Bonds

Question 1

What is a serial bond?

Answer 1

Any bond that matures in installments

Question 2

What is a term bond?

Answer 2

Any bond that matures on a single date

Question 3

What is a debenture bond?

Answer 3

A bond not secured by any collateral

Question 4

What is a sinking fund bond?

Answer 4

Cash is held in a sinking fund for repayment of bond at maturity

5 years of requirements and maturity details should be disclosed

Question 5

What is the formula to calculate proceeds of a bond sale?

Answer 5

Present Value of the principal payment at maturity
+ Present Value of Interest Payments made
= Market Value of Bond Proceeds

Question 6

How is the present value of a bond calculated?

Answer 6

Step 1: PV of $1 @ Yield Rate (not Stated Rate)
x Bond Face Value

PLUS

Step 2: PV of an Ordinary Annuity of $1 for Term @ Yield
x (Stated Rate x Face)

Question 7

Which costs are included in bond issuance costs? How are they recorded?

Answer 7

Include Promotion, Engraving, Printing, Legal, Underwriter, Registration

Debited to a deferred charge account and amortized over life of Bond using S/L, with amortization beginning at issuance

Bond Proceeds – Bond Issuance Costs = Net Bond Proceeds

Question 8

How are bonds reported when classified as trading securities?

Answer 8

Reported at FMV with unreleased gains and losses being included in earnings

Question 9

How are bonds amortized under the interest method?

Answer 9

Both discount and premium amortization amounts increase each year

Question 10

What is the stated rate for a bond?

Answer 10

Rate on the face of the bond

Question 11

What is the market rate on a bond?

Answer 11

Rate that bonds are currently selling for

Question 12

What happens when the bond’s market rate is greater than the stated rate?

Answer 12

Bond will need to sell at a discount in order for buyers to be interested. The difference in market rate vs. the stated is made up by the buyer purchasing the bond for less than par value

Question 13

What happens when a bond’s market rate is less than the stated rate?

Answer 13

Bond will need to sell at a premium in order for buyers to be interested. The difference in market rate vs. the stated is made up by the buyer purchasing the bond for more than par value

Question 14

How does accrued interest on a bond affect the purchase price?

Answer 14

The purchaser of the bonds must give the bond issuer the amount of accrued interest up front

The purchaser records this extra payment as interest receivable; he doesn’t add it to the bond itself

Question 15

When does interest expense start accruing on a bond?

Answer 15

When the bonds are dated, which is not necessarily when they are issued

Question 16

How is an interest payment on a bond calculated?

Answer 16

Cash for payment = Stated rate x Face amount

Question 17

What amount of interest is expensed on a bond interest payment?

Answer 17

Interest expense = effective yield x carrying value

Any difference between expense and cash payment is applied as amortization against premium/discount

Question 18

How is the retirement of bonds recorded?

Answer 18

Gain or Loss is Ordinary

Extraordinary if both unusual and infrequent

Question 19

For journal entries recording bond interest payments and amortizing discounts or premiums with the SL method, which entry is the plug?

Answer 19

Interest income (for bond buyers)

Interest expense (for bond issuers)

Question 20

For journal entries recording bond interest payments and amortizing discounts or premiums with the effective interest method, which entry is the plug?

Answer 20

Amortization of discount or premium

For bond buyers this will be part of their “bond investment” entry

Question 21

Who needs to keep premiums or discounts as a separate journal entry?

Answer 21

Bond issuers

Question 22

Who can keep bond premiums or discounts included in one journal entry?

Answer 22

Bond buyers

They can include premiums or discounts in “bond investments”

Question 23

Are discounts recorded as debits or credits?

Answer 23

Debits

The issuer will record the bond as follows:
Debit - Cash
Debit - Discount
Credit - Bonds Payable

While bonds payable and discounts/premiums are separate entries, the official bond payable number is still net of discount/premium

Question 24

When bond issue costs are amortized, how should they be recorded?

Answer 24

They are a deferred charge (asset) that is amortized as interest expense

Question 25

How do discounts, premiums, and issue costs affect the bond’s book value for the issuer?

Answer 25

Discounts decrease the bond’s book value

Premiums increase

Bond issue costs decrease

Question 26

How do you calculate the gain or loss on the early retirement of bonds?

Answer 26

Book value
- amount paid to retire
= gain (loss)

Question 27

How are bonds with detachable stock warrants recorded?

Answer 27

Proceeds are allocated between warrants and the bond based on relative FV

If one security’s FV is not determinable, then the book value is the FV for it and the rest of the proceeds for the other

Question 28

For bonds with detachable stock warrants, how are the warrants classified?

Answer 28

Paid-in capital

Question 29

What provides a complication for the journal entries of detachable stock warrants?

Answer 29

Since warrants entitle investors to purchase X shares for $Y apiece, while the book value is based on FV, there is a need to reconcile the numbers

Question 30

What are the journal entries used by the borrower when stock warrants are exercised?

Answer 30

Debit: Cash (based on the actual cash paid)
Debit: APIC - Stock Warrants (book value lowered by % of warrants exercised)
Credit: Common Stock (number of shares x par value)
Credit: APIC - Common Stock (balancing entry)

Question 31

What are the journal entries used by the investor when stock warrants are exercised?

Answer 31

Debit: Inv. in Common Stock (balancing entry)
Credit: Stock Warrants (book value (based on FV) lowered by % of warrants exercised)
Credit: Cash (actual cash paid)

Question 32

What are convertible bonds?

Answer 32

Bonds that can be converted to stock

Question 33

What is a big accounting difference between convertible bonds and bonds with detachable stock warrants?

Answer 33

No value is assigned to the conversion feature, since the debt cannot be separated from the conversion feature. Thus, nothing is added to equity.

Question 34

What is the same about the book value and market value methods for convertible bonds?

Answer 34

Both remove the bond’s book value (including premium or discount) and credit the common stock at par value

Question 35

What is the book value method for converting convertible bonds?

Answer 35

Credit (or sometimes debit) APIC as a plug for the difference between bond book value and stock par value

No gain or loss ever recognized

Question 36

How are conversion costs accounted for in the book method?

Answer 36

NOT charged to an expense

Conversion costs affect the amount attributed to APIC

APIC = the difference between bond BV and stock par value, and conversion costs effectively lower the bond BV

Question 37

What is the market value method for converting convertible bonds?

Answer 37

Credit (or sometimes debit) APIC for the difference between stock par value and stock fair value

Bond’s BV
- Stocks’ FV
= Gain (loss)

Question 38

What is induced conversion?

Answer 38

When the debtor tries to induce conversion by improving the conversion privileges, though these privileges are changed only for a limited time

Must be applied consistently to all convertible bonds of an issuance

Question 39

How should induced conversions be recorded?

Answer 39

Debtor should recognize expense for the difference between FV for the securities (and other things) transferred and the FV of the securities issuable under the original (non-improved) terms

FV should be measured when the inducement offer is ACCEPTED, not merely offered

Expense should not be extraordinary

Question 40

Are registered bonds considered secured or unsecured?

Answer 40

Unsecured