CHAPTER 15

NON-CURRENT LIABILITIES

CHAPTER STUDY OBJECTIVES

1. Describe the characteristics of bonds. Debt offers the following advantages over equity: (1) shareholder control is not affected, (2) income tax savings result, (3) earnings per share may be higher, and (4) return on equity may be higher. Bonds are a common form of long-term debt issued by entities. Bonds have many different features and may be secured, unsecured, convertible, and callable. The terms of the bond are set forth in the bond indenture, and a bond certificate provides the specific information about the bond itself.

2. Calculate the price of a bond. Because interest rates fluctuate, the market price of a bond may vary. Bond pricing is determined using time value of money concepts. To calculate the price of a bond, it is necessary to calculate the present value of the following two cash flows associated with the bond: (1) the present value of the interest payments over the life of the bond and (2) the present value of the principal to be repaid. This calculation may be done using either present value tables or a financial calculator.

3. Account for bond transactions. When bonds are issued, the Bonds Payable account is credited for the bonds’ market value (present value). Bonds are issued at a discount if the market interest rate is higher than the contractual interest rate. Bonds are issued at a premium if the market interest rate is lower than the contractual interest rate.

Bond discounts and bond premiums are amortized to interest expense over the life of the bond using the effective-interest method of amortization. Amortization of the bond discount or premium is the difference between the interest paid and the interest expense. Interest paid is calculated by multiplying the face value of the bonds by the contractual interest rate. Interest expense is calculated by multiplying the amortized cost of the bonds at the beginning of the interest period by the market interest rate. The amortization of a bond discount increases interest expense. The amortization of a bond premium decreases interest expense.

4. Account for the retirement of bonds. When bonds are retired at maturity, Bonds Payable is debited and Cash is credited. There is no gain or loss at retirement. When bonds are redeemed before maturity, it is necessary to (1) pay and record any unrecorded interest, (2) eliminate the amortized cost of the bonds at the redemption date, (3) record the cash paid, and (4) recognize any gain or loss on redemption.

5. Account for instalment notes payable. Instalment notes payable are repayable in a series of instalments. Each payment consists of (1) interest on the unpaid balance of the note, and (2) a reduction of the principal balance. These payments can be either (1) fixed principal plus interest payments or (2) blended principal and interest payments. With fixed principal payments, the reduction in principal is constant but the cash payment and interest decrease each period (as the principal decreases). With blended payments, the cash payment is constant but the interest decreases and the principal reduction increases each period.

6. Account for leases. For IFRS or a capital lease under ASPE, the lessee records the asset and the related obligation at the present value of the future lease payments on the balance sheet. The income statement reflects both the interest expense and depreciation expense. For an operating lease under ASPE, lease (or rental) payments are recorded as an expense by the lessee (renter).

7. Explain and illustrate the methods for the presentation and analysis of non-current liabilities. The current portion of debt is the amount of the principal that must be paid within one year of the balance sheet date. This amount is reported as a current liability in the balance sheet, and the remaining portion of the principal is reported as a non-current liability. The nature of each liability should be described in the notes accompanying the financial statements. A company’s long-term solvency may be analyzed by calculating two ratios. Debt to total assets indicates the proportion of company assets that is financed by debt. Interest coverage measures a company’s ability to meet its interest payments as they come due.

Exercises

Exercise 1

The following list contains bond terms and terminology:

1. A __________ is an example of a secured bond.

2. Unsecured bonds are also known as _________ .

3. The ___________ is the rate investors demand for lending funds.

4. The ___________ is the amount of principal the issuing company must pay at the maturity date.

5. A bond secured by specific assets set aside to retire the bonds is called a.

Bond terms:

1. premium
2. face value
3. discount
4. mortgage bond
5. market interest rate
6. debentures
7. sinking fund bond

Instructions

Match the bond terms to the correct terminology.

Exercise 2

On June 30, 2021, Gorgeous Inc. sold $ 1,200,000 (face value) of bonds. The bonds are dated June 30, 2021, pay interest semi-annually on December 31 and June 30, and will mature on June 30, 2024. The following schedule was prepared by the accountant for 2021:

Semi-annual Interest to Interest Unamortized Bond

Interest Period be Paid Expense Amortization Amount Amortized cost

$ 62,906 $ 1,137,094

Dec 31, 2021 $ 36,000 $ 45,484 $ 9,484 53,422 1,146,578

Instructions

On the basis of the above information, answer the following questions. (Round your answer to the nearest dollar or percent.)

a) What is the contractual rate of interest for this bond issue?

b) What is the market rate of interest for this bond issue?

c) What was the selling price of the bonds as a percentage of the face value?

d) Prepare the journal entry to record the sale of the bond issue on June 30, 2021.

e) Prepare the journal entry to record the payment of interest and amortization on December 31, 2021.

Exercise 3

On September 1, 2021, Bear Corporation issued $ 1,000,000, 6%, 10-year bonds. Interest is payable annually with the first payment due on September 1, 2022.

Instructions

a) For each of the following market rate assumptions, identify whether Bear would issue the bonds at face value, at a discount, or at a premium: (1) 5%, (2) 6%, and (3) 7%.

b) Provide the appropriate journal entry on September 1, 2021 to record the issuance of the bonds if the market rate of interest is 7%. Round your answer to the nearest dollar.

c) Assuming Bear has a December 31 year end, prepare the year-end adjusting entry to account for accrued interest on the bonds.

Exercise 4

On September 1, 2021, Imperial Corporation issued $ 1,000,000, 6%, 10-year bonds. Interest is payable annually with the first payment due on September 1, 2022.

Instructions

a) Provide the appropriate journal entry on September 1, 2021 to record the issuance of the bonds if the market rate of interest is 5%. Round your answer to the nearest dollar.

b) Assuming Imperial has a December 31 year end, prepare the 2021 year-end adjusting entry to account for accrued interest on the bonds. Round your answer to the nearest dollar.

c) Prepare a partial balance sheet at December 31, 2021 for Imperial Corporation displaying all amounts related to the bonds.

d) Prepare the journal entry on September 1, 2022 to record the first interest payment.

e) Assume the bonds were redeemed for $ 1,050,000 at September 30, 2024 when the amortized cost was $ 1,035,000. Record the redemption of the bonds.

Exercise 5

On September 1, 2021, Guss Corporation issued $ 1,000,000, 6%, 10-year bonds. Interest is payable annually with the first payment due on September 1, 2022.

Instructions