Bài giảng Fundamental Financial Accounting Concepts - Chapter 10: Accounting for Long-Term Debt

Accounting for Long-Term DebtChapter TenMcGraw-Hill/IrwinMcGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.Long-term notes are liabilities that usuallyhave terms from two to five years.Each payment covers interest for the period and a portion of the principal.With each payment, the interest portion gets smaller and the principal portion gets larger.PrincipalCompanyLenderPaymentsLong-Term Notes Payable10-*Applying payments to principal and interest Identify the unpaid principal balance.Amount applied to interest = Unpaid principal balance × Interest rate.Amount applied to principal = Cash payment – Amount applied to interest in .Unpaid principal balance = Unpaid principal balance in  – Amount applied to principalin .Long-Term Notes Payable10-*The amount applied to the principal increases each year. The amount of interest decreases each year.Annual payments are constant.Long-Term Notes Payable10-*Line of CreditEnable the company to borrow and repay  funds.Usually specify a maximum credit line.Normally used for short-term borrowing to finance seasonal business needs.10-*Long-term borrowing of a large sum of money, called the principal.Principal is usually paid back as a lump sum at maturity. Individual bonds are often denominated with a face value of $1,000.Bond Liabilities10-*Periodic interest payments based on a stated rate of interest.Interest is paid semiannually.Interest paid is computed as: Interest = Principal × Stated Interest Rate × TimeBond prices are quoted as a percentage of the face amount. For example, a $1,000 bond priced at 104 would sell for $1,040.Bond Liabilities10-*Bond Issue DateBond Interest PaymentsBond Interest PaymentsCorporationInvestorsInterest Payment = Principal × Interest Rate × Time Bond Liabilities10-*Bond LiabilitiesAdvantages of bonds Longer term to maturity than notes payable issued to banks. Bond interest rates are usually lower than bank loan rates.10-*Secured and Unsecured Term and Serial Convertible and CallableCharacteristics of Bonds10-*The Market Rate of Interest The selling price of a bond is determined by the market rate of interest versus the stated rate of interest.=><=10-* Gains or losses incurred as a result of early redemption of bonds should be reported as other income or other expense on the income statement.Bond RedemptionsCompanies may redeem bonds with acall provision prior to the maturity date.10-*Effective Interest Rate MethodEffective interest is a more accurate way to amortize bond discounts and premiums.It correctly reflects the bond’s changing carrying value. 10-*Effective Interest Rate MethodLet’s assume Mason Company uses the effective interest method on its $100,000 bond.Step 1:Determine the cash payment for interest.Face value of bondX Stated rate of interestCash payment$ 100,000X .09$ 9,00010-*Effective Interest Rate Method Step 2:Determine the amount of interest expense.Carrying value of bond liabilityX Effective rate of interestInterest expense$ 95,000X .1033$ 9,814$100,000 face value - $5,000 discount = $95,000 carrying value10-*Effective Interest Rate MethodStep 3:Determine the amortization of the bond discount.Interest expense- Cash paymentDiscount amortization$ 9,814- 9,000$ 814Step 4:Update the carrying value of the bond liability.Discount amortization+ Beginning carrying valueEnding carrying value$ 814+ $ 95,000$ 95,81410-*Effective Interest Rate Method* The decrease in the amount of the discount increases the amount of the bond liability.10-*Effective Interest Rate Method (Appendix)Notice that when using the effective interest method, interest expense increases each year. 10-*Financial Leverage and Tax Advantage of Debt FinancingFinancial leverage: Debt financing can increase return on equity when the borrower earns more on the borrowed funds than it pays in interest. As this example shows, the cost of financing is the same, but debt financing has a tax advantage.10-*Times Interest Earned RatioTimes InterestEarned=Net income + Interest expense + Income tax expenseInterest expenseThe ratio shows the amount of resources generated for each dollar of interest expense. In general, a high ratio is viewed more favorable than a low ratio.Numerator is commonly called EBIT,Earnings before interest and taxes.10-*End of Chapter Ten10-*