Bonds and Debt Restructuring 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 Engraving; Printing; Legal; Underwriter; Registration
Debited to a deferred charge account and amortized over life of Bond using S/L
Bond Proceeds - Bond Issuance Costs = Net Bond Proceeds
Time of amortization begins when issued
How are bonds amortized under the interest method?
Both discount and premium amortization amounts increase each year
(GAAP accepted method of amortizing discounts and premiums)
Describe the book value method when converting from bonds to stocks.
No gain or loss recognized
APIC is the plug for the difference between the Bond’s Book Value and the Par Value of the Common Stock
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 total cash that seller receives will be MORE than they normally would (set aside any considerations for premium or discount; they are irrelevant for this point).
Basically; the purchaser of the bonds must give the bond issuer the amount of accrued interest up front.
When does interest expense start accruing on a bond?
When the bonds 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
What are convertible bonds? Which recording method is used?
Bonds that can be converted to stock
Book value method used if no gain or loss
Market value method used if there is a gain or loss
The interest rate on convertible bonds are typically lower than non-convertible bonds
How is the retirement of bonds recorded?
Gain or Loss on the Income Statement as part of Continuing Operations, unless both unusual & infrequent, then reported as extraordinary item
When is a gain recognized in a debt restructuring?
If terms are modified; and future payments are now less than the carrying amount of the debt; then a Gain is recognized
What is the gain recognized under a settlement of debt?
Gain recognized:
Difference between cash paid and carrying amount of debt
Difference between non-cash asset given and re-valued at FMV and debt carrying amount
For a creditor; how is a loan impairment recorded?
If future cash flows discounted at loan’s Effective Interest Rate are less than Carrying Value:
Effective Rate calculated using original rate; not modified rate
What is the carrying amount of a bond?
Net amount at which the bond is being reported on the balance sheet
FV + premium or - discount
AKA “Book Value”
Initially the same as issue price, but gradually approaches the FV as time passes since premium/discount is amortized over life of bond
Callable Bond
A bond which the issuer has the right to redeem prior to maturity
Covenants
Restrictions that borrowers must agree to
If an entity chooses not to elect the FV method to value its bonds, how is the bond and premium/discounts reported?
Bond is recorded at issue price
The effective interest method is used to amortize the discounts/premiums
If an entity chooses to elect the FV method to value its bonds, how are the bonds recorded?
Bonds are reported at FV at the end of each reporting period, and the resulting gain or loss is reported in earnings.
3 ways to restructure debt:
- Transfer of Property
- Equity Interest in the Debtor is Issued
- Modification of Terms
When restructuring debt with a Transfer of Property, how do the debtor and creditor record this?
Debtor:
Difference between the CV of debt and FMV of the asset giving up = Ordinary Gain/Loss or Extraordinary Gain
Creditor:
Records new asset at FMV and recognizes an Ordinary Loss
When restructuring debt with Issuing Equity Interest in the Debtor - how is this recorded?
Equity is recorded as if issued for FMV
Difference between the CV of the Debt and the FMV of the Equity - Gain
How can you restructure debt by modifying the Terms?
- Reduction of the interest rate
- Extension of the Maturity Date
- Reduction of the Face amount and Accrued Interst
If future payments < Obligation : Gain to Debtor and Ordinary Loss to Creditor
If future payments > Obligation: No Gain/Loss; Considered an adjustment to the interest rate
Under IFRS, how is the debt portion of convertible bonds shown in the financial statements : equity or a liability?
Bonds are shown as a liability at the PV of payments to be made
The remaining is shown as equity
What is the difference between interest payable and interest expense when using the effective interest method to calculate the amortization of a premium or discount on a bond?
Interest Payable is the actual cash payment. (Face x Stated Rate) Interest Expense (CV x Effective Rate)
The difference between the 2 is the amortization of the premium or discount
What is the effect of changing an investment classification from Trading Security to HTM?
No change is reported in Net Income or OCI
The gain or loss would have already been recorded in Net Income
The investment is recorded at the value it was at when it was a trading security even if there were any previous gains/losses on the investment. It is not recorded at it’s original cost. From that point forward it is held at that value and then any discounts or premiums are then amortized.
What is the effect of changing an investment classification from HTM to AFS?
When HTM is reclassified as AFS it should be recorded at it’s fair value. Any change in value should be recorded in OCI.
What is the effect of changing an investment classification from AFS to Trading?
The AFS has already been valued at its FV with changes being recorded in OCI. When it is reclassified as a Trading Security the gain/loss that was recorded in OCI is removed and is recorded in the Income Statement
What is the effect of changing an investment classification from Trading Security to AFS?
Any gain/loss on the trading security has already been recorded in Net Income.
No other changes are to be made at the time of reclassification. The gain/losses will now start to be recorded in OCI.
What is the effect of changing an investment classification from HTM to Trading Security?
An Investment that is HTM is held at it’s original cost. So, when it is reclassified as trading, the investment is then valued at it’s FV and any gain/loss from the original cost is recorded in Net Income.
