Chapter 15 Financial Accounting Textbook PDF

1 WEYGANDT. KIESO. KIMMEL. TRENHOLM. KINNEAR. BARLOW. ATKINS PRINCIPLES OF FINANCIAL ACCOUNTING CANADIAN EDITION Chapter 15 Non-current Liabilities Prepared by: D...

1 WEYGANDT. KIESO. KIMMEL. TRENHOLM. KINNEAR. BARLOW. ATKINS PRINCIPLES OF FINANCIAL ACCOUNTING CANADIAN EDITION Chapter 15 Non-current Liabilities Prepared by: Debbie Musil Kwantlen Polytechnic University 2  Learning Goals Let’s turn the following into students friendly learning goals…. explain the characteristics of debt financing as a method of financing; compare the advantages and disadvantages of debt financing and equity financing; 3  Non-current Liabilities Bonds payable – Bond basics – Accounting for bond issues and retirements Notes payable – Fixed principal payments – Blended payments Statement presentation and analysis Copyright John Wiley & Sons Canada, Ltd. 4  Chapter 15: Success Criteria I will be successful when I can…. 1. Compare the impact of issuing debt instead of equity. 2. Account for bonds payable. 3. Account for instalment notes payable. 4. Explain and illustrate the methods for the presentation and analysis of non-current liabilities. Copyright John Wiley & Sons Canada, Ltd. 5  Debt Issue Injects Power into Electric Company As a class let’s read the opening article for Chapter 15 on Page 627.  Textbook Reading Please silently read Pages 628 – 629 and answer Questions – Non-Current Liabilities. Copyright John Wiley & Sons Canada, Ltd. 7  Non-current Liabilities Debt that is not current is a non-current liability: – Current if settled within one year or normal operating cycle of company Common types: – Bonds payable – Notes payable Referred to as financial liabilities Copyright John Wiley & Sons Canada, Ltd. 8  Advantages of Debt over Equity Shareholder control is not affected – Debt holders have no voting rights Income tax savings – Interest expense deductible; dividends are not Earnings per share may be higher – No common shares are issued Return on equity may be higher – Lower profit and shareholders’ equity Copyright John Wiley & Sons Canada, Ltd. 9  Before You Go On Copyright John Wiley & Sons Canada, Ltd. 10  Textbook Questions Work on BE15-2 and E15-1. Copyright John Wiley & Sons Canada, Ltd. 11  Textbook Questions Work on E15-1. Copyright John Wiley & Sons Canada, Ltd. 12  Chapter 15: Success Criteria I will be successful when I can…. 1. Compare the impact of issuing debt instead of equity. 2. Account for bonds payable. 3. Account for instalment notes payable. 4. Explain and illustrate the methods for the presentation and analysis of non-current liabilities. Copyright John Wiley & Sons Canada, Ltd. 13  Textbook Reading Answer the first question on the document Questions – Bonds Payable Copyright John Wiley & Sons Canada, Ltd. 14  Bond Basics Board of directors approve issuing bonds – Face value: amount due at maturity – Contractual interest rate (coupon rate): rate used to calculate amount of interest received Usually an annual rate but paid semi-annually – Maturity date: date when final payment is due Details are included in the bond certificate Once issued, bonds (like shares of public corporations) are traded on organized securities exchanges Usually issued in small denominations ($1,000) Copyright John Wiley & Sons Canada, Ltd. 15  Determining the Market Value of Bonds The amount that must be invested today at a specific rate of interest over a specific amount of time is the present value. Market value (present value) depends on three factors: – Dollar amounts to be received – Length of time (n) until the amounts are received – Market (effective) rate of interest (i), which investors demand for loaning funds to the corporation Present value tables or formulas are used to determine present value Copyright John Wiley & Sons Canada, Ltd. 16  Issuing Bonds at Face Value If market interest rate = contractual rate, bonds are issued at face value (par) : Semi-annual interest payments and expense ($1,000,000 x 5% x 6/12 = $25,000) are recorded using the effective-interest method as follows Bonds payable are reported at amortized cost as a non-current liability if maturity date is more than one year away Copyright John Wiley & Sons Canada, Ltd. 17  Textbook Questions Work on BE15-5 b) Copyright John Wiley & Sons Canada, Ltd. 18  Determining the Market Value of Bonds 3 Bonds may be issued at face value, a discount (< face value), or a premium (> face value) – Due to contractual rate being higher or lower than market interest rate: Copyright John Wiley & Sons Canada, Ltd. 19  Textbook Reading Answer the 2nd question on the document Questions – Bonds Payable Copyright John Wiley & Sons Canada, Ltd. 20  Issuing Bonds at a Discount 2 Entry to record bonds issued at a discount: Discount is an additional cost of borrowing – Deducted from face value of bonds payable on balance sheet – Allocated to interest expense (amortized) over the life of the bonds using the effective interest method Copyright John Wiley & Sons Canada, Ltd. 21  Effective-Interest Amortization Three steps to calculate amortization: 1. Calculate bond interest paid 2. Calculate interest expense 3. Amortization amount is difference Copyright John Wiley & Sons Canada, Ltd. 22  Amortizing Bond Discount For the first interest period: 1. Calculate bond interest paid = $1,000,000 x 5% x 6/12 = $25,000 2. Calculate interest expense = $957,345 x 6% x 6/12 = $28,720 3. Determine amortization amount = $25,000 - $28,720 = $3,720 Subsequent periods are calculated in a similar manner – Amortized cost of bond increases for each period based on amortization of discount Copyright John Wiley & Sons Canada, Ltd. 23  Textbook Questions Work on BE15-5 a) Copyright John Wiley & Sons Canada, Ltd. 24  Textbook Reading Answer the 3rd question on the document Questions – Bonds Payable Copyright John Wiley & Sons Canada, Ltd. 25  Issuing Bonds at a Premium 2 Entry to record bonds issued at a premium: Premium reduces the cost of borrowing – Added to face value of bonds payable reported on balance sheet – Allocated to interest expense over the term of the bonds – called amortizing the premium Copyright John Wiley & Sons Canada, Ltd. 26  Amortizing Bond Premium For the first interest period: 1. Calculate bond interest paid = $1,000,000 x 5% x 6/12 = $25,000 2. Calculate interest expense = $1,044,915 x 4% x 6/12 = $20,898 3. Determine amortization amount = $25,000 - $20,898 = $4,102 Subsequent periods are calculated in a similar manner – Carrying value of bond decreases for each period based on amortization of premium Copyright John Wiley & Sons Canada, Ltd. 27  Textbook Questions Work on BE15-5 c) Copyright John Wiley & Sons Canada, Ltd. 28  Summary of Differences Interest payment is the same as it is based on face value of bond Interest expense changes as amortized cost of bond changes – Discount: interest expense increases as amortized cost increases towards face value of bond – Premium: interest expense decreases as amortized cost declines towards face value of bond Copyright John Wiley & Sons Canada, Ltd. 29 E15-3. Textbook Questions 30 E15-3. Textbook Questions 31 E15-4. Textbook Questions 32 E15-4. Textbook Questions 33  Bond Retirements: Redeeming Bonds at Maturity Amortized cost of bonds at maturity will equal their face value – Regardless of the issue price of bonds Entry to record redemption of bonds at maturity: – After last interest payment has been recorded Copyright John Wiley & Sons Canada, Ltd. 34  Bond Retirements: Redeeming Bonds before Maturity To record redemption of bonds: – Update any unrecorded interest If redeemed between semi-annual interest payment dates – Eliminate amortized cost of bonds at redemption date = face value of bonds - (+) unamortized discount (premium) – Record cash paid – Recognize gain or loss on redemption Gain (loss) if cash paid < (>) amortized cost of bonds Copyright John Wiley & Sons Canada, Ltd. 35  Group Work Questions In groups you will work on: Group 1: BE15-8 (Amy, Adrian) Group 2: BE15-9 (Jiho, Famie) Group 3: BE15-10 (Anshu, Elmeri) Group 4: E15-6 (Pritish, Ryan, Priyanshu) Copyright John Wiley & Sons Canada, Ltd. 36 Work on BE15-8. Textbook Questions Copyright John Wiley & Sons Canada, Ltd. 37  Textbook Questions Work on BE15-9 Work on BE15-10 Textbook Questions Copyright John Wiley & Sons Canada, Ltd. 39 Work on E15-6. Textbook Questions 40  Textbook Questions Work on E15-6 (continued) 41  Chapter 15: Success Criteria I will be successful when I can…. 1. Compare the impact of issuing debt instead of equity. 2. Account for bonds payable. 3. Account for instalment notes payable. 4. Explain and illustrate the methods for the presentation and analysis of non-current liabilities. Copyright John Wiley & Sons Canada, Ltd. 42  Installment Notes Payable Similar to short-term notes payable except term exceeds one year Interest rate can be fixed or variable (floating) over the term of the note May be unsecured or secured by specific assets (collateral) – Secured notes are commonly known as mortgages Repayable in a series of periodic payments (instalments), which consist of interest and principal, either: – Fixed principal payments plus interest, or – Blended principal and interest payments Copyright John Wiley & Sons Canada, Ltd. 43  Notes Payable: Fixed Principal Payments Periodic payments vary due to change in interest owed: – Principal is repaid in equal periodic amounts – Interest is calculated on the outstanding principal balance Copyright John Wiley & Sons Canada, Ltd. 44  Textbook Questions Work on BE15-12 a) Copyright John Wiley & Sons Canada, Ltd. 45  Notes Payable: Blended Payments Equal periodic payments that include principal and interest: – Amount of interest and principal changes with each payment – Interest decreases and principal increases each period Copyright John Wiley & Sons Canada, Ltd. 46  Textbook Questions Work on BE15-12 b) Copyright John Wiley & Sons Canada, Ltd. 47  Textbook Questions Work on E15-9 a) Copyright John Wiley & Sons Canada, Ltd. 48 Work on E15-9 Textbook Questions Copyright John Wiley & Sons Canada, Ltd. 49  Textbook Questions Work on E15-9 b) Copyright John Wiley & Sons Canada, Ltd. 50  Textbook Questions Work on E15-9 Copyright John Wiley & Sons Canada, Ltd. 51  Chapter 15: Success Criteria I will be successful when I can…. 1. Compare the impact of issuing debt instead of equity. 2. Account for bonds payable. 3. Account for instalment notes payable. 4. Explain and illustrate the methods for the presentation and analysis of non-current liabilities. Copyright John Wiley & Sons Canada, Ltd. 52  Statement Presentation Non-current liabilities are reported in a separate section of the balance sheet, immediately after current liabilities Copyright John Wiley & Sons Canada, Ltd. 53 Chapter 15 TEST REVIEW QUESTIONS Copyright John Wiley & Sons Canada, Ltd. 54 E15-8 Copyright John Wiley & Sons Canada, Ltd. 55 Copyright John Wiley & Sons Canada, Ltd. 56 Copyright John Wiley & Sons Canada, Ltd. 57 P15-1A Copyright John Wiley & Sons Canada, Ltd. 58 P15-1A Textbook Questions Copyright John Wiley & Sons Canada, Ltd. 59 P15-1A (continued) Textbook Questions Copyright John Wiley & Sons Canada, Ltd. 60 P15-3A Copyright John Wiley & Sons Canada, Ltd. 61 P15-3A Textbook Questions Copyright John Wiley & Sons Canada, Ltd. 62 P15-3A (continued) Textbook Questions Copyright John Wiley & Sons Canada, Ltd. 63 P15-7A Copyright John Wiley & Sons Canada, Ltd. 64 P15-7A Textbook Questions 65 P15-7A (continued) Textbook Questions Copyright John Wiley & Sons Canada, Ltd. 66 P15-7A (continued) Textbook Questions 67 P15-7A (continued) Textbook Questions Copyright John Wiley & Sons Canada, Ltd. 68  Copyright Copyright © 2014 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein. Copyright John Wiley & Sons Canada, Ltd. 69  Determining the Market Value of Bonds 2 Market value of a bond = the present value of all future cash payments promised by the bond: – Periodic interest payments, plus – Repayment of principal (face value) when bond matures Market rates change daily and can therefore differ from contractual interest rate Copyright John Wiley & Sons Canada, Ltd. 70  Issuing Bonds at a Discount If market interest rate > contractual rate, bonds are issued at a discount Selling price is determined as follows: Difference between selling price and face value of bonds is the amount of the discount = $1,000,000 face value - $957,345 selling price = $42,655 discount Copyright John Wiley & Sons Canada, Ltd. 71  Issuing Bonds at a Premium If market interest rate < contractual rate, bonds are issued at a premium Selling price is determined as follows: Difference between selling price and face value of bonds is the amount of the premium = $1,044,915 selling price - $1,000,000 face value = $44,915 premium Copyright John Wiley & Sons Canada, Ltd. 72