Long-term Liabilities

Current Liabilities (due within less than one year)

Initially booked at nominal value (not present value)

Long-term Liabilities (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

KNOWLEDGE FOR ACTION

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 loan period

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 until maturity. Zero-coupon: company only pays lump sum at maturity

KNOWLEDGE FOR ACTION

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

KNOWLEDGE FOR ACTION

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

Issuance 1/1/10 Dr. Cash (+A) 10,000 Cr. Notes Payable (+L)

10,000

KNOWLEDGE FOR ACTION

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

Periodic interest payments 12/31/10 Dr. Interest Expense (+E) Cr. Cash (-A) 12/31/11 Dr. Interest Expense (+E) Cr. Cash (-A)
KNOWLEDGE FOR ACTION

500 500 500 500

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

Repayment 12/31/12 Dr. Notes Payable (-L) Dr. Interest Expense (+E) Cr. Cash (-A)

10,000 500 10,500

KNOWLEDGE FOR ACTION

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. 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

KNOWLEDGE FOR ACTION

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. 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 Principal Beg Bal 10,000 Payment = (3672) Interest Principal Principal (Beg Bal * .05) (3672 - Interest) End Bal (500) (3,172) 6,828

12/31/10

KNOWLEDGE FOR ACTION

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. 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 Principal Beg Bal 10,000 6,828 Payment = (3672) Interest Principal Principal (Beg Bal * .05) (3672 - Interest) End Bal (500) (3,172) 6,828 (341) (3,331) 3,497

12/31/10 12/31/11

KNOWLEDGE FOR ACTION

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. 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 Principal Beg Bal 10,000 6,828 3,497 Payment = (3672) Interest Principal Principal (Beg Bal * .05) (3672 - Interest) End Bal (500) (3,172) 6,828 (341) (3,331) 3,497 (175) (3,497) 0

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

KNOWLEDGE FOR ACTION

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 Pay interest ($500) + principal ($3172) Pay interest ($341) + principal ($3331) Pay interest ($175) + principal ($3497)

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

KNOWLEDGE FOR ACTION

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 Pay interest ($500) + principal ($3172) Pay interest ($341) + principal ($3331) Pay interest ($175) + principal ($3497)

1/1/10

12/31/10

12/31/11

12/31/12

2010 payment 12/31/10 Dr. Mortgage Payable (-L) Dr. Interest Expense (+E) Cr. Cash (-A)

3,172 500 3,672

KNOWLEDGE FOR ACTION

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 Pay interest ($500) + principal ($3172) Pay interest ($341) + principal ($3331) Pay interest ($175) + principal ($3497)

1/1/10

12/31/10

12/31/11

12/31/12

2011 payment 12/31/11 Dr. Mortgage Payable (-L) Dr. Interest Expense (+E) Cr. Cash (-A)

3,331 341 3,672

KNOWLEDGE FOR ACTION

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 Pay interest ($500) + principal ($3172) Pay interest ($341) + principal ($3331) Pay interest ($175) + principal ($3497)

1/1/10

12/31/10

12/31/11

12/31/12

2012 payment 12/31/12 Dr. Mortgage Payable (-L) Dr. Interest Expense (+E) Cr. Cash (-A)

3,497 175 3,672

KNOWLEDGE FOR ACTION

Bonds Payable
Bonds Payable
Coupon bonds require semi-annual coupon payments plus payment of face value at maturity

Elements and Terminology

Price or proceeds (PV) Face value or par value (FV) Market interest rate or effective rate or yield-to-maturity (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 Price
Price = Present value of FV + Present Value of PMT

KNOWLEDGE FOR ACTION

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) interest rate 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
KNOWLEDGE FOR ACTION

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) interest rate of 5.0%. KP receives proceeds from the bond of $10,000.
Receive $10,000 Pay coupon Pay coupon Pay coupon Pay coupon Pay coupon Pay coupon ($250) ($250) ($250) ($250) ($250) ($250) + principal ($10,000)

1/1/10

6/30/10

12/31/10

6/30/11

12/31/11

6/30/12

12/31/12

KNOWLEDGE FOR ACTION

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) interest rate of 5.0%. KP receives proceeds from the bond of $10,000.
Receive $10,000 Pay coupon Pay coupon Pay coupon Pay coupon Pay coupon Pay coupon ($250) ($250) ($250) ($250) ($250) ($250) + principal ($10,000)

1/1/10

6/30/10

12/31/10

6/30/11

12/31/11

6/30/12

12/31/12

Issuance 1/1/10 Dr. Cash (+A) 10,000 Cr. Bonds Payable (+L) 10,000

KNOWLEDGE FOR ACTION

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) interest rate of 5.0%. KP receives proceeds from the bond of $10,000.
Receive $10,000 Pay coupon Pay coupon Pay coupon Pay coupon Pay coupon Pay coupon ($250) ($250) ($250) ($250) ($250) ($250) + principal ($10,000)

1/1/10

6/30/10

12/31/10

6/30/11

12/31/11

6/30/12

12/31/12

Periodic coupon payments Dr. Interest Expense (+E) Cr. Cash (-A)

250 250

KNOWLEDGE FOR ACTION

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) interest rate of 5.0%. KP receives proceeds from the bond of $10,000.
Receive $10,000 Pay coupon Pay coupon Pay coupon Pay coupon Pay coupon Pay coupon ($250) ($250) ($250) ($250) ($250) ($250) + principal ($10,000)

1/1/10

6/30/10

12/31/10

6/30/11

12/31/11

6/30/12

12/31/12

Payment at maturity 12/31/12 Dr. Bonds Payable (-L) Dr. Interest Expense (+E) Cr. Cash (-A)

10,000 250 10,250

KNOWLEDGE FOR ACTION