Bonds Flashcards
Bonds - In the accounting for Bonds which values are fixed and which values are changeable in accordance to the market forces?
Bond Fixed Values:
Stated Interest Rate, Coupon Amount, Face value of Bond.
Bond Variable Values:
Market Interest Rate, Price of bond paid whether a Premium or a Discount, and interest expense.
Bonds - How often is interest accrued and how often is it paid and by what amount ?
Interest is accrued and recorded monthly in the company books.
Interest is paid in the US every 6 months, while in other countries it is paid annually.
Interest payment (coupon payment) is always as stated on the semiannual coupon.
Bonds - When does a Premium occur?
It occurs when the bonds stated rate is higher than the market rate, so it becomes desirable for investors and for that they would be willing to pay a premium for it.
Bonds - When does a Discount occur?
It occurs when the bonds stated rate is lower than the market rate, so it becomes undesirable for investors and for that they would only pay a discount for it.
Bonds - Conceptually what is a Bond Discount ? and for that, state the nature of the account “Discount on Bonds Payable”.
A Discount resembles an ADDITIONAL interest expense (compared to what it would have been if the bond was sold at PAR). This additional expense would be divided systematically over the life of the bond.
“Discount on Bonds Payable” account is a CONTRA account to Bond’s Payable, therefore it has a DEBIT balance (Discount/Debit) “D/D”.
Bonds - Conceptually what is a bond PREMIUM ? and for that, state the nature of the account “Premium on Bonds Payable”.
A PREMIUM resembles a REDUCTION in interest expense (compared to what it would have been if the bond was sold at PAR). This reduction in interest expense would be divided systematically over the life of the bond.
“Discount on Bonds Payable” account is an ADJUNCT account to Bond’s Payable, therefore it has a CREDIT balance.
Bonds -To figure out the PV of the a bond’s maturity value (stated amount), which interest rate “i” would you use, and for what period “n” ?
To obtain the proper factor used to find the PV of a bond’s maturity value, use the same “n” and “i” that you used for discounting the semiannual interest payments.
Bonds - What is the Carrying Value of a Bond Payable and where would that be reported?
A Bond Payable always goes in the internal books at PAR, then it gets matched with its Premium or Discount accounts to make up the Carrying Value.
Bonds Payable are reported on the Balance Sheet at their Carrying Value:
Carrying Value = Face + Unamortized Premium
Carrying Value = Face - Unamortized Discount
Bonds - What are Bond Issue costs and how are they treated under both GAAP and IFRS?
Bond Issue Costs are transaction cost to issue bonds they include legal fees, accounting fees, underwriting commissions and printing.
Under US GAAP, Bond Issue Costs are capitalized as “Deferred Charges” (Asset Account) and then amortized as an expense over the life of the bond using the Straight Line Method.
Under IFRS , Bond issue costs are treated as a reduction of the Liability’s carrying value, and amortized over the life of the bond using the Effective Interest Method.
Bonds - What are the Two methods known to be used for Bond Amortization (Amortization of the Premium or the Discount) ?
1) Effective Interest Method , both under GAAP and IFRS.
2) Straight Line Method , neither GAAP or IFRS, but allowed under GAAP if it results in no material difference in comparison to the effective interest method.
Amortized Amount under Straight Line Method =
Premium or Discount / Number of periods
Bonds - What is the formula to calculate Interest Expense?
Bond Interest Expense = Coupon Payment - Amortized Premium
Bond Interest Expense = Coupon Payment + Amortized Discount
Hint: Under Straight Line Amortization Interest Expense will be Constant every single period ( usually a period is semiannual). Under the effective interest method Interest Expense is variable under each period.
Bonds - From the investor’s side, at what amount would the initial Bond Investment be valuated ?
Initially the “Investment in Bond” account would be valued at purchase price.
Additional Interest Revenue caused by a Discount would be added periodically to the “Investment in Bond” account, till it eventually reaches face value at maturity.
The reduction in Interest Revenue caused by a premium would be subtracted periodically from the “Investment in Bond” account, till it eventually reaches face value at maturity.
Bonds - From the investor’s side, what is the formula to calculate interest revenue?
Bond Interest Revenue =
Coupon Payment - Amortized Premium
Coupon Payment + Amortized Discount
Hint: Under Straight Line Amortization Interest Revenue will be Constant every single period ( usually a period is semiannual). Under the effective interest method Interest Revenue is variable under each period.
Bonds -Under the effective interest method what is the formula for calculating interest expense?
And for that what is the formula for calculating the coupon interest payment ?
Interest expense = Net carrying value x market interest rate
(Income Statement effect)
Coupon payment = Face value x stated interest rate
( Balance Sheet effect)
The difference between Interest Expense and Coupon Payment for the period is the Amortized Amount.
Bonds- list the column titles of an amortization table under the effective interest method?
(Hint- there are 6 of them)
1- Date 2- Beginning Net Carrying value 3- Interest expense for the period 4- Coupon payment 5- Premium or Discount Amortization amount 6- Ending Net Carrying value
