Chapter 9: Long-Term Liabilities – Bonds Payable, Amortization, and Other Long-Term Liabilities

Long-Term Liabilities

Introduction to Long-Term Liabilities

Long-term liabilities are obligations that are not due within the next year. The most common types include bonds payable, long-term loans, leases, and deferred tax liabilities. These liabilities are crucial for financing large investments and operations in corporations.

Bonds Payable and Interest Expense

Accounting for Bonds Payable

Bonds are debt instruments where investors (bondholders) lend money to issuers (corporations or governments) for a fixed period. The issuer pays periodic interest and repays the principal at maturity.

• Term Bonds: All mature at the same time.

• Serial Bonds: Mature in installments over time.

• Secured Bonds: Backed by specific assets.

• Unsecured Bonds (Debentures): Backed only by the issuer's creditworthiness.

Key terms include principal (face value), maturity date, stated (coupon) rate, and interest payment dates (often semiannual).

Bond Pricing and Market Rates

The price of a bond depends on the relationship between the stated interest rate and the current market rate:

• At Par: Market rate = Stated rate; bond sells at face value.

• At Discount: Market rate > Stated rate; bond sells below face value.

• At Premium: Market rate < Stated rate; bond sells above face value.

Bonds are quoted as a percentage of face value (e.g., 101.5 means 101.5% of face value).

Accounting for Bond Issuance

When bonds are issued, the issuer records cash received and a liability for bonds payable. If issued at a discount or premium, a contra-liability or adjunct account is used.

• At Par: Debit Cash, Credit Bonds Payable.

• At Discount: Debit Cash and Discount on Bonds Payable, Credit Bonds Payable.

• At Premium: Debit Cash, Credit Premium on Bonds Payable and Bonds Payable.

Straight-Line Amortization of Discounts and Premiums

Under the straight-line method, the total discount or premium is allocated evenly over the bond's life. This affects interest expense recognized each period.

• Discount: Increases interest expense above cash paid.

• Premium: Decreases interest expense below cash paid.

Journal entries for interest payments include both the cash interest and the amortization of discount or premium.

International Perspective

IFRS requires the effective-interest method for amortization, while GAAP allows straight-line if results are not materially different.

Carrying Value of Bonds

The carrying value (CV) of a bond is the net amount reported on the balance sheet. For bonds issued at a discount, CV increases over time; for bonds at a premium, CV decreases over time, both converging to face value at maturity.

Early Retirement of Bonds

Bonds may be retired before maturity, either by calling them at a set price or purchasing them on the open market. The difference between the carrying value and the retirement price results in a gain or loss.

Convertible Bonds

Convertible bonds can be exchanged for stock instead of cash at maturity, offering investors potential upside if the company grows. (Journal entries for conversions are not required for this course.)

Other Long-Term Liabilities

Deferred Income Taxes

Deferred income taxes arise from temporary differences between accounting income and taxable income, often due to different depreciation methods. These differences reverse over time.

• Income Tax Expense: Based on accounting income (GAAP).

• Income Taxes Payable: Based on taxable income (tax law).

• Deferred Tax Liability: The difference, to be paid in future periods.

Air Traffic Liability

Airlines record liabilities for tickets sold and loyalty points earned but not yet redeemed. These are recognized as revenue when the flight occurs or points are redeemed. Portions expected to be redeemed within a year are current liabilities; the rest are noncurrent.

Leases

Leases allow use of assets without ownership. Finance leases transfer ownership at the end; operating leases do not. Both types must be capitalized under GAAP, with the asset and liability recorded on the balance sheet.

Financial Statement Analysis: Leverage and Coverage

The Leverage Ratio

The leverage ratio (equity multiplier) measures total assets per dollar of equity. The debt ratio measures the proportion of total liabilities to total assets.

Times-Interest-Earned Ratio

This ratio indicates how many times operating income covers interest expense. A higher ratio means greater ability to service debt.

• Formula: $\text{Times-Interest-Earned} = \frac{\text{Income from Operations}}{\text{Interest Expense}}$

Reporting Long-Term Liabilities

Balance Sheet Presentation

Long-term liabilities are reported in detail on the balance sheet, including bonds, notes, lease obligations, and payroll support loans. Current maturities and issuance costs are deducted as appropriate.

Scenario Analysis and Debt Covenants

Debt Covenants and Compliance Tools

Lenders may impose covenants (limits on ratios or balances) to protect their interests. Companies use scenario analysis tools, such as Excel's What-If Analysis Scenario Manager, to test the impact of potential projects on covenant compliance.

• Common Covenants: Minimum current ratio, maximum debt ratio, minimum times-interest-earned ratio.

• Scenario Analysis: Helps managers evaluate if new projects would violate covenants before proceeding.

Summary Table: Key Bond Accounting Concepts

Situation	Market Rate vs. Stated Rate	Bond Price	Accounting Effect
At Par	Market = Stated	Face Value	No discount or premium
At Discount	Market > Stated	Below Face Value	Interest expense > cash paid
At Premium	Market < Stated	Above Face Value	Interest expense < cash paid

Additional info: The notes above expand on the provided slides by including definitions, formulas, and examples for clarity and completeness, as well as a summary table for quick reference.