Chapter 12

Debt Financing

Debt Financing : Liabilities

The obligation of a particular entity to transfer assets or provide services. Must be the result of past transactions or events. Probable transfer of assets (or services) must be in the future.

Classification of Liabilities
Current Liabilities- Paid within one year or the operating cycle, whichever is longer. Noncurrent LiabilitiesNot paid within one year or the operating cycle, whichever is longer.

Accounting for Short-Term Debt

Short-Term obligations are due within one year or an operating cycle. Account Payable - the amount due for the purchase of merchandise. Notes Payable - a formal written promise to pay a sum of money in the future, also known as a promissory note.

Short-Term Obligations Expected to be Refinanced

A short-term obligation that is expected to be refinanced on a long-term basis should not be reported as a current liability
1. Management must intend to refinance the obligation on a longterm basis. 2. Management must demonstrate an ability to refinance the obligation.

Review : From P3-40 b. Classification

Bank notes payable include two separate notes payable to First Interstate. (Today is 12/31/2013) (1) A $30,000, 8% note issued March 1, 2011, payable on demand. Interest is payable every six months. (2) A 1-year, $50,000, 11.5% note issued January 2, 2013. On December 30,2013, Sierra negotiated a written agreement with First Interstate Bank to replace the note with a 2-year, $50,000, 10%, note to be issued January 2, 2014.

Review of Time Value : Corporate Bond Example

Exercise) The company issued new corporate bonds on 1/1/12, with face value $1,000 due in 3 years. The bond pays 10% stated interest rate at the end of each year. Market interest rate is 8%. What is the market value of the bonds ?
Analysis : The cash receipt from the bond 1/1/12 12/31/12 12/31/13 12/31/14 : Assume 8% interest -----------|------------------|-----------------|-----------------|----------------------------------today $ 100 $ 100 $ 100 : stated interest (10%) $1,000 : principal

Value of the bond = PV of 3 payments of $100 + PV of $1,000 at 12/31/14 at 8% market interest rate

Corporate Bonds
Face Value $1,000 Interest 10% Interest 6% 12/31 each year

BOND PAYABLE
Bond Date 1/1/06 1/1/12
1. 2. 3. 4. 5.

Maturity Date 12/31/08 12/31/14

Face value (maturity or par value) Maturity Date Stated Interest Rate Other Factors: Interest Payment Dates 6. Market Interest Rate Bond Date 7. Issue Date

Table : Present Value of 1

Periods 1 2 3 4 5 6 7 8 9 10 6% 0.94340 0.89000 0.83962 0.79209 0.74726 0.70496 0.66506 0.62741 0.59190 0.55839 8% 0.92593 0.85734 0.79383 0.73503 0.68058 0.63017 0.58349 0.54027 0.50025 0.46319 9% 0.91743 0.84168 0.77218 0.70843 0.64993 0.59627 0.54703 0.50187 0.46043 0.42241 10% 0.90909 0.82645 0.75132 0.68301 0.62092 0.56447 0.51316 0.46651 0.42410 0.38554 12% 0.89286 0.79719 0.71178 0.63552 0.56743 0.50663 0.45235 0.40388 0.36061 0.32197

(Textbook page TVM-24)

Table : Present Value of an Ordinary Annuity of 1

Periods 1 2 3 4 5 6 7 8 9 10 6% 0.94340 1.83339 2.67301 3.46511 4.21236 4.91732 5.58238 6.20979 6.80169 7.36009 8% 0.92593 1.78326 2.57710 3.31213 3.99271 4.62288 5.20637 5.74664 6.24689 6.71008 9% 0.91743 1.75911 2.53130 3.23972 3.88965 4.48592 5.03295 5.53482 5.99525 6.41766 10% 0.90909 1.73554 2.48685 3.16986 3.79079 4.35526 4.86842 5.33493 5.75902 6.14457 12% 0.89286 1.69005 2.40183 3.03735 3.60478 4.11141 4.56376 4.96764 5.32825 5.65022

(Textbook page TVM-26)

Review : Determining the Selling Price

Stated interest rate is Above market rate The bonds sells: At a premium
(Cash received is greater than face amount)

Equal to market rate

At par value
(Cash received is equal to face amount)

At a discount Below market rate

(Cash received is less than face amount)

E 12-26 Market Values of Bond Issues

What is the market value of each of the following bond issues? (Round to the nearest dollar) (a) 10% bonds of $1,000,000 sold on bond issue date; 10-year life; interest payable semi-annually; effective rate, 12%.

(b) 9% bonds of $200,000 sold on bond issue date; 5year life; interest payable semiannually; effective rate, 8%. (c) 8% bonds of $150,000 sold 30 months after bond issue date; 15-year life; interest payable semiannually; effective rate, 10%.

Back to the first Corporate Bond Example

Exercise) The company issued new corporate bonds on 1/1/12, with face value $1,000 due in 3 years. The bond pays 10% stated interest rate at the end of each year. Market interest rate is 8%. What is the market value of the bonds ?
Analysis : The cash receipt from the bond 1/1/12 12/31/12 12/31/13 12/31/14 : Assume 8% interest -----------|------------------|-----------------|-----------------|----------------------------------today $ 100 $ 100 $ 100 : stated interest (10%) $1,000 : principal

Value of the bond = PV of 3 payments of $100 + PV of $1,000 at 12/31/14 at 8% market interest rate

Straight-Line Method
Considered practical when the discount or premium amount is small.

The discount or premium is allocated equally to each period over the outstanding life of the bond.

Straight-Line Method

In our last example, straight-line premium amortization would be: $51.54 3 = $17.18 every year.

Effective Interest Method

More accurate method when the discount or premium amount is material.

The interest expense is recorded at effective interest rate, and then discount or premium is adjusted

E 12-30 Amortization of Bond Premium or Discount

On January 1, 2012, Terrel Company sold $100,000 of 10-year, 8% bonds at 93.5, an effective rate of 9%. Interest is to be paid on July 1 and December 31. Compute the amount of premium or discount amortization in 2012 and 2013 using (1) the straightline method and (2) the effective-interest method. Make the journal entries to record the amortization when the effective-interest method is used.

E12-24 Accounting for Mortgages

On January 1, 2013, Lily Company purchased a building for $2,000,000. The company made a 25% down payment and took out a mortgage payable over 30 years with monthly payments of $11,006.47. The first payment is due February 1, 2013. The mortgage interest rate is 8%.

1. Determine how much of the first two mortgage payments would be applied to interest expense and how much would be applied to reducing the principal. (Note : The 8% interest rate is compounded monthly.)
2. Make the journal entry necessary to record the first mortgage payment on February 1, 2013.

Interest on Long Term Payable

At January 1, 2012, the Marlow Consulting Inc. purchases furniture and paid in exchange a promissory note with a face value of $100,000, a due date of December 31, 2013, and a stated interest rate of 11%, with interest payable at the end of each year. The fair value of furniture is $101,736, and the note is considered to have an appropriate imputed market rate of interest of 10%. The company adopts the effective interest method to recognize interest expenses.
QUESTIONS : Journal entries at (1) January 1, 2012, (2) December 31, 2012 and (3) December 31, 2013.
From Old Exam

End of Chapter 12

Chapter 13
Shareholders Equity

The Nature of Shareholders Equity

Assets Liabilities = Shareholders Equity

Net Assets
(Residual Interest)

Sources of Shareholders Equity

Amounts invested by shareholders

Amounts earned by corporation

Stockholders Equity Paid-in Capital Retained Earnings

Common Stock
Common Stock - when a corporation is formed, the single class of stock is typically issued. Owners of common stock have these basic rights:
1. To vote in the election of directors and in the determination of certain corporate policies. 2. Preemptive right- to maintain ones proportional interest in the corporation through purchase of additional common stock if and when it is issued.

Par or Stated Value

Par Value Amount written on the face of the stock. In general, it has no economic implication.

Today, most stocks have a nominal par value (for example $1.00) or no par value.

Capital Stock
Par value stock Designated dollar amount per share stated in the corporate charter. Par value has no relationship to market value. No-par stock Dollar amount per share not designated in corporate charter. Corporations can assign a stated value per share (treated as if par value for accounting purpose).

Issuance of Capital Stock

The issuance of stock for cash is recorded by a debit to Cash and a credit to Capital Stock for the par value. When the amount of cash received for the stock is more than the par value, the excess is recorded as a credit to additional paid-in capital or paid in capital in excess of par.

Capital Stock Issued for Cash

Stocks with par value : Goode Corporation issued 4,000 shares of $1 par common stock on April 1, 2012, for $45,000 cash. With no par value: Goode Corporation issued 4,000 shares of no par common stock without a stated value on April 1, 2012, for $45,000 cash.

Capital Stock Issued for Consideration Other than Cash

Record Non-cash Assets or Issued Common Shares at fair market value

AC Company issues 200 shares of $0.50 par value common stock in return for land. The companys stock is currently selling for $50 per share.

E 13-24 Common Stock

Verdero Company is authorized to issue 100,000 shares of $2 par value common stock. Verdero has the following transactions: (a) Issued 20,000 shares at $30 per share; received cash. (b) Issued 250 shares to attorneys for services in securing the corporate charter and for preliminary legal costs of organizing the corporation. The value of the services was $9,000. (c) Issued 300 shares, valued objectively at $10,000, to the employees instead of them cash wages.

E 13-24 Continued
(d) Issued 12,500 shares of stock in exchange for a building valued at $295,000 and land valued at $80,000. (The building was originally acquired by the investor for $250,000 and has $100,000 of accumulated depreciation; the land was originally acquired for $30,000.) (e) Received cash for 6,500 shares of stock sold at $38 per share. (f) Issued 4,000 shares at $45 per share; received cash.

Preferred Stock
Generally does not have voting rights.

Usually has a par or stated value.

Dividend and liquidation preference over common stock.

May be convertible, callable, and/or redeemable.

Preferred Stock
Priority in receiving dividends Rights given up by preferred stockholders :
1. Voting- most PS are not allowed to vote for the board of directors. 2. Sharing in success- Cash dividends received by PS are usually fixed in amount. If the firm does extremely well, their dividend amount is not adjusted.

Types of Preferred Stock

Cumulative
Has the right to receive accumulated dividends before any dividends may be paid to common stockholders.

NonCumulative

Has no right to passed dividends.

Preferred Stock Dividends

Cumulative
Unpaid dividends must be paid in full before any distributions to common stock.

Dividends in arrears (dividends carryforwarded) are not liabilities, but the per share and aggregate amounts must be disclosed.

E 13-26 Preferred Stock

Anderson Company paid dividends at the end of each year as follows: 2011, $150,000; 2012, $240,000; and 2013, $560,000. Determine the amount of dividends per share paid on common and preferred stock for each year, assuming independent capital structures as follows; (a) 300,000 shares of no-par common; 10,000 shares of 100 par, 9% noncumulative preferred. (b) 250,000 shares of no-par common; 20,000 shares of $100 par, 9% noncumulative preferred. (c) 250,000 shares of no-par common; 20,000 shares of $100 par, 9% cumulative preferred (d) 250,000 shares of $1 par common; 30,000 shares of $100 par, 9% cumulative preferred

Treasury Stock
Stock issued by a corporation but subsequently reacquired by the corporation and held for possible future reissuance or retirement. Reported as a contra-equity account, not as an asset. Never creates a gain or loss on reacquisition, reissuance, or retirement. May decrease Retained Earnings, but cannot increase it.

Treasury Stock
Usually does not have:
Voting rights. Dividend rights.

Preemptive rights.
Liquidation rights.

Reduces both assets and stockholders equity.

Accounting for Treasury Stock

(one-transaction concept)

(rarely used : NOT covered in the class)

Treasury Stock ; Example

March 10 Issued 10,000, $1 par value shares at $15 per share
Reacquired 1,000 shares at $40 per share. Reissued 700 shares at $45 per share. Retired remaining 300 shares of treasury stock.

March 25

April 13 April 25

E 13-29 Treasury Stocks

The stockholders equity of Thomas Company as of December 31, 2012, was as follows:

Common stock, $1 par, authorized 275,000 shares; 240,000 shares issued and outstanding ....$ 240,000 Paid-in capital in excess of par 3,840,000 Retained earnings .900,000
On June 1, 2013, Thomas reacquired 15,000 shares of its common stock at $16. The following transactions occurred in 2013 with regard to these shares. July 1 Sold 5,000 shares at $20. Aug. 1 Sold 7,000 shares at $14. Sept. 1 Retired 1,000 shares.

Accounting for Dividends

Declaration date- The date the corporations board of directors formally declares a dividend will be paid. Date of record- The date on which stockholders of record are identified as those who will receive a dividend. Date of payment- The date when the dividend is actually distributed to stockholders.

Cash Dividends
ABC Corporation declares a $100,000 dividend; the following journal entries should be made:
Declaration Date
Retained Earnings Dividends Payable 100,000 100,000

Payment Date
Dividends Payable Cash 100,000 100,000

E 13-46 Stockholders Equity

Kenny Co. began operations on January 1, 2012, by issuing at $15 per share one-half of the 950,000 shares of $1 par value common stock that had been authorized for sale. In addition, Kenny has 500,000 shares of $5 par value, 6% preferred shares authorized. During 2012, Kenny had $1,025,000 of net income and declared $237,500 of dividends. During 2013, Kenny had the following transactions: Jan. 10 Apr. 1 Issued an additional 100,000 shares of common stock for $l7 per share. Issued 150,000 shares of the preferred stock for $8 per share.

E 13-46 Stockholders Equity

July 19 Authorized the purchase of a custommade machine to be delivered in January 2014. Kenny restricted $295,000 of retained earnings for the purchase of the machine.

Oct. 23
Dec. 3l

Sold an additional 50,000 shares of the preferred stock for $9 per share.

Reported $1,215,000 of net income and declared a dividend of $635,000 to stockholders of record on January 15, 2014, to be paid on February I, 2014.