LONG-TERM LIABILITIES

BONDS
Bonds are a form of interest-bearing notes payable.
Bonds are normally issued when very large amount of
borrowed funds are required.

-Bond splits very large borrowing into small units.

-It is transferable.

-Company issues a certificate which will mention

the following(among other things):
Par value or face value of the bond.
Name of the issuing company.
Interest rate.
Maturity date.
Name of the bondholder.
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Bonds offer 3 advantages over common

stock.(Stockholders benefit from the advantages)
1) Bondholders have no voting rights.
With additional borrowings stockholders can
have same voting rights without any
additional investment.
2) Results in tax savings. Bond interest is tax
deductible; dividends are not.
3) Chances are that earnings/share will be
higher because bond related
funds/investment may generate additional
income( before interest & taxes) more than
the interest expense. See example on a separate
page.

One disadvantage in using bonds is that the company

must pay interest on due dates even when the
profitability/liquidity is poor.
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TYPES OF BONDS

Secured & Unsecured Bonds

Secured bonds have specific assets of the issuer pledged

as security for the bonds. Eg a bond secured by real estate
is called a mortgage bond.

Unsecured bonds are also called debenture bonds.

Term & Serial Bonds

In case of term bonds entire principal amount

of bond is paid on a specified future date, while in
case of serial bonds principal is paid in a series
(installments).

Registered & Bearer Bonds

Registered Bonds are issued in the name of the owner.

Bearer Bonds are not registered in any name.

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Convertible & Callable Bonds

Bonds that can be converted into common

stocks at the option of the bondholders are called
convertible bonds.

Bonds that the issuing company can retire prior

to
maturity at a stated value are called callable
bonds.

Market value of a bond keeps changing with

changes in market interest rates

ACCOUNTING FOR BOND ISSUES

Bonds can be issued at face value, below face value

(at a discount),or above face value(at a premium).
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Issuing Bonds at Face Value

Suppose on Jan.1,2010, ABC Corporation issues
$10,000,000 five-year bonds at 10% (100% of face value).
The entry would be:
Dr Cr
1/1/2010 Cash 10,000,000
Bonds Payable 10,000,000

Assuming interest is payable semi-annually on July 1 and

Jan. 1,the entry would be:

1/7/2010 Bond Interest Expense 500,000

Cash 500,000

If the accounts are closed on 31 Dec.,entry will be:

31/12/2010 Bond Interest Expense 500,000

Bond Interest Payable 500,000

Entry for payment of interest will be:

1/1/2011 Bond Interest Payable 500,000
Cash 500,000

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Why are bonds issued at a discount or premium?

Issuing Bonds at a Discount

If on 1/3/2009 ABC Corpn. issues $ 10,000,000 ,five-year
10% bonds at 92.639% of face value ,then at the time of
issuance entry will be:
Dr Cr
Cash 9,263,900
Discount on Bonds 736,100
Bonds Payable 10,000,000

Nature of A/C Discount on Bonds?

This A/C is contra to Bonds Payable.
Another point to be noted is that in addition to 10% interest
ABC Corpn has to pay Rs 736,100(amount of discount) to
the bondholders after 5 years. So the total cost of
borrowing is:
INTEREST + AMOUNT OF DISCOUNT
Annual Borrowing Cost= Annual Interest+(Discount /5)
or Interest Expense /Year = Rs 1,000,000 + 736,100/5
= Rs 1,000,000 + 147,220
 = Rs 1,147,220

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If interest on bonds is payable semi-annually the 6 monthly
Interest Expense=Rs 1,147,220/2 = Rs.573,610

Journal entry on 1/9/2009:

__DR__ __CR___
Bond Interest Expense 573,610
Cash 500,000
Discount on Bonds 73,610
To record bond interest expense for 6 months
(1/3/2009 to 31/8/2009)

Adjusting entry on 31/12/2009(closing date):

__DR____ ___CR____
Bond Interest Expense 382,407
Bond Interest Payable 333,333
Discount on Bonds 49,074
To record bond interest expense for 4 months
(1/9/2009 to 31/12/2009).

Journal Entry on 1/3/2010:

Bond Interest Payable 333,333

Bond Interest Expense 191,204
 Discount on Bonds 24,537
Cash 500,000
To record bond interest expense for 2 months
(Jan-Feb 2010)and payment for 6 months ended
(1/9/09 to 28/2/2010)
7a
 -8-
Issuing Bonds at a Premium
Bonds are issued at a premium when bond interest rate is higher than the market interest rate.
Premium collected from the bondholders can be viewed as an amount out of which additional
interest is paid; thus the premium sets off the interest paid by the company out of its own pocket.
So the interest expense is reduced.
Premium on Bonds is a liability a/c. However this liability reduces with time and has the effect of
reducing the interest expense(borrowing cost).
Suppose J.J. Corporation issues 1000 bonds at $1020 with
par value of $1000 each on 1 March 2009.Other particulars
of the bonds were:
Maturity period: 10 years Interest rate: 9%
Interest payable on: 1 Sept & 1 March
___DR____ ____CR____
1/3/09 Cash 1,020,000
Bonds Payable 1,000,000
Premium on Bonds 20,000

1/9/09 Bond Interest Expense 44,000

Premium on Bonds 1,000
Cash 45,000
(To record Interest Expense for 6 months-Mar to Aug 09)

31/12/09Bond Interest Expense 29,333

Premium on Bonds 667
 Bond Interest Payable 30,000
(To accrue interest for 4 months- Sept to Dec 09)

-9-

1/3/10 Bond Interest Expense 14,667

Premium on Bonds 333
Bond Interest Payable 30,000
Cash 45,000
(To record Interest Exp. for 2 months & payment for 6 months)

1/3/2019Bonds Payable 1,000,000

Cash 1000,000
(To record redemption of bonds
on maturity)

Redeeming Bonds before Maturity

When bonds are retired prematurely they are redeemed at a

value above par. Eg if the above bonds(with premium) are
to be retired early after 5 years at 103(par value + 3%) then
the balance in the Premium on Bonds a/c will be:

Premium on Bonds____
10,000 | 20,000
(total of all 10 |
Debits in 5 years) |
| Bal. 10,000

-10-

Journal entry at premature retirement:

DR CR
Bonds Payable 1,000,000
Premium on Bonds 10,000
Loss on Bond Redemption 20,000
Cash 1,030,000

CONVERTING BONDS INTO COMMON STOCK

The company transfers the carrying(or book) value of the

bonds to the paid-in capital a/cs.

Carrying value= Par value of bonds+Bal. in Premium a/c

or (-Bal. in Discount a/c)

If the above bonds are converted into 30,000 shares of $10

par value of common stock after 5 years (instead of
redemption) the journal entry will be:

Bonds Payable 1,000,000

Premium on Bonds 10,000
Common Stock 300,000
Paid-in Capital in Excess of
Par Value-Common Stock 710,000

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LONG TERM NOTES PAYABLE

-Similar to short-term interest-bearing notes payable except

that the terms of the notes exceeds one year.

-May be secured by mortgage of some specific asset.

Individual borrowers normally issue mortgage notes
payable to purchase a house.

-Mostly require repayment(of principal) in installments

over term of the loan.

-Interest rate may be fixed or adjustable.

Example: ABC Company issues a $500,000, 12% , 20-

year mortgage note on Dec 31, 2010.Instalment of interest
& principal is payable every 6 months ($33,231).
JOURNAL ENTRY
31/12/10 Cash 500,000
Mortgage Notes Payable 500,000
30/6/10 Interest Expense 30,000
Mortgage Notes Payable 3,231
Cash 33,231

-12-

LEASE LIABILITIES

Contractual arrangement between owner of property

(lessor) and renter of the property (lessee).

Operating Lease
In operating lease the intent is temporary use of the
property by the lessee while the lessor remains the owner.
So, a simple journal entry to record rent or lease expense is
made. Rent-a-Car charges Rs 36,580 from XY Co. for
renting a car for one week.
DR CR
Car Rental Expense 36,580
Cash 36,580

Capital Lease
-In capital lease the contract transfers most of the risks and
rewards of ownership from lessor to lessee.
-This lease is intended to provide financing to the lessee
for the eventual purchase of the property.
-Therefore the property acquired through this lease should
be recorded by the lessee as an asset at a value equal to the
present value of all future payments.

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If any one of the following conditions exists, the lessee

should record the leased property as an asset:

1) The lease transfers ownership of the property to the

lessee.
2) The lease contains a bargain purchase option.
3) The lease period is at least 75% of the life of the
leased property.
4) The present value of the lease payments is at least
90% of the fair market value of the property.

ABC Company decides to lease new equipment for 4 years

& its life is estimated to be 5 years. Other relevant data:
Present value of lease payments= $ 190,000=market value.
Lease contract does not contain any clause for transfer of
ownership or bargain purchase option.
Since the above conditions 3 & 4 have been met equipment
should be recorded as an asset.
Dr Cr
Leased Asset-Equipment 190,000
Lease Liability 190,000

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ABC CORPORATION
Balance Sheet(partial)
As on 31-12-2010

Long-term liabilities
Bonds payable 10% due on 30/6/2015 $ 1,000,000
Less: Discount on bonds payable __ 80,000

$ 920,000
Mortgage notes payable 11%, due
on 31/3/2020 & secured by land 500,000
Lease liability 440,000
Total long term liabilities $ 1,860,000
NOTE CORRECTION: The date of the Journal Entry should be 30-9-12
and not 30-6-12.