issue and redemption of long-term liabilities

8/11/2019 Issue and Redemption of Long-term Liabilities

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Issue and Redemption of Long-

term Liabilities



ISSUE OF LONG-TERM LIABILITIES(E.G. BONDS)



Long-term Liabilities

• A liability is an obligation of the business to

pay cash for goods or services taken on credit

or for money borrowed.

• Liabilities can be classified as either current or

long-term.



Current liabilities

• Obligations that fall within the coming year

e.g. accounts payable, owing on rent etc, bank

overdraft



Long-term liabilities

• Obligations due beyond one year.

• E.g. bonds, notes payable and mortgage



Bonds

• Projects that demand large amounts of money

often are funded from bond issuances.

• Which are essentially loans from the general

public.

• Both private and public sector organisations

may use issue of bonds.



What is a bond?

• A bond is its issuer’s written promise to pay

back an amount borrowed upon maturity plus

interest at specified times.

• A bond is a debt owed by the enterprise to the

bondholder.



Example of a Bond



Advantages of bonds

• Bonds do not affect owner control (equity

financing affects ownership of a company but

bonds financing do not).

• Interest on bonds is tax deductible



Disadvantages of bonds

• The business is obligated to pay back the bond

on maturity and pay interest throughout the

life of the bond

• Creditors such as bond holders have a claim

on the business.



Issuance of Bonds

• Bonds may be sold to the public at par or no

par (discount or premium).

• (but we will focus on “at par”.



Bond issue price and rate of return

• The issue price of bonds is dependent on thedominant rate.

• There is the contractual rate of interest which

is stated on the bond certificate and there isthe market rate of interest which representsthe rate of return demanded by investors.

•

When the MARKET RATE equals the statedrate the bond will be issued at face or parvalue.



• The bond will sell at Par value when the

market rate = contractual rate.



Case 1 - Issuing bonds at par

• Grace Co. Ltd is issued $800 000 of 9%, 10

year bonds dated January 1, 2011, that

matures on December 31, 2021 and pay

interest semi-annually on each June 30 andDec. 31.

• Task: show the relevant journal entries



Case 2

• On Jan 1, 2013, the Dash Corporation issued

$1000 000 par value, of 10 year, 10% bonds.

The bonds annual interest payments becomes

payable on every December 31.

• Required: the relevant journal entries



REDEMPTION OF LONG-TERMLIABILITIES E.G. BONDS



Bonds and Sinking Funds

• When debentures or bonds are issued

consideration should be given to having the cash

pay off the debt instruments upon maturity!

• Therefore, when a bond is issued, the issuercreates a sinking fund (reserve) to provide the

necessary funds at redemption.

•The sinking funds assures investors that enoughmoney will be available to repay the bonds and

other debt instruments upon maturity



template

The JournalDate Details Debit$ Credit $

Bonds sinking fund

cash

X xxxx xxx

X xxxx xxx

To record annual installments to sinking

fund

Cash

Sinking fund investment income

X xxx

X xxx

Being sinking funds earnings

Bonds payable

Bonds sinking fund

X xxxx xxx

X xxxx xxx

The payment of bonds upon maturity



Case1 – Redemption of bonds

• On December 31, 2013, Jesu Inc issued $2

000 000 par value 8% 5-year bonds. The bonds

contract calls for a sinking fund to be maintained

thoughout the life of the bond. The company isto make five annual payments of $327 595 to the

fund beginning December 31, 2014. The fund

will earn a net return of 10%.

• Task: the relevant journal entries for the

redemption of bonds



Case 2

• Margo Inc

• See handout

issue and redemption of long-term liabilities

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