Bonds Flashcards
Secured and unsecured bonds
A secured bond has a claim to specific assets. Unsecured has no such claim and the bond holders are unsecured creditors.
Serial Bonds
Bonds that mature at staggered intervals
Single maturity bonds
Most CPA problems are this type of bond and it just means a bond with a single maturity date
Callable and redeemable bonds
Bonds that can be matured before the maturity date a specified price
Convertible and non-convertible
A convertible bond can be converted into stock. Most bond problems will be “regular” bonds that are not convertible, and just have a single maturity date.
For bond problems you’ll need to know:
Issue date Face value Coupon rate or stated interest rate Effective rate or yield rate Interest payment dates Maturity date of bond Premium on bonds Discount on bonds
Face value
This is usually stated something like 10, $1,000 bonds for a total of $10,000 of bonds.
Coupon rate or stated interest rate
This determines the cash interest paid
Effective rate or yield rate
This determines interest expense and bond price
Interest payment dates
This is usually twice a year
Maturity date of bond
Again, if the market rate is greater than stated rate, there is a discount
If the market rate is less than the stated rate, there is a premium
If the market rate is the same as the stated rate, there is no premium or discount
Bond price is the present value of future cash payments discounted at the yield rate
Premium on bonds
Cash proceeds - face amounts
Discount on bonds
Face amount - cash proceeds
Discount example JE
ABC issues $100,000 of 10% bonds at 97. ABC received $97,000 in cash, so there is a discount of $3,000.
Entry to record bond issue
Cash 97,000
Discount 3,000
Bonds payable 100,000
Premium Example
ABC issues $100,000 of 10% bonds at 102. ABC received $102,000 in cash, so there is a premium of $2,000.
Entry to record the bond issue
Cash $102,000
Bonds payable $100,000
Bond premium $2,000
Actual Cash payment
Bond’s stated rate * the face amount
Doesn’t change from payment to payment
Portion of discount amortized
Bringing the carrying value of the bond back up to its face amount by the bond’s maturity date
Portion of premium being amortized
Brings the carrying amount back down to the face amount by the bond’s maturity date
Bond Issue Costs
Reported on the balance sheet as a deduction to the bond carrying amount.
The issuance costs are amortized over the life of the bond to interest expense.
Bond issue costs include accounting fees, legal fees, printing fees, and underwriting fees. IFRS works the same way.
Fair value option for bonds (or notes payable)
A company can elect to record a bond at fair value - the fair value option. The election can never be changed, and it can apply to one or several bonds. The bond is recorded at fair value. The amortization of a premium or discount still applies. Any change in fair value is recognized in earnings as unrealized gains or losses.
Increase in fair value
Means a loss: the company owes more
Decrease in fair value
Means a gain: company owes less
Book value method
At conversion you just transfer the bond balances to stock accounts and no gain or loss is recorded
Market value method
At conversion the stock accounts are credited for the market value of the stock or bonds, the bond accounts are closed, and a gain or loss is recorded for the difference. You’re comparing the market value of the bonds to the market value of the stock, and the difference will be either a gain or loss
Bonds with Warrants
A company can issue bonds that also give the bond purchaser stock warrants (stock rights).
Both the bonds and the warrants need to be allocated a value. If the fair value of both the bonds and the warrants is known, then allocate the total bond price in proportion to the fair values
If only one fair value is known, you assign the fair value to that security and allocate the remaining bond price to the other security. When allocating a value to the warrants, this is recorded in equity, not debt.
Notes Payable
Stated rate
This is the rate stated in the note and determines the actual cash payment of interest each period.
Effective rate or yield rate
Market rate of interest. If the note is to be reported at present value, then you use the effective rate.
When the effective rate is bigger than the stated rate, the note is issued at a discount. When the effective rate is lower than the stated rate, the note is issued at a premium.
A discount is a contra account to the note. A discount is amortized over the life of the note and the discount increases the liability of the note.
Discount (Notes Payable)
A discount is a contra account to the note. A discount is amortized over the life of the note and the discount increases the liability of the note
Premium
Adjunct account to the note. Is amortized over the life of the note and decreases the liability of the note
Debt covenants
These are when a creditor gives a debtor specific covenants that they have to meet. These are usually financial ratios that the debtor has to stay within a certain range of, for example, total liabilities to tangible net worth.
If the debtor falls out of covenant, there are penalties such as the debt being due immediately.
