ACG2021
Complete test 3 study guide
chapter 8
special acquisitions:
financing a business with debt
Long-term notes payable and mortgages
I.
When
a company borrows money for longer than one year, that obligation is called a
long-term note payable
a. Typically repaid with a series of
equal payments over the life of the note
b. Each monthly payment includes
interest and principal reduction
c. The amount of periodic interest
expense declines over the life of the note, while the amount of principal
reduction increases
II.
A
mortgage is a special kind of note payable
a. Used for the specific purpose of
purchasing property
b. Gives the lender a claim against
that property if payments are not made
EXAMPLE #1
On June 1,
2005 Joe’s Jerk Shack bought a new building for a future restaurant at a sales
price of $100,000. They paid $35,000 cash and obtained a mortgage for the
remainder of the balance. Payments in the amount of $700 are to be made
monthly. The first payment will be made on June 30. The interest rate on the
mortgage is 6%.
- Show the entry for the purchase
of the building on June 1.
- What was interest expense for
June? July?
- What was the outstanding
balance of the mortgage on June 30? July 31?
- Show the journal entries for
the June and July interest payments.
|
|
|
|
P x R x T |
|
|
|
|
Beginning Principal |
Total Payment |
Interest Expense |
Principal Reduction |
Ending Principal |
|
June |
$65,000 |
$700 |
$65000 x .06 x (1/12) = $325 |
$700 - $325 = $375 |
$65000 - $375 = $64,625 |
|
July |
$64, 625 |
$700 |
$64625 x .06 x (1/12) = $323 |
$700 - $323 = $377 |
$64625 - $377 = $64,248 |
- Show the entry for the purchase
of the building on June 1.
Debit Credit
6/1 Building $100,000
Cash $35,000
Mortgage Payable $65,000
- What was interest expense for
June? July?
Using the above table:
June = $325
July = $323
- What was the outstanding
balance of the mortgage on June 30? July 31?
Using the above table:
June 30 =
$64,625
July 31 =
$64,248
- Show the journal entries for
the June and July interest payments.
Debit Credit
June Interest Expense $325
Mortgage Payable $375
Cash $700
July Interest Expense $323
Mortgage Payable $377
Cash $700
Long-term liabilities:
Raising money by issuing bonds
I.
What
is a bond?
a. When firms need to borrow large
amounts of money, they borrow it from the general public
b. A bond is a written agreement that
specifies the company’s responsibility to pay interest and repay the principal
to the bondholders
c. Bondholders are willing to lend
money for a longer period of time than banks
d. Rate of interest on bonds is usually
lower than the rate of interest on a bank loan
e. The issuance of bonds may involve
disadvantages such as restrictions against additional borrowing or requirements
to maintain certain financial ratio levels
II.
More
about bonds
a. Bondholders are creditors of a company,
not owners
b. Most bonds pay interest semiannually
c. Most bonds have a face value of
$1,000
d. Bonds can be bought and sold in the
secondary market
Issuing bonds payable
I.
Getting
the money
a. Bonds may be issued at
i.
Par
– equal to face value (Market Rate = Stated Rate)
ii.
Premium
– above face value (Stated Rate > Market Rate)
iii.
Discount
– below face value (Stated Rate < Market Rate)
b. Cash is increased
c. Bonds payable (a liability) is
increased
II.
Paying
the bondholders
a. Interest is calculated as principal
(face value) x interest rate x time
b. Every interest payment will be
identical
i.
Cash
paid to the bondholder is determined by the terms of the bond agreement
ii.
Not
affected by issue price
III.
Issuing
bonds at par, premium, or discount
a. Market rate of interest (what the
investors are demanding) may not equal the stated rate of interest (printed on
the bond)
b. If market rate = stated rate, bonds
sell at par
c. If market rate > stated rate,
bonds will sell at a discount (below face amount)
d. If market rate < stated rate,
bonds will sell at a premium (above face amount)