the accounting for the fair
value option.
4. Apply the methods of bond
discount and premium 8. Explain the reporting of
off-balance-sheet financing
amortization.
arrangements.
9. Indicate how to present and analyze
14-19
non-current liabilities.
Effective-Interest Method
Bond issued at a discount - amount paid at maturity is more
than the issue amount.
Bonds issued at a premium - company pays less at maturity
relative to the issue price.
Adjustment to the cost is recorded as bond interest expense over
the life of the bonds through a process called amortization.
Required procedure for amortization is the effective-interest
method (also called present value amortization).
14-20 LO 4
Effective-Interest Method
Effective-interest method produces a periodic interest
expense equal to a constant percentage of the carrying value
of the bonds.
ILLUSTRATION 14-5
Bond Discount and Premium
Amortization Computation
14-21 LO 4
Effective-Interest Method
Bonds Issued at a Discount
Illustration: Evermaster Corporation issued €100,000 of 8% term
bonds on January 1, 2015, due on January 1, 2020, with interest
payable each July 1 and January 1. Investors require an
effective-interest rate of 10%. Calculate the bond proceeds.
ILLUSTRATION 14-6
Computation of Discount on Bonds Payable
14-22 LO 4
ILLUSTRATION 14-7
Bond Discount
Amortization Schedule
14-23
Effective-Interest Method ILLUSTRATION 14-7
Bond Discount
Amortization Schedule
Journal entry on date of issue, Jan. 1, 2015.
Cash 92,278
Bonds Payable 92,278
14-24 LO 4
Effective-Interest Method ILLUSTRATION 14-7
Bond Discount
Amortization Schedule
Journal entry to record first payment and amortization of the
discount on July 1, 2015.
Interest expense 4,614
Bonds payable 614
Cash 4,000
14-25 LO 4
Effective-Interest Method ILLUSTRATION 14-7
Bond Discount
Amortization Schedule
Journal entry to record accrued interest and amortization of the
discount on Dec. 31, 2015.
Interest expense 4,645
Interest payable 4,000
Bonds payable 645
14-26 LO 4
Effective-Interest Method
Bonds Issued at a Premium
Illustration: Evermaster Corporation issued €100,000 of 8% term
bonds on January 1, 2015, due on January 1, 2016, with interest
payable each July 1 and January 1. Investors require an
effective-interest rate of 6%. Calculate the bond proceeds.
ILLUSTRATION 14-8
Computation of Premium on Bonds Payable
14-27 LO 4
ILLUSTRATION 14-9
Bond Premium
Amortization Schedule
14-28
Effective-Interest Method ILLUSTRATION 14-9
Bond Premium
Amortization Schedule
Journal entry on date of issue, Jan. 1, 2015.
Cash 108,530
Bonds payable 108,530
14-29 LO 4
Effective-Interest Method ILLUSTRATION 14-9
Bond Premium
Amortization Schedule
Journal entry to record first payment and amortization of the
premium on July 1, 2015.
Interest expense 3,256
Bonds payable 744
Cash 4,000
14-30 LO 4
Effective-Interest Method
Accrued Interest
What happens if Evermaster prepares financial statements at the
end of February 2015? In this case, the company prorates the
premium by the appropriate number of months to arrive at the
proper interest expense, as follows.
ILLUSTRATION 14-10
Computation of Interest
Expense
14-31 LO 4
Effective-Interest Method
ILLUSTRATION 14-10
Accrued Interest Computation of Interest
Expense
Evermaster records this accrual as follows.
Interest expense 1,085.33
Bonds payable 248.00
Interest payable 1,333.33
14-32 LO 4
Effective-Interest Method
Bonds Issued between Interest Dates
Bond investors will pay the seller the interest accrued from the
last interest payment date to the date of issue.
On the next semiannual interest payment date, bond investors
will receive the full six months’ interest payment.
14-33 LO 4
Effective-Interest Method
Bonds Issued at Par
Illustration: Assume Evermaster issued its five-year bonds,
dated January 1, 2015, on May 1, 2015, at par (€100,000).
Evermaster records the issuance of the bonds between interest
dates as follows.
(€100,000 x .08 x 4/12) = €2,667
Cash 100,000
Bonds payable 100,000
Cash 2,667
Interest expense 2,667
14-34 LO 4
Effective-Interest Method
Bonds Issued at Par
On July 1, 2015, two months after the date of purchase,
Evermaster pays the investors six months’ interest, by making
the following entry.
($100,000 x .08 x 1/2) = $4,000
Interest expense 4,000
Cash 4,000
14-35 LO 4
Effective-Interest Method
Bonds Issued at Discount or Premium
Illustration: Assume that the Evermaster 8% bonds were issued
on May 1, 2015, to yield 6%. Thus, the bonds are issued at a
premium price of €108,039. Evermaster records the issuance of
the bonds between interest dates as follows.
Cash 108,039
Bonds payable 108,039
Cash 2,667
Interest expense 2,667
14-36 LO 4
Effective-Interest Method
Bonds Issued at Discount or Premium
Evermaster then determines interest expense from the date of
sale (May 1, 2015), not from the date of the bonds (January 1,
2015).
ILLUSTRATION 14-12
Partial Period Interest
Amortization
14-37 LO 4
Effective-Interest Method
Bonds Issued at Discount or Premium
The premium amortization of the bonds is also for only two
months.
ILLUSTRATION 14-13
Partial Period Interest
Amortization
14-38 LO 4
Effective-Interest Method
Bonds Issued at Discount or Premium
Evermaster therefore makes the following entries on July 1,
2015, to record the interest payment and the premium
amortization.
Interest expense 4,000
Cash 4,000
Bonds payable 253
Interest expense 253
14-39 LO 4
SPECIAL ISSUES RELATED TO
NON-CURRENT LIABILITIES
Extinguishment of Non-Current Liabilities
Extinguishment with cash before maturity,
14-40 LO 6
Extinguishment of Non-Current Liabilities
Extinguishment with Cash before Maturity
◆ Net carrying amount > Reacquisition price = Gain
◆ Reacquisition price > Net carrying amount = Loss
◆ At time of reacquisition, unamortized premium or
discount must be amortized up to the reacquisition
date.
14-41 LO 6
Extinguishment with Cash before Maturity
Illustration: Evermaster bonds issued at a discount on January 1,
2015. These bonds are due in five years. The bonds have a par value
of €100,000, a coupon rate of 8% paid semiannually, and were sold to
yield 10%.
ILLUSTRATION 14-21
Bond Premium Amortization Schedule, Bond Extinguishment
14-42 LO 6
Extinguishment with Cash before Maturity
Two years after the issue date on January 1, 2017, Evermaster
calls the entire issue at 101 and cancels it. ILLUSTRATION 14-22
Computation of Loss on
Redemption of Bonds
Evermaster records the reacquisition and cancellation of the
bonds as follows.
Bonds Payable 94,925
Loss on Extinguishment of Bonds 6,075
Cash 101,000
14-43 LO 6
Thank You….
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