Bonds

Question 1

Current Portion of LT Debt

Answer 1

Serial Bonds will have many more times where Current portion is bifurcated than a Bullet (Single Maturity Bond).

Question 2

Debenture

Answer 2

UNSECURED Loan

Question 3

Bond Issue Costs

Answer 3

? - where are Bond issue costs reported if not interest expense - ?

These costs include legal costs, printing costs, and promotion costs.

They are capitalized as a noncurrent deferred charge (asset account) and amortized to expense over the term of the bonds using the straight-line method. The rationale for capitalization is that the issue costs will provide benefits the entire bond issue. This is an example of the matching concept. The costs are not netted against the proceeds. Like accrued interest, bond issue costs have no effect on the premium or discount recorded.

REVIEW: issues where receive less funds (Origination fee) etc….

Question 4

Period of Amortization

Answer 4

The period over which bond discount or premium is amortized is the period from bond issue date to maturity date, even if the firm contemplates retiring the bonds early.

Question 5

KEY Bond Dates

Answer 5

NEEDS REVIEW

Maturity Date, Issue Date, Bond Date, Bond Term

Question 6

Effective Interest Rate

Answer 6

AKA Market Rate

The price of a bond issue is the present value of the face value and interest payments using the effective interest rate.

Question 7

Key information not listed in the Bond

Answer 7

Issue Date and Market Rate of Interest

Question 8

Effective Interest Method for Interest Expense

Answer 8

Under the effective interest method, interest for a period is the product of the yield rate and the book value at the beginning of the period.

Question 9

PV vs. FV

Answer 9

The future value of $1 is the reciprocal of the present value of $1. The $10,000 invested therefore will accumulate to $10,000(1/.826) = $12,107 in two years.
Another calculation leading to the same result is $10,000(1.10)(1.10) = $12,100 (discrepancy due to rounding of the present value factor).

Question 10

Interest

Answer 10

When debt is issued at a discount from face value, the firm receives an amount less than face value but must pay the face value at issuance.
Interest is defined as amounts paid to service debt over and above the amount borrowed. For example, a $1,000 face value bond issued for $940 creates a $60 discount. The firm must pay the cash interest required over the bond term and $1,000 face value at the end of the term.

Question 11

What type of bonds in a particular bond issuance will not all mature on the same date?

Answer 11

Serial bonds mature according to a schedule. For example, after 20 years, 10% of the bonds may be retired at the end of each of the next 10 years. The bond term ends at the end of the 30th year.

Question 12

Bond Price

Answer 12

The bond price is the present value of the future cash payments to be paid by the issuer over the bond term. These payments are (1) the face value paid at maturity and (2) the interest payments. Each interest payment is the product of the coupon rate for the appropriate portion of a year (usually six months) and the face value. The stream of interest payments is an annuity. Both the single payment (face value) and the annuity are discounted at the yield or market rate of interest. The result is the bond price.

Question 13

Interest Payable

Answer 13

WATCH for questions that want Interest Payable and not Interest EXPENSE

Face value of the bonds at the beginning of the period by the contractual interest rate.

Face stays the same, but would depend on Number of bonds outstanding etc.

Question 14

Types of Bonds

Answer 14

NEEDS REVIEW

Term Bonds etc.

Question 15

Term Bonds

Answer 15

Both the registered debentures and collateral trust bonds are term bonds. A term bond matures on a single date. Although the bonds may be called or converted, these events may not occur, in which case they would be retired all on one date.
The subordinated debentures are serial bonds that mature in $30,000 amounts beginning 1997. They do not all mature on the same date.

Question 16

Setting up Bond Amort Table

Answer 16

Carrying Amount (PV) is used to get Interest Expense (Beg x Market Rate).

Question 17

Issue Price for a $1000 Bond

Answer 17

The issue price for one $1,000 face value bond is the present value of all future payments discounted at the yield rate of 9%.

Issue price = $1,000(.422) + .06($1,000)(6.418) = $807

Question 18

Accrued Interest and Dates

Answer 18

The net book value of the bonds on the issuance date is $388,000 (.97 x $400,000). The three months of accrued interest collected on issuance increases the proceeds but does not affect the net bond liability. Accrued interest is reported separately from the net bond liability.

Bond Date is when Interest starts accruing (? - always a Interest Pmt Date - ?)

Question 19

Sinking Fund

Answer 19

The sinking fund requirement is not a current maturity, but it is a payment that is required to be added to an investment account.

Question 20

SL vs. Effective Interest Amortization

Answer 20

The SL method recognizes the average amount of discount amortization every period, which must be larger than under the effective interest method early in the bond term. Thus, interest expense under the SL method results in higher interest expense, lower retained earnings, and higher bond carrying value because more discount is amortized early in the bond term than under the effective interest method

Question 21

Serial Bonds

Answer 21

Serial bonds mature serially according to a schedule set in the bond contract. At each date, a portion of the bond issue is paid off (matures) until the entire face value of the issue is retired. Each portion is a percentage of the total face value of the issue. Serial bonds are designed to reduce the risk, to the bondholder, of default by the issuing firm.

Question 22

Accrued interest on a bond issue is the interest computed between bond date and issue date.

Answer 22

NEEDS REVIEW

Question 23

Accrued Interest

Answer 23

When bonds are issued between interest dates, the total cash received by the company issuing the bonds will be equal to the selling price of the bonds plus interest accrued since the last interest date. This sum is called the proceeds. The accrued interest computation uses the stated rate.

The purpose of collecting accrued interest from the bondholder on issuance (if the bond is issued between interest dates) is to facilitate the trading of bonds and to guarantee that the bondholder receives interest only for the period of time the bonds are held. By requiring the investor to pay for the interest accrued since the last interest date, the issuing company can issue “full” interest checks to all bondholders at the next interest date.

Question 24

Accrued Interest

Answer 24

When bondholders sell bonds to other investors on the bond market, there is no effect on the firm’s accounting. The buyer pays the seller for accrued interest since the last interest payment date.

The issuance of bonds between interest dates affects the entry for issuance. Accrued interest payable is credited for the interest collected from the bondholders and cash is increased by this amount. There is no interest expense recognized at this point because the bond term has just begun. Accrued interest has no effect on the premium or discount to be recorded.

The interest expense entries under the straight-line method also are affected. The bond term reflects a shorter period of time.

Question 25

Accrued Interest vs Interest Expense Accrual

Answer 25

NEEDS REVIEW

Question 26

A bond is issued October 1. The bond pays interest each August 31 and February 28. Accrued interest on the issue consists of one month’s interest.

Answer 26

TRUE. Key is to know the Bond Interest Payment Dates.

JET: this means the “:Bond Date” is Sept 1 (day after Aug 31)? Either way, will get 6 mos interest on Feb 28, but has only earned 5, so must pay for 1 month accrued interest at purchase.

Question 27

Accrued Interest KEYS

Answer 27

Based off Stated Rate and Face Value (not Book or Price) just like what CASH INTEREST is based off of.

Separate from Disc / Premium

Question 28

Asset vs Liability

Answer 28

Increase in FV of Bond causes a “loss” as Liability is now larger.

Bond Issue Costs are an Asset, so any write off would INCREASE the loss from early extinguishment.

Question 29

How many months of interest are collected at issuance when bonds are issued between interest dates?

Answer 29

Number of months between the most recent interest payment date and the date of issuance.

Question 30

Bond Term

Answer 30

Issuance Date to Maturity Date

Will be less than original Term of say 8 years and could be say 94 months and not 96.

Question 31

BOND DATE

Answer 31

NEEDS REVIEW

JET: it doesn’t matter? Just need Issue Date and Int Payment Dates….?

The total proceeds on the bond issue equal the total bond price plus accrued interest. The latter amount is the cash interest between the bond issuance date (April 1, 2004), and the most recent interest payment date before the bond issuance date (November 1, 2003), a period of 5 months.

The most recent interest payment date in this case is the bond date.

Question 32

Net Proceeds and Issuance Costs

Answer 32

The price at which bonds sell is calculated as the present value of the principal amount plus the present value of the bond interest payments; both are discounted using the market rate of interest appropriate for the bonds. (The market rate of interest is also the effective rate or the interest rate the bonds will yield.) The bond issue cost will be deducted from the gross proceeds to determine the net amount to be received by the issuer.

Question 33

On November 1, 2005, Mason Corp. issued $800,000 of its 10-year, 8% term bonds dated October 1, 2005. The bonds were sold to yield 10%, with total proceeds of $700,000 plus accrued interest. Interest is paid every April 1 and October 1. What amount should Mason report for interest payable in its December 31, 2005 balance sheet?

Answer 33

One month of accrued interest was collected from the bondholders at issuance for the period October 1 - November 1, and interest for the next two months to December 31 was accrued.

Question 34

KEYS to Date Issues

Answer 34

Count whole months to not get confused by 1st or 31st.

Question 35

Bond Issue Cost Amortization

Answer 35

Total months based on the Term (Issue to Maturity) and how many months since Issue Date to B/S Date for that years expense to recognize.

Question 36

Bond Liability vs. Bonds Payable

Answer 36

Liability should be Net of Disc / Prem, but Bonds Payable is that Account (Gross) before the Contra Account of Disc / Prem.

Question 37

Net Cash Receipts and Proceeds from Bond Issue

Answer 37

JET: is Net Receipts different from Proceeds as Proceeds is Price + Accrued Interest, but Net Receipts is less Issue Costs.

The net cash receipts from the bond issue equals the total bond price plus accrued interest between the bond date and the issue date less the bond issue costs. Accrued interest is collected from the bondholders for two months because they will be paid six months of interest on July 1

Question 38

Reported Interest Expense vs Paid Interest vs Accrued Interest

Answer 38

The bonds have been outstanding seven months by the end of 2004. The firm has borrowed money for seven months. Therefore, seven months’ interest should be recognized in 2004.

Only six months of interest was PAID in 2004 because the bonds were issued after April 1 (one of the two interest payment dates per year), but that is not what the question asks.

Question 39

FV Option on Bonds

Answer 39

In IFRS, can not be chosen arbitrarily for a specific bond.

Question 40

Convertible Bonds

Answer 40

Conversion feature ignored until actually converted via Book or Market Method.

Book: Transfer Bond balances to Stock balances with no Gain / Loss

Market: Bond Balances Closed and Stock Balances Credits with Market Value and Gain / Loss for difference.

Gain / Loss recorded in ???

Question 41

What amount is allocated to owners’ equity on issuance of convertible bonds that can be settled in cash?

Answer 41

Issuance price less the present value of the bonds using the prevailing rate on similar bonds.

Question 42

What is the accounting treatment by the issuer for additional consideration paid to induce conversion of convertible bonds?

Answer 42

Recognize expense for the fair value of the additional consideration.

Question 43

What is the accounting treatment for convertible bonds with a beneficial conversion feature?

Answer 43

The excess of fair value of the stock to be issued upon conversion (measured at the date of issuance) over the face value of the bonds, is allocated to owners’ equity.

Question 44

Convertible Bond Liability Measurement

Answer 44

There is no method of objectively determining the value of the conversion feature for a convertible bond. The conversion feature is not separable as is the case with detachable stock warrants.
Thus, the entire proceeds are allocated to the bond liability, which in this case includes a premium.

Question 45

Convertible Bonds with Common stock exceeding Bond Carrying Value.

Answer 45

When bonds are converted to stock and accounted for by the book value method, the owners’ equity is increased by the book value of the bonds.
There is no gain or loss because the book value of the bonds is simply transferred to the stock accounts. Common stock, and additional paid in capital are increased if necessary.

If the total par of common stock issued exceeds the book value of the bonds, then retained earnings is decreased. Retained earnings can never be increased on conversion.

Question 46

Convertible Debt vs. detachable warrants

Answer 46

In contrast to stock issued with detachable warrants, bonds convertible to stock are recorded the same way as nonconvertible bonds. The conversion feature is not separable at the issue date; there is no known market value for the conversion feature. Therefore, no value is assigned to the conversion feature at issuance.

Question 47

Convertible Bonds: Book vs Market

Answer 47

Under the book value method, the book value of the bonds converted is transferred to the common stock account and additional paid-in capital. No gain or loss is recorded. The market value of the stock issued on conversion is not used in the recording of the stock.
Under the market value method, the stock issued is recorded at its market value. The bonds were issued at a small premium, a portion of which has been amortized. The stock issued has an aggregate par equal to the face value of the bonds.

The stock’s market value is much higher than its par value. Thus, the bond carrying value is considerably less than the market value of the stock issued according to the information in the question.

Therefore, the recorded value of the common stock and additional paid-in capital of the stock issued exceeds the book value of the bonds, causing a loss to be recorded.

Question 48

Convertible Debt Market Value Method

Answer 48

KEY: issuing stock to retire debt so if have to issue more stock in $ to retire the Carrying value of the debt then must have a loss. Gain for Holder of the Bonds (above water).

Total Equity side of transaction is the Market Value Total (Bonds x Price x shares per Bond) then split into Common (Par or Legal) and then APIC plug.

Bond side of entry is the same with Loss for difference.

Question 49

FV Allocation on Bonds with Detachable Warrants

Answer 49

Both TRUE -

1. When the market values of both the bonds and detachable stock warrants are known, the allocation of total bond price is based on relative market values.
2. When only one of the market values is known, that market value is the allocation to the relevant security, and the allocation to the other security is the remaining amount of the price to allocate.

Question 50

KEYS to Detachable Warrants

Answer 50

Break out Accrued Interest first.

Have to allocate some value to the Warrant, so even if issued at Premium, the Credit to Equity (Warrants) for that Value may result in bonds being booked at a discount (i.e. at a Premium BECAUSE of the Warrants).

Question 51

Bonds with Detachable Warrants: only one FV known

Answer 51

Only the warrants have a known market value. Therefore, that value is allocated to the warrants.
Had both the warrants and bonds (without warrants) been quoted, then the issue proceeds would be allocated based on relative sales value.

When the market value for only one of the two securities is known, the known market value is allocated to that security, and the proceeds less this market value is allocated to the other security.
In this case, the market value of the warrants is known, but the market value of the preferred is not. Therefore, the preferred stock is recorded at the total amount of the proceeds from the entire issue, less the total market value of the warrants.

Had the market value of both securities been known, then the total proceeds would have been allocated based on the relative fair values of the securities.
Bonds sold with detachable stock warrants. The price per bond is $1,019. Only the warrants have an established market value after the issuance. The total market value of the warrants for one bond is $39. Therefore, each bond will be recorded at $980.

Question 52

Main Co. issued bonds with detachable common stock warrants.
Only the warrants had a known market value. The sum of the fair value of the warrants and the face amount of the bonds exceeds the cash proceeds.

Answer 52

Receive less Cash, so Bonds must be at Discount.

Question 53

Detachable Warrants: Relative FV Allocation

Answer 53

1. Need TOTAL FV (Market) Value of Bonds and Warrants.
2. Alllocate the Bond % above to the Bond Price (Proceeds after adj for acc. int).
3. Compare to Face to get Prem / Disc

Question 54

On July 28, Vent Corp. sold $500,000 of 4%, eight-year subordinated debentures for $450,000. The purchasers were issued 2,000 detachable warrants, each of which was for one share of $5 par common stock at $12 per share. Shortly after issuance, the warrants sold at a market price of $10 each. What amount of discount on the debentures should Vent record at issuance?

Answer 54

The market value of the detachable warrants at issuance is allocated to owners’ equity, with the remainder of the proceeds being allocated to the bonds. The value of the warrants is 2,000 x $10 = $20,000. This leaves $430,000 ($450,000 - $20,000) to allocate to the bond issue. The total face value of the bonds is $500,000, yielding $70,000 of discount (($500,000 - $430,000).

Question 55

Blue Co. issued preferred stock with detachable common stock warrants at a price which exceeded both the par value and the market value of the preferred stock.
At the time the warrants are exercised, Blue’s total stockholders’ equity is increased by the

Answer 55

When the preferred stock was issued, a portion of the proceeds was allocated to an owners’ equity account for the warrants. When the warrants are exercised, this account, which holds the carrying value of the warrants, is closed.

Cash is increased, and common stock (and possibly contributed capital in excess of par) also is increased to account for the issuance of stock. The net effect on owners’ equity of the exercise is, therefore, the amount of cash received.

Question 56

Bonds with detachable stock warrants were issued by Flack Co. Immediately after issue the aggregate market value of the bonds and the warrants exceeds the proceeds.
Is the portion of the proceeds allocated to the warrants less than their market value, and is that amount recorded as contributed capital?

Answer 56

Because the total market value of the bonds and warrants exceeds the proceeds, and the allocation of the proceeds is based on the relative fair values of the bonds and warrants, a smaller amount (the portion of the proceeds) than market value is allocated to each security. The amount allocated to the warrants is recorded in an OE account such as detachable stock warrants outstanding.

Question 57

On December 30, 2004, Fort, Inc. issued 1,000 of its 8%, 10-year, $1,000 face value bonds with detachable stock warrants at par.
Each bond carried a detachable warrant for one share of Fort’s common stock at a specified option price of $25 per share. Immediately after issuance, the market value of the bonds without the warrants was $1,080,000, and the market value of the warrants was $120,000.

In its December 31, 2004, balance sheet, what amount should Fort report as bonds payable?

Answer 57

The proceeds of the issue ($1,000,000 because the bonds were issued at par) is allocated based on the relative fair values of the two securities. The total market value of the two securities after issuance is $1,200,000 ($1,080,000 + $120,000). The allocation to the bonds is then $900,000 [($1,080,000/$1,200,000)$1,000,000].

Question 58

Refinancing CL into NCL

Answer 58

IFRS - must do before B/S Date not just before Financials issued.

The firm must also be able to refinance the obligation and demonstrate that ability before the issuance of the financial statements. There are three ways to meet this requirement. Each must occur in the period between the balance sheet date and the date the financial statements are issued or are available to be issued, if the liability is to be reclassified as noncurrent.

a. Actually refinance the liability on a long-term basis. In this case, the firm replaces the current liability with a noncurrent liability.
b. Enter into a noncancelable refinancing agreement supported by a viable lender. The agreement must extend more than one year beyond the balance sheet date. The purpose of the agreement is to refinance the liability on a noncurrent basis.
c. Issue equity securities replacing the debt.

Question 59

Deferred tax Liability classification

Answer 59

The deferred tax liability relating to depreciation is noncurrent. The classification of a deferred tax account is based on the classification of the underlying account, which in this case is a plant asset (always noncurrent).

Question 60

Current Assets used to retire CL

Answer 60

The portion of the note paid between the balance sheet date and the date of issuing the financial statements is classified as current because current assets were used to retire that part of the note.
Even though proceeds from the bond issue may be used to replenish these funds, the $250,000 payment nonetheless reduced current assets. The remainder of the note is classified as noncurrent because the firm fully intends to refinance the remaining $500,000 with a long-term liability, and has shown its ability to do so by actually issuing bonds for the purpose of refinancing before issuing the financial statements.

Thus, the FAS 6 requirements for reclassifying the remaining $500,000 portion of the current note payable as noncurrent have been met.

Question 61

Sinking Fund and Maturities Disclosures

Answer 61

FAS 47 requires the disclosure of the aggregate amount of maturities and sinking fund requirements for all long-term debt for each of the five years following the balance sheet date. The detail for each year is disclosed by the amount of both the sinking fund requirement and the maturity.

Question 62

Disclosures on Refinancings and CL vs NCL

Answer 62

Essentially, as long as the firm actually refinances the liability on a noncurrent basis before issuing the financial statements, or it enters into a non-cancelable agreement to do so (again before issuing the financial statements), then the liability can be reclassified.

The details of the refinancing must be disclosed in the notes. The note is not to be classified as a current liability because it will cause no reduction in current assets or increase in current liabilities during the coming period.

Question 63

DEBT RETIREMENT

Answer 63

OFTEN TESTED

Question 64

KEYS to Debt Retirement

Answer 64

Opposite of Assets (IF Mkt > Book in a Gain Position)

Once have Book Value (Carrying) of Bonds, think what it will take NOW (Current Mkt) to retire them (Int Rates down = prices higher so more cash to retire bonds as need to buy them to retire them. Any DDIC Asset also to be written off reducing gain or increasing loss.

When a liability is retired for less than its book value, a gain is recorded because the firm reduces its liabilities more than the reduction in its cash or other assets used for retirement.

Think of Key Balances impacted by a retirement:

1. Bonds Payable (Book Value of Face plus or Minus Unamortized Premium or Discount
2. Unamortized DDIC (Asset)
3. Gain / Loss = Book less unamort DDIC less Cash
4. Account for outstanding Interest and other normal entries needed BEFORE retirement.

Loss = cash paid − debt book value + unamortized debt issue costs

Gain = debt book value − unamortized debt issue costs − cash paid

Question 65

In substance defeasance

Answer 65

If the debtor firm places assets into an irrevocable trust for the purpose of retiring debt (in-substance defeasance), the liability nonetheless remains on the balance sheet, along with the assets, separately reported. The liability is not extinguished nor is a gain or loss recorded.

Question 66

The CPA exam has previously asked the following type of question in relation to an early retirement of bonds: “In computing the gain or loss on the above bond retirement, the price paid for the bonds is compared to which of the following values?”

Answer 66

This question refers to the computation of the gain or loss. The loss in the above example is the difference between the cash paid to retire the debt and the book value of the debt retired less the unamortized bond issue costs on the portion of the debt retired:

Question 67

Timeline on Amortizing PRem / Discount to get Book Value

Answer 67

Count WHOLE Years and then add in partial; that is if Jan 1 2000 to July 1 2005 it is FIVE YEARS (must amort in Year 2000 as well).

Question 68

On June 30, 2005, Town Co. had outstanding 8%, $2,000,000 face amount, 15-year bonds that matured on June 30, 2015. Interest is payable on June 30 and December 31.
The unamortized balances in the bond discount and deferred bond issue costs accounts on June 30, 2005 were $70,000 and $20,000, respectively. On June 30, 2005, Town acquired all these bonds at 94 and retired them.
What net carrying amount should be used in computing gain or loss on this early extinguishment of debt?

Answer 68

The journal entry for retirement:
Bonds payable	2,000,000	
Bond discount		70,000
Bond issue costs		20,000
Cash .94($2,000,000)		1,880,000
Gain		30,000

Question 69

A 15-year bond was issued in 1995 at a discount. During 2005, a 10-year bond was issued at face amount with the proceeds used to retire the 15-year bond at its face amount.
The net effect of the 2005 bond transactions was to increase long-term liabilities by the excess of the 10-year bond’s face amount over that of the 15-year bond’s:

Answer 69

The proceeds of the second bond issue, which equal the second issue’s carrying value and face value, were used to retire the first issue at that same amount.
However, the first issue has a lower carrying value than the face value because of the unamortized discount. Therefore, the net increase in long-term debt is the amount of the unamortized discount, which also equals the difference between the carrying values of the two issues.

Question 70

A 15-year bond was issued in 1995 at a discount. During 2005, a 10-year bond was issued at face amount with the proceeds used to retire the 15-year bond at its face amount.
The net effect of the 2005 bond transactions was to increase long-term liabilities by the excess of the 10-year bond’s face amount over that of the 15-year bond’s:

Answer 70

The proceeds of the second bond issue, which equal the second issue’s carrying value and face value, were used to retire the first issue at that same amount.
However, the first issue has a lower carrying value than the face value because of the unamortized discount. Therefore, the net increase in long-term debt is the amount of the unamortized discount, which also equals the difference between the carrying values of the two issues.

Question 71

Early Debt Retirement and Interest Payment Dates

Answer 71

NEEDS REVIEW: when do you need to factor in the interest payment dates; i.e. When to record any interest entry or other entry to retirement date before the actual Bond Retirement entries.

Question 72

Early Debt Retirement and Bond Issue Costs (DDIC)

Answer 72

THINK: as if writing off that asset as well. If were calculating gain on some asset, would add any other component asset to figure out NBV for Gain / Loss so do opposite here.

The unamortized bond issue costs reduce the gain because they are an asset that has no further benefit. The write-off simply reduces the gain. Had there been a net loss, the removal of the bond issue costs would have increased that loss.