CH.9 Long-Term Liabilities
In order to expand its business, Mueller Inc. is borrowing $1 million from its bank. Mueller is utilizing this type of financing:
Debt
Methods of Long-Term Financing with Debt (liabilities) Include:
Notes payable, Leases, & Bonds
6% stated interest rate and 4% market interest rate
Premium - Investors will pay more than face value
What are the possible benefits of leasing an asset rather than purchasing an asset?
Protection against declining asset value Lower periodic payments on the asset Improvement in cash flows
____________ bonds are supported by a specific asset the issuer pledges as collateral.
Secured
Bonds that mature in installments are referred to as
Serial
Bonds that mature on one specific date are called
Term
Glueck Company issues bonds with a stated rate of 5% and a market rate of 4%. Glueck's bonds will issue at
a premium.
A corporation will issue bonds when
the interest on the bond plus the bond issue cost is less than the interest payments for a bank loan.
Most bonds issued today are ______.
unsecured.
Cost of Debt Financing
interest expense (tax-deductible) ADVANTAGE
A(n) __________________ bond is backed by a lien on specified real estate owned by the issuer.
secured.
The two types of financing
Debt & Equity
6% stated interest rate and 8% market interest rate
Discount - Investors will pay less than face value
True or false: The full balance of a 10 year installment note payable that requires annual payments is reported as long-term debt.
False. Reason: The note must be split into its current and long-term portions.
Equity financing
obtaining investment from stockholders
Debt financing
borrowing money$
If ABC Company receives $100,000 cash in exchange for issuing 100 bonds at their $1,000 face value, the transaction will be recorded with a:
debit to Cash of $100,000 and a credit to Bonds payable of $100,000.
Capital structure (CS)
mixture of liabilities & stockholders' equity a business uses - Debt financing -Equity financing
On January 1, 2021, Splash City issues $360,000 of 7% bonds, due in 10 years, with interest payable semiannually on June 30 and December 31 each year. Assuming the market interest rate on the issue date is 7%, the bonds will issue at $360,000. Record the bond issue on January 1, 2021, and the first two semiannual interest payments on June 30, 2021, and December 31, 2021. Record the second semiannual interest payment.
SAME AS THE FIRST SEMIANNUAL INTEREST PAYMENT =$360,000 * 7% * 1/2(semi annually) =$12,600
Munster Inc. issues $20 million in bonds and pledges its land holdings as collateral. Munster's bonds are:
Secured.
At the beginning of a lease period, the lessee records
a lease asset and lease payable for the present value of the lease payments.
On January 1, 2021, Tropical Paradise borrows $49,000 by agreeing to a 6%, five-year note with the bank. The funds will be used to purchase a new BMW convertible for use in promoting resort properties to potential customers. Loan payments of $947.31 are due at the end of each month with the first installment due on January 31, 2021. Record the first monthly payment.
Interest expense(debit)= amount borrowed * % yr note * 1 month fraction of yr (1/12) = $49,000 * 6% * 1/12 = $245 Cash (credit) = is the monthy payment = $947.31 Note payable(debit)= is the difference cash & interest expense = $947.31 - $245 =$702.31
Periodic Payments on installment notes typically include:
a portion that reflects interest. a portion that reduces the outstanding loan balance.
XYZ Company has a 10 year installment note requiring $5,000 to be paid within the current year and $45,000 to be paid over the remaining 9 years. How is this installment note reported in the balance sheet of XYZ Company?
$5,000 current note payable; $45,000 long-term note payable.
On January 1, 2021, Splash City issues $360,000 of 7% bonds, due in 10 years, with interest payable semiannually on June 30 and December 31 each year. Assuming the market interest rate on the issue date is 7%, the bonds will issue at $360,000. Record the bond issue on January 1, 2021, and the first two semiannual interest payments on June 30, 2021, and December 31, 2021. Record the first semiannual interest payment.
=$360,000 * 7% * 1/2(semi annually) =$12,600
Calculate the times interest earned ratio for E-Travel and Pricecheck. times interest ratio= (net income + interest expense + tax expense)/ interest expense
E-Travel 297,526 + 83,233 + 152,400 = $533,159 $533,159/ 83,233 =6.41 __________________________ Pricecheck (487,472 + 23,084 + 46,168 = $556,724 556,724 / 23,084 = 24.12 Pricecheck is better able to meet interest payments as they become due.
In order to expand its business, Mueller Inc. is selling $10 million in common stock. Mueller is utilizing this type of financing:
Equity
During the current year, Katie Corp. pays $5,120 on an installment note. The outstanding loan balance at the beginning of the year was $50,000; the effective interest rate is 8%. Which of the statements regarding the installment note balance at the end of the current year is correct?
The balance is $48,880. Reason: $50,000 - (5,120 - 4,000 (interest expense)) 50,000 * 8% = $4,000 (interest expense) 5,120 - 4,000= $1,120 (notes payable) 50,000- 1,120= $48,880.
What are typically shown in an amortization schedule related to an installment notes payable?
The cash paid each payment period The carrying value of the note at the end of the period The carrying value of the note at the beginning of the period
ABC Company issues a bond with a face value of $100,000 at face amount on January 1. ABC prepares financial statements only at December 31, so no adjusting entries are made during the year to accrue interest. If the bond carries a stated interest rate of 6% payable in cash on December 31 of each year, the journal entry to record the first bond interest payment includes ______.
a credit to Cash of $6,000. a debit to Interest expense of $6,000. Reason: Since no previous adjusting entry was recorded to accrue interest, there would be no Interest payable balance to decrease. The debit is to Interest expense and a credit to Cash for $6,000. Reason: Interest expense should be debited, not credited. The credit is to Cash. first bond interest payments uses the interest formula 100,000* 6%= $6,000
Margot Inc. issues bonds with a stated rate of 5%; the company's market interest rate is 6%. The bonds will issue at:
a discount
Walker Inc. signs a $24,000 installment note, which requires equal monthly payments of $1,100 over the next two years. The journal entry to recognize the note includes a:
credit to Notes Payable for $24,000. debit to Cash for $24,000
Smith Company enters into a lease agreement with Rent-All Corp. The present value of the lease payments is equal to $25,000. Smith records:
debit lease asset $25,000 credit lease payable $25,000
Western Company enters into a lease agreement with ABC Rents. The present value of the lease payments is equal to $50,000. Western records:
debit lease asset $50,000; credit lease payable $50,000
January 1 Borrow $101,000 from Captive Credit Corporation. The installment note bears interest at 6% annually and matures in 5 years. Payments of $1,953 are required at the end of each month for 60 months. Pay the first monthly installment of $1,953 related to the $101,000 long-term note payable borrowed in January 1. Round your interest calculation to the nearest dollar.
interest expense= $101,000 * 6% * 1/12 = $505 notes payable = interest expense - cash = 1,953 - 505 =$1448
On December 31, Leann Corp. paid $5,120 on an installment note that requires annual payments. The outstanding loan balance on January 1 was $50,000; the effective interest rate is 8%. The journal entry to recognize the payment should include debits to
notes payable for $1,120. interest expense for $4,000. outstanding loan balance*interest rate=interest expense 50,000 * 8% = $4,000 (interest expense) installment note- interest expense= notes payable 5,120- 4000- $1,120 (notes payable)
On December 31, Katie Corp. records a journal entry related to an installment note that includes a debit to interest expense for $4,000, and a debit to notes payable for $9,000. Katie's journal entry should also include a credit to cash for:
$13,000. Reason: $4,000 + $9,000. if there is a debit to both interest expenses & notes payable, then you add them together = credit to cash amount
At the beginning of the year, Petra owes $10,000 on an installment notes payable, which has an interest rate of 6%. At the end of the year, Petra makes a payment of $2,000. After the payment, the carrying value of the installment notes payable will be:
$8,600. Reason: $10,000 - $(2,000 - (10,000 x .06) = $8,600
Depreciation on the building for the month of January is calculated using the straight-line method. At the time the building was purchased, the company estimated a service life of 10 years and a residual value of $24,400. Prepare the adjusting journal entry for depreciation.
(assets cost - residual value) /service life = (121,000 - 24,400)/10 =9660/ 12 (months in yr) =805
The journal entry to record the issuing of 100 bonds at their $1,000 face value will include a debit to ______ and a credit to ______.
Cash; Bonds Payable. Reason: The entry to record the issuance of bonds includes a debit to Cash and a credit to Bonds Payable. Reason: The entry to record the issuance of bonds includes a debit to Cash and a credit to Bonds Payable. Bonds Receivable would not be credited unless you had previously loaned money and are getting paid back.
You are analyzing the following four companies based on their debt to equity ratio. Which company has the highest risk of insolvency? Company A 2.5 Company B 1.0 Company C 0.9 Company D 3.0
Company D
The journal entry to recognize the signing of an installment notes payable includes:
Credit Notes Payable. Debit Cash.
On January 1, 2021, Tropical Paradise borrows $49,000 by agreeing to a 6%, five-year note with the bank. The funds will be used to purchase a new BMW convertible for use in promoting resort properties to potential customers. Loan payments of $947.31 are due at the end of each month with the first installment due on January 31, 2021. Record the second monthly payment.
Interest expense(debit)- (amount borrowed - 1st monthly's note payable) * % yr note * 1 month fraction of yr (1/12 = ($49,000- $702.31) * 6% * 1/12 = $241.49 Cash (credit) = is the monthy payment = $947.31 Note payable(debit)= is the difference cash & interest expense = $947.31 - $241.49 =$705.82
6% stated interest rate and 6% market interest rate
Investors will pay face value
Which of the following are typically shown in an amortization schedule related to an installment notes payable requiring period payment of interest and principal?
The decrease in the carrying value of the note The cash paid each payment period The carrying value of the note at the end of the period Interest expense based on the beginning period carrying value and the effective rate of the loan
ABC Company issues a bond with a face value of $100,000 at face amount on January 1. The bond carries a stated annual interest rate of 6% payable in cash on December 31 of each year. If ABC issues monthly financial statements, it must make an adjusting entry on January 31 that includes ______.
a debit to Interest expense of $500. a credit to Interest payable of $500. Reason: The interest payment will be made on December 31, not January 31. Reason: Interest expense= $100,000 x 6% x (1/12) = $500 (1/12) = $500
Smith Company enters into a lease agreement with Rent-All Corp. At the beginning of the lease period, Smith Company records:
a lease asset a lease payable
Cost of Equity Financing
dividends (NOT tax-deductible) DISADVANTAGE bc. Interest expense will reduce net income, which will reduce retained earnings.
On January 1, 2021, Splash City issues $360,000 of 7% bonds, due in 10 years, with interest payable semiannually on June 30 and December 31 each year. Assuming the market interest rate on the issue date is 7%, the bonds will issue at $360,000. Record the bond issue on January 1, 2021, and the first two semiannual interest payments on June 30, 2021, and December 31, 2021. Record the bond issue.
record the amount that the bond is issued originally
Record the issuance of a note payable or Record the establishment of the Note Payble.
recorded on the first date- the date borrowed
