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0verview Week 10
Text: Chapter 9 LO 1 - 4, pp. 498 - 515; LO 10, pp. 523 - 527. Demo Questions: BE9.2, E9.2, PSA9.5, Additional Demonstration Question Self-Study Questions: Q3, Q8, Q9,; E9.3; E9.5; PSA9.1; PSA9.2; PSA9.4, 5; * BSB9.5 NB. Additional Self Study Questions on Debenture (Bond) Issues Explain the difference between current and non-current liabilities. Identify types of current liabilities and explain how to account for them. Identify types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them Calculate the issue price, and record the debentures (bonds) issues at: a) par, b) at a discount, c) at a a premium Calculate and record the relevant interest expense and payment entries required under the effective interest method Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long term debt.
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Developed by Dr Anne Abraham Adapted by Ron Day 2009 John Wiley & Sons Australia, Ltd
Other Payables Other Payables amounts owing to other than suppliers of inventory
E.g. Wages and other payroll deductions payable Employers deduct amounts from employees wages and salaries if they are required to be paid to other parties: See E9.2 Mar 31 Dr Cr Cr Cr Cr Wages Expense Cr ABC Health Fund payable Pay-as-you-go withheld tax payable Superannuation fund payable Union Fees payable Wages payable 70 000 4 500 7 500 2 200 500 55 300
(Entry to record accrual of interest owing to XXX Bank at end of period 10% x $60,000 x 6/12) Journal entry to settle the liability June 1 Dr Notes payable Dr Interest expense Dr Interest payable Cr Cash 60 000 3 000 3 000 66 000
NON-CURRENT LIABILITIES
are obligations where the future sacrifice of economic benefits is not expected to be paid until after 1 year Referred to as debt financing/borrowing from single or multiple lenders Common forms of single lender borrowing are: - Bank loans - Long-term notes payable Common forms of multiple lender borrowing direct from the public - Unsecured notes no security over assets (therefore higher risk and interest) - Debentures (Bonds) subject to a secured charge on the issuers assets Why would a company raise money direct from the public from multiple lenders?
the total loan repayments - the amount originally borrowed = interest Equal periodic loan instalments consist of part interest, part principal - (i) interest expense (fixed percentage by principal balance) - (ii) remainder of instalment is a reduction of the principal of the loan Jan 31 Dr Interest Expense Dr Mortgage Loan Payable Cr Cash at Bank 1 062 3 938 5 000
- NCL - CL
= = = = =
Mortgage balance at 31/03/2013 (1 yr after balance date) $42 833 Mortgage bal at 31//3/2012 - Mortgage bal at 31/3/2013 $94 288 - $42 833 $51 455
PV of $1 formula/tables provides a discount factor to convert FV to PV. The PV of $1 000 in a years time, if interest rate is 10% PV = FV / (1 + r) n = $1 000/(1 + 0.1)1 = $909.09
- Fig 9.8, p.515 calculates this by summing the reduction in principal amounts for next 12 months for the CL, and summing the remaining amounts for the NCL.
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Present Value of a single sum of $1 table helps us to calculate this by providing the relevant discount rate for each interest rate and period .
- Refer to the PV of $1 table and find the discount factor at 10% int for 3 periods - Calculate the PV by multiply the FV by the discount factor - Compare to the amounts in present value terms PV [i=10%, n=3] of $90 000 0.751 (see Table 1) = $67 590 Amount to be received immediately 70 000 *Choose Difference - 2 410
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Alternatively, you can look up discount factors for a PV of an annuity $1 (Table 2 bottom half of PV tables page) PV of an annuity of $30 000 per yr for 3yrs [i=10%, n=3] = $30 000 x 2.487 (see Table 2) = $74 610 *Choose Amount to be received immediately 70 000 Difference + 4 610
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Debenture (Bond) Certificate provides details of the contract (name of issuer, face value due on maturity, maturity date, face rate of interest) Face Value (FV) is the principal amount due at maturity Book Value (BV) is the carrying amount of the note/debenture/bond in the companys ledger and statement of financial position Face Rate (FR) is the coupon rate on the face of the note/debenture/bond that determines the amount of interest paid to the holder each period Market Rate (MR) - the rate of interest on similar securities at date of issue, It is used in discounting the PV of the Principal and PV of interest annuity when determining issue price, and used to calculate interest exp (FR x FV) Issue Price- the amount paid by the borrower to the lender at time of issue. It may be > or < the face value, if the MR differs from FR at time of issue
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Example 3- Solution
PV of principal (i = 5%, n = 10) = $100 000 x 0.614 = $ 61 400 PV of interest payments (MR = 5% , n = 10) = $5 000 x 7.722 = $ 36 110
= $ 100 000 rounded
PV calculations where interest is paid semi-annually (twice a yr) In this case: i) adjust the interest rate (i) to that rate per period ii) adjust number of periods (n) to number of interest periods .
Example 3
Calculate issue price of a 10% semi annual 5 yr, $100 000 bond issued at par (market rate of interest also is 10%), with interest paid semi annually interest rate becomes 10/2 = 5% and No. of periods becomes 5 2 = 10
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10%
Face Value
Where MR < FR the debentures (Bonds) will be issued at a premium - Investors will pay more for a higher face rate of interest (FR) that they will receive, compared to the market rate (MR) on similar investments.
12%
Discount
- The premium results in an effective rate = the market rate at issue date - Present value calculations using the market rate will = the issue price
See interactive spreadsheet that illustrates the effects when market interest rate of similar securities differs from the face rate at date of issue
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31/12/10 Dr
(NB. Above entries would normally be recoded in cash payment journal) (iv) Record the Balance Sheet presentation: Non-current Liabilities: Debentures Payable 500 000
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(ii) Record the Journal entry at issue date: 1/1/10 Dr Cash Cr Debentures payable 437 740 437 740
(2) Calculate debenture (bond) interest paid (FV x FR) (3) Calculate the increase or decrease to debentures (Bonds) payable by finding the difference between (1) and (2)
Bond interest expense Book value (carrying Market amt) at beg of period x rate (BV) (MR)
x of interest
(FR)
Face Rate
Entry to record redemption at maturity 30/6/2030 Dr Debentures Payable 1 000 000 Cr Cash 1 000 000 (To record redemption of debentures at maturity)
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Eg. Entry to record redemption before maturity at 103% of face value Dr Debentures Payable Dr Loss on Redemption of Debentures Cr Cash (To record redemption of debentures at 103) 1 000 000 30 000 1 030 000
Example:
More working capital indicates more current assets available to meet current liabilities.
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Example:
Example:
A higher ratio indicates better liquidity. A higher ratio indicates better liquidity.
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= Profit before income tax + Interest expense Interest expense - Provides an indication of an entitys ability to meet interest payments as they become due Example:
The ratio indicates the extent to which the entitys assets are financed by creditors.
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A higher interest coverage is interpreted as indicating a greater ability to meet interest payments.
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Before next week 1. Do Week 10 Self-Study Questions. 2. Check solutions on Blackboard after doing the questions yourself. 3. You may want to complete reflective, self-evaluation and learning strategies exercise. 4. Skim read chapter 10; LO 1-9, pp.552-585 Start with Summary of Learning objectives on pp. 587-588 5. Obtain a copy of Week 11 lecture material from Blackboard to bring to class Feedback from Mid semester Test available on blackboard this week Part B of Assignment due Friday May 14 at 2pm
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