Bond Flashcards
Take a step back and think about what the discount or premium is (bonds sold below or above face value). A bond discount tells you that the effective rate is higher than the coupon rate. A bond premium tells you that the coupon rate is higher than the effective rate.
If you sell bonds at a discount there is a liability (normal credit balance), but you also have the contra-liability account, the discount on bonds (normal debit balance). Over the course of the bond term the discount is amortized to interest expense.
Journal entry:
Dr Interest Expense
Cr Discount on Bonds Payable
Cr Cash
Cash in this entry reflects the obligation of making the coupon payment, but interest expense shows the coupon payment plus the bond discount amortization. The amortization of the discount is a non-cash activity. Remember, net income is littered with estimates and non-cash items because of accrual accounting. The point of the statement of cash flows is to show the true change in cash, so several income statement and balance sheet accounts must be considered.
Bottom line: amortization of bond discounts increase interest expense, but it isn’t a true cash outflow so you need to ADD it back to net income for the CF statement. Amortization of bond premium decreases interest expense, but it isn’t a true cash inflow so you need to SUBTRACT it from net income for the CF statement.
Bond redemption is the process of repaying the bond’s principal amount to the bondholders when the bond matures or when the issuer decides to call the bond before its maturity date in case of a callable bond. When the bond reaches its maturity date (the end), you usually get the full face value.
Examples of significant noncash financing and investing activities
* property dinidends paid
* conversion of bonds to stock
* issuance of common stock to retire debt
* purchase of property or equipment with note payable
