Bonds and Debt Restructuring

Question 1

What is a serial bond?

Answer 1

Any bond that matures in installments

Question 2

What is a term bond?

Answer 2

Any bond that matures on a single date

Question 3

What is a debenture bond?

Answer 3

A bond not secured by any collateral

Question 4

What is a sinking fund bond?

Answer 4

Cash is held in a sinking fund for repayment of bond at maturity
5 years of requirements and maturity details should be disclosed

Question 5

What is the formula to calculate proceeds of a bond sale?

Answer 5

Present Value of the principal payment at maturity + Present Value of Interest Payments made = Market Value of Bond Proceeds

Question 6

How is the present value of a bond calculated?

Answer 6

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)

Question 7

Which costs are included in bond issuance costs? How are they recorded?

Answer 7

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

Question 8

How are bonds amortized under the interest method?

Answer 8

Both discount and premium amortization amounts increase each year

(GAAP accepted method of amortizing discounts and premiums)

Question 9

Describe the book value method when converting from bonds to stocks.

Answer 9

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

Question 10

What is the stated rate for a bond?

Answer 10

Rate on the face of the bond

Question 11

What is the market rate on a bond?

Answer 11

Rate that bonds are currently selling for

Question 12

What happens when the bond’s market rate is greater than the stated rate?

Answer 12

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

Question 13

What happens when a bond’s market rate is less than the stated rate?

Answer 13

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

Question 14

How does accrued interest on a bond affect the purchase price?

Answer 14

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.

Question 15

When does interest expense start accruing on a bond?

Answer 15

When the bonds are issued

Question 16

How is an interest payment on a bond calculated?

Answer 16

Cash for payment = Stated rate x Face amount

Question 17

What amount of interest is expensed on a bond interest payment?

Answer 17

Interest expense = effective yield x carrying value

Any difference between expense and cash payment is applied as amortization against premium/discount

Question 18

What are convertible bonds? Which recording method is used?

Answer 18

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

Question 19

How is the retirement of bonds recorded?

Answer 19

Gain or Loss on the Income Statement as part of Continuing Operations, unless both unusual & infrequent, then reported as extraordinary item

Question 20

When is a gain recognized in a debt restructuring?

Answer 20

If terms are modified; and future payments are now less than the carrying amount of the debt; then a Gain is recognized

Question 21

What is the gain recognized under a settlement of debt?

Answer 21

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

Question 22

For a creditor; how is a loan impairment recorded?

Answer 22

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

Question 23

What is the carrying amount of a bond?

Answer 23

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

Question 24

Callable Bond

Answer 24

A bond which the issuer has the right to redeem prior to maturity

Question 25

Covenants

Answer 25

Restrictions that borrowers must agree to

Question 26

If an entity chooses not to elect the FV method to value its bonds, how is the bond and premium/discounts reported?

Answer 26

Bond is recorded at issue price The effective interest method is used to amortize the discounts/premiums

Question 27

If an entity chooses to elect the FV method to value its bonds, how are the bonds recorded?

Answer 27

Bonds are reported at FV at the end of each reporting period, and the resulting gain or loss is reported in earnings.

Question 28

3 ways to restructure debt:

Answer 28

1. Transfer of Property 2. Equity Interest in the Debtor is Issued 3. Modification of Terms

Question 29

When restructuring debt with a Transfer of Property, how do the debtor and creditor record this?

Answer 29

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

Question 30

When restructuring debt with Issuing Equity Interest in the Debtor - how is this recorded?

Answer 30

Equity is recorded as if issued for FMV | Difference between the CV of the Debt and the FMV of the Equity - Gain

Question 31

How can you restructure debt by modifying the Terms?

Answer 31

- 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

Question 32

Under IFRS, how is the debt portion of convertible bonds shown in the financial statements : equity or a liability?

Answer 32

Bonds are shown as a liability at the PV of payments to be made The remaining is shown as equity

Question 33

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?

Answer 33

``` 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

Question 34

What is the effect of changing an investment classification from Trading Security to HTM?

Answer 34

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.

Question 35

What is the effect of changing an investment classification from HTM to AFS?

Answer 35

When HTM is reclassified as AFS it should be recorded at it's fair value. Any change in value should be recorded in OCI.

Question 36

What is the effect of changing an investment classification from AFS to Trading?

Answer 36

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

Question 37

What is the effect of changing an investment classification from Trading Security to AFS?

Answer 37

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.

Question 38

What is the effect of changing an investment classification from HTM to Trading Security?

Answer 38

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.