13.1 Explain the Pricing of Long-Term Liabilities
- Businesses can obtain financing (cash) through profitable operations, issuing (selling) debt, and by selling ownership (equity).
- Notes payable and bonds payable are specific types of debt that businesses issue in order to generate financial capital.
- Liabilities are categorized as either current or noncurrent based on when the liability will be settled relative to the operating period of the business.
- A bond indenture is a legal document containing the principal amount, maturity date, stated interest rate and other requirements of the bond issuer.
- Bonds can be issued under different structures and include different features.
- Periodic interest payments are based on the amount borrowed, the interest rate, and the time period for which interest is calculated.
- Bond selling prices are determined by the market interest rate at the time of the sale and the stated interest rate of the bond.
- Bonds can be sold at face value, at a premium, or at a discount.
13.2 Compute Amortization of Long-Term Liabilities Using the Effective-Interest Method
- The effective-interest method is a common method used to calculate the interest expense for a given interest payment.
- There is an inverse relationship between the price of a bond and the market interest rate.
- The carrying value of a bond sold at a discount will increase during the life of a bond until the maturity or face value is reached.
- The carrying value of a bond sold at a premium will decrease during the life of a bond until the maturity or face value is reached.
- The amount of cash to be paid, the interest expense, and the premium or discount amortization (when applicable) with each periodic payment are calculated based on an amortization table or schedule.
13.3 Prepare Journal Entries to Reflect the Life Cycle of Bonds
- When a company issues a bond, the specific terms of the bond are contained in the bond indenture.
- Journal entries are recorded at various stages of a bond, including when the bond is issued, for periodic interest payments, and for payment of the bond at maturity.
- The difference between the face value of a bond and the cash proceeds are recorded in the discount (when the proceeds are lower than the face value) and premium (when the proceeds are higher than the face value) accounts.
- The carrying or book value of a bond is determined by the balances of the Bond Payable and Discount and/or Premium accounts.
- Interest expense associated with a bond interest payment is calculated by the bond’s carrying or book value multiplied by the market interest rate.