Chapter 12

• Long-term liabilities


  Liabilities that do not need to be paid within one year or within the entity’s operating cycle
• Common long-term liabilities

  • Long-term notes payable
  • Mortgages payable
• Amortization schedule


  Details each loan payment’s allocation between principal and interest and the beginning and ending balances of the loan
• Interest is computed as beginning balance multiplied by interest rate multiplied by time
• Mortgages payable are long-term debts that are backed with a security interest in specific property
• Mortgages payable are similar to long-term notes payable except that mortgages payable are secured with specific assets
• Bonds payable are long-term debts issued to multiple lenders called bondholders, usually in increments of $1,000 per bond
• Face value


  The amount a borrower must pay back to the bondholders on the maturity date
• Maturity date


  The date on which the borrower must pay the principal amount to the bondholders
• Stated interest rate


  The interest rate that determines the amount of cash interest the borrower pays and the investor receives each year
• Types of Bonds

  • Term bonds
  • Serial bonds
  • Secured bonds
  • Debentures
• Term bonds


  Bonds that all mature at the same time
• Serial bonds


  Bonds that mature in installments at regular intervals
• Secured bonds


  Bonds that give bondholders the right to take specified assets of the issuer if the issuer fails to pay principal or interest
• Debentures

  Unsecured bonds backed only by the creditworthiness of the bond issuer
• A bond can be issued at face value, a discount, or at a premium
• Discount on bonds payable


  Occurs when the issue price is less than face value
• Premium on bonds payable


  Occurs when the issue price is above face value
• The time value of money is the recognition that money earns interest over time
• Present value


  The amount a person invests now to receive a greater amount in the future
• Future value


  The value of an investment at the end of a specific time frame
• The stated rate is the rate printed on a bond
• Market interest rate(Effective interest rate)


  The rate that investors demand to earn for loaning their money
• Borrowing by issuing bonds payable carries a risk: The company may be unable to pay off the bonds and the related interest
• Debt is a less expensive source of capital than stock and does not affect the ownership percentage
• Financial leverage


  Earning more income on borrowed money than the related interest expense
• Journal entries are required to record the issuance of bonds at face value, a discount, or a premium
• Discount on Bonds Payable is a contra account to Bonds Payable
• Bonds Payable minus the discount gives the carrying amount of bonds, also known as the carrying value
• Amortization


  The gradual reduction of an item over time
• We can amortize a bond discount by using the straight-line amortization method
• When the stated interest rate is greater than the market interest rate, the bonds are sold at a premium
• Premium on Bonds Payable

  An adjunct account to Bonds Payable
• Retirement of bonds payable involves paying the face value of the bonds
• Bonds can be retired at the maturity date or before
• When a bond is matured, the carrying value always equals the face value
• Companies sometimes retire their bonds prior to maturity to relieve the pressure of paying interest payments
• Callable bonds


  Bonds that the company may call, or pay off, at a specified price
• To retire bonds before maturity

  1. Record partial-period amortization of Discount or Premium and partial-period interest payment if the retirement date does not fall on an interest payment date

  2. Remove the portion of unamortized Discount or Premium that correlates with bonds being retired

  3. Debit Bonds Payable at face value

  4. Credit a gain or debit a loss on retirement

  5. Credit Cash for the amount paid to retire bonds
• At the end of each period, all current and long-term liabilities are reported on the balance sheet