lecture slides video07!02!1

8/13/2019 Lecture Slides Video07!02!1

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KNOWLEDGE FOR ACTION

Long-term Liabilities

Current Liabili ties (due within less than one year)

Initially booked at nominal value (not present value)

Long-term Liabil ities (due in periods beyond one year)

Initially booked at present value of future cash payments

After initial recognition, some liabilities can be marked to fair value,while most are recorded at amortized cost

As a result, liabilities can be a mix of fair value and amortized cost


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Common Types of Debt

Bank loan

Borrow principal; make periodic interest payments; repay principal at end of loan

Mortgage

Borrow principal; make periodic interest and principal payments over the loanperiod

Corporate bonds

Company promises to pay periodic cash flows ( coupons ), plus a lump sum

( principal ) at maturity.Investors offer the company the present value of coupons and principal

Investors can then trade the bonds freely unti l maturi ty.

Zero-coupon : company only pays lump sum at maturity


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Accounting for a Bank Loan

On 1/1/2010, KP Inc. borrows $10,000 from a bank for a 3-year loan.The bank charges the firm 5.0% interest per year on the loan.

Borrow$10,000

Pay interest($500)

Pay interest($500)

Pay interest + principal($500 + $10,000)

1/1/10 12/31/10 12/31/11 12/31/12


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Borrow$10,000

Pay interest($500)

Pay interest($500)


1/1/10 12/31/10 12/31/11 12/31/12

Issuance

1/1/10 Dr. Cash (+A) 10,000

Cr. Notes Payable (+L) 10,000


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Borrow$10,000

Pay interest($500)

Pay interest($500)


1/1/10 12/31/10 12/31/11 12/31/12

Periodic interest payments

12/31/10 Dr. Interest Expense (+E) 500

Cr. Cash (-A) 500

12/31/11 Dr. Interest Expense (+E) 500

Cr. Cash (-A) 500


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Borrow$10,000

Pay interest($500)

Pay interest($500)


1/1/1012/31/10 12/31/11 12/31/12

Repayment

12/31/12 Dr. Notes Payable (-L) 10,000

Dr. Interest Expense (+E) 500

Cr. Cash (-A) 10,500


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Accounting for a Mortgage

On 1/1/2010, KP Inc. borrows $10,000 from a bank on a 3-yearmortgage. The bank charges KP 5.0% interest/year on the mortgage.The required payment is $3,672 per year.

PV calculation to get payment:

PV = 10,000, FV = 0, r = 0.05, n = 3, PMT = ? (use Excel/calculator/PV table to solve)

PMT = $3,672


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PMT = $3,672

Payment = (3672)

Principal Interest Principal PrincipalBeg Bal (Beg Bal * .05) (3672 - Interest) End Bal

12/31/10 10,000 (500) (3,172) 6,828


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PMT = $3,672

Payment = (3672)


12/31/10 10,000 (500) (3,172) 6,82812/31/11 6,828 (341) (3,331) 3,497


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PMT = $3,672

Payment = (3672)


12/31/10 10,000 (500) (3,172) 6,82812/31/11 6,828 (341) (3,331) 3,49712/31/12 3,497 (175) (3,497) 0


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Borrow$10,000

Pay interest ($500) +principal ($3172)



1/1/10 12/31/10 12/31/11 12/31/12

Issuance

1/1/10 Dr. Cash (+A) 10,000

Cr. Mortgage Payable (+L) 10,000


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Borrow$10,000




1/1/10 12/31/10 12/31/11 12/31/12

2010 payment

12/31/10 Dr. Mortgage Payable (-L) 3,172


Cr. Cash (-A) 3,672


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Accounting for a Mortgage On 1/1/2010, KP Inc. borrows $10,000 from a bank on a 3-year

mortgage. The bank charges KP 5.0% interest/year on the mortgage.The required payment is $3,672 per year.

Borrow$10,000




1/1/10 12/31/10 12/31/11 12/31/12

2011 payment



Cr. Cash (-A) 3,672


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Accounting for a Mortgage On 1/1/2010, KP Inc. borrows $10,000 from a bank on a 3-year

mortgage. The bank charges KP 5.0% interest/year on the mortgage.The required payment is $3,672 per year.

Borrow$10,000




1/1/10 12/31/10 12/31/11 12/31/12

2012 payment



Cr. Cash (-A) 3,672


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Bonds Payable Bonds Payable

Coupon bonds require semi-annual coupon payments plus payment of face value atmaturity

Elements and TerminologyPrice or proceeds (PV)

Face value or par value (FV)

Market interest rate or effective rate or yield-to-maturi ty (r)

Coupon rate (stated in bond agreement)Coupon payment (PMT) = face value * coupon rate

Number of periods (n)

Because bonds are semi-annual, double the number of periods and divide rates by 2

Bond PricePrice = Present value of FV + Present Value of PMT


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Accounting for a Bond On 1/1/2010, KP Inc. issues a 3-year, 5% coupon, $10,000 face value

bond. Investors price the bond using an effective (market) interestrate of 5.0%. KP receives proceeds from the bond of $10,000.

PV calculation to get bond price:Double the number of periods and divide the interest rate by 2!

Present value of face value

PV = ?, FV = 10,000, r = 0.025, n = 6, PMT = 0 (use Excel, calculator, or PV table to solve)

PV = $8,623

Present value of payment

PV = ?, FV = 0, r = 0.025, n = 6, PMT = 250 (10,000 x 0.025)

PV = $1,377

Price = $10,000 (8,623 + 1,377)

Can also get price by putting in all elements PV = ?, FV = 10,000, r = 0.025, n=6, PMT = 250

PV = $10,000


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Receive$10,000

Pay coupon($250)

Pay coupon($250)

Pay coupon ($250)+ principal ($10,000)

1/1/10 6/30/10 6/30/11 12/31/12

Pay coupon($250)

12/31/10

Pay coupon($250)

12/31/11

Pay coupon($250)

6/30/12


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Issuance

1/1/10 Dr. Cash (+A) 10,000

Cr. Bonds Payable (+L) 10,000

Receive$10,000

Pay coupon($250)

Pay coupon($250)


1/1/10 6/30/10 6/30/11 12/31/12

Pay coupon($250)

12/31/10

Pay coupon($250)

12/31/11

Pay coupon($250)

6/30/12


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Periodic coupon payments


Cr. Cash (-A) 250

Receive$10,000

Pay coupon($250)

Pay coupon($250)


1/1/10 6/30/10 6/30/11 12/31/12

Pay coupon($250)

12/31/10

Pay coupon($250)

12/31/11

Pay coupon($250)

6/30/12


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Payment at maturity

12/31/12 Dr. Bonds Payable (-L) 10,000


Cr. Cash (-A) 10,250

Receive$10,000

Pay coupon($250)

Pay coupon($250)


1/1/10 6/30/10 6/30/11 12/31/12

Pay coupon($250)

12/31/10

Pay coupon($250)

12/31/11

Pay coupon($250)

6/30/12

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