Bonds

Question 1

Secured and unsecured bonds

Answer 1

A secured bond has a claim to specific assets. Unsecured has no such claim and the bond holders are unsecured creditors.

Question 2

Serial Bonds

Answer 2

Bonds that mature at staggered intervals

Question 3

Single maturity bonds

Answer 3

Most CPA problems are this type of bond and it just means a bond with a single maturity date

Question 4

Callable and redeemable bonds

Answer 4

Bonds that can be matured before the maturity date a specified price

Question 5

Convertible and non-convertible

Answer 5

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.

Question 6

For bond problems you’ll need to know:

Answer 6

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

Question 7

Face value

Answer 7

This is usually stated something like 10, $1,000 bonds for a total of $10,000 of bonds.

Question 8

Coupon rate or stated interest rate

Answer 8

This determines the cash interest paid

Question 9

Effective rate or yield rate

Answer 9

This determines interest expense and bond price

Question 10

Interest payment dates

Answer 10

This is usually twice a year

Question 11

Maturity date of bond

Answer 11

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

Question 12

Premium on bonds

Answer 12

Cash proceeds - face amounts

Question 13

Discount on bonds

Answer 13

Face amount - cash proceeds

Question 14

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.

Answer 14

Entry to record bond issue

Cash 97,000
Discount 3,000
Bonds payable 100,000

Question 15

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.

Answer 15

Entry to record the bond issue

Cash $102,000
Bonds payable $100,000
Bond premium $2,000

Question 16

Actual Cash payment

Answer 16

Bond’s stated rate * the face amount

Doesn’t change from payment to payment

Question 17

Portion of discount amortized

Answer 17

Bringing the carrying value of the bond back up to its face amount by the bond’s maturity date

Question 18

Portion of premium being amortized

Answer 18

Brings the carrying amount back down to the face amount by the bond’s maturity date

Question 19

Bond Issue Costs

Answer 19

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.

Question 20

Fair value option for bonds (or notes payable)

Answer 20

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.

Question 21

Increase in fair value

Answer 21

Means a loss: the company owes more

Question 22

Decrease in fair value

Answer 22

Means a gain: company owes less

Question 23

Book value method

Answer 23

At conversion you just transfer the bond balances to stock accounts and no gain or loss is recorded

Question 24

Market value method

Answer 24

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

Question 25

Bonds with Warrants

Answer 25

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.

Question 26

Notes Payable

Stated rate

Answer 26

This is the rate stated in the note and determines the actual cash payment of interest each period.

Question 27

Effective rate or yield rate

Answer 27

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.

Question 28

Discount (Notes Payable)

Answer 28

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

Question 29

Premium

Answer 29

Adjunct account to the note. Is amortized over the life of the note and decreases the liability of the note

Question 30

Debt covenants

Answer 30

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.