Bonds Flashcards
What is a serial bond?
Any bond that matures in installments
What is a term bond?
Any bond that matures on a single date
What is a debenture bond?
A bond not secured by any collateral
What is a sinking fund bond?
Cash is held in a sinking fund for repayment of bond at maturity
5 years of requirements and maturity details should be disclosed
What is the formula to calculate proceeds of a bond sale?
Present Value of the principal payment at maturity
+ Present Value of Interest Payments made
= Market Value of Bond Proceeds
How is the present value of a bond calculated?
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)
Which costs are included in bond issuance costs? How are they recorded?
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
How are bonds reported when classified as trading securities?
Reported at FMV with unreleased gains and losses being included in earnings
How are bonds amortized under the interest method?
Both discount and premium amortization amounts increase each year
What is the stated rate for a bond?
Rate on the face of the bond
What is the market rate on a bond?
Rate that bonds are currently selling for
What happens when the bond’s market rate is greater than the stated rate?
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
What happens when a bond’s market rate is less than the stated rate?
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
How does accrued interest on a bond affect the purchase price?
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
When does interest expense start accruing on a bond?
When the bonds are dated, which is not necessarily when they are issued
How is an interest payment on a bond calculated?
Cash for payment = Stated rate x Face amount
What amount of interest is expensed on a bond interest payment?
Interest expense = effective yield x carrying value
Any difference between expense and cash payment is applied as amortization against premium/discount
How is the retirement of bonds recorded?
Gain or Loss is Ordinary
Extraordinary if both unusual and infrequent
For journal entries recording bond interest payments and amortizing discounts or premiums with the SL method, which entry is the plug?
Interest income (for bond buyers)
Interest expense (for bond issuers)
For journal entries recording bond interest payments and amortizing discounts or premiums with the effective interest method, which entry is the plug?
Amortization of discount or premium
For bond buyers this will be part of their “bond investment” entry
Who needs to keep premiums or discounts as a separate journal entry?
Bond issuers
Who can keep bond premiums or discounts included in one journal entry?
Bond buyers
They can include premiums or discounts in “bond investments”
Are discounts recorded as debits or credits?
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
When bond issue costs are amortized, how should they be recorded?
They are a deferred charge (asset) that is amortized as interest expense
How do discounts, premiums, and issue costs affect the bond’s book value for the issuer?
Discounts decrease the bond’s book value
Premiums increase
Bond issue costs decrease
How do you calculate the gain or loss on the early retirement of bonds?
Book value
- amount paid to retire
= gain (loss)
How are bonds with detachable stock warrants recorded?
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
For bonds with detachable stock warrants, how are the warrants classified?
Paid-in capital
What provides a complication for the journal entries of detachable stock warrants?
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
What are the journal entries used by the borrower when stock warrants are exercised?
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)
What are the journal entries used by the investor when stock warrants are exercised?
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)
What are convertible bonds?
Bonds that can be converted to stock
What is a big accounting difference between convertible bonds and bonds with detachable stock warrants?
No value is assigned to the conversion feature, since the debt cannot be separated from the conversion feature. Thus, nothing is added to equity.
What is the same about the book value and market value methods for convertible bonds?
Both remove the bond’s book value (including premium or discount) and credit the common stock at par value
What is the book value method for converting convertible bonds?
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
How are conversion costs accounted for in the book method?
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
What is the market value method for converting convertible bonds?
Credit (or sometimes debit) APIC for the difference between stock par value and stock fair value
Bond’s BV
- Stocks’ FV
= Gain (loss)
What is induced conversion?
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
How should induced conversions be recorded?
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
Are registered bonds considered secured or unsecured?
Unsecured
