Bonds and PV Tables

Question 1

Bond - Definition

Answer 1

A bond is a borrowing agreemtn in which the issuer promises to repay a certain amount of money (face/par value) to the purchaser, after a certain period of time (term) at a certain interest rate (effective, yield, market rate).

Question 2

Term Bond

Answer 2

A bond that will pay the entire principal upon maturity at the end of the term

Question 3

Serial Bond

Answer 3

A bond in which the principal matures in installments

Question 4

Debenture Bonds

Answer 4

unsecured bonds that are not supported by any collateral

Question 5

Stated, face, coupon, nominal rate

Answer 5

The rate printed on the bond, represents the amount of cash the investor will receive every payment

Question 6

Carrying Amount

Answer 6

This is the net amount at which the bond is being reported on the issuer’s balance sheet, and equals the face value of the bond plus the premium or less the discount and less any bond issue costs.

It is also called the book value or reported amount. It will initially be the same as issue price, net of issue costs but gradually approaches the face value as time passes, since the premium or discount and the bond issue costs are amortized as an adjustment to interest expense over the life of the bond.

Question 7

Premium

Answer 7

When the bond was issued above the face value or at a “premium”

When the bond is issued at a premium, the effective rate of interest will be lower than the stated rate, since the cash interest and principal repayment are based on face value, but the company acutally received more money than that.

Question 8

Discount

Answer 8

When the bond was issued below face value or at a “discount”

When the bond is issued at a discount, the effective rate of interest will be higher than the stated rate, since the issuer must pay cash interest and principal based on a higher amount thatn the funds actually received upon issuance.

Question 9

Effective Rate, Yield, Market Interest Rate

Answer 9

This is the actual rate of interest the issuer is paying on the bond based on the issue price. The effectve rate is often called the market rate of interest or yield.

Question 10

Issuance of Bonds (JE) Issued at Par

Answer 10

Question 11

Present Value of the Face

Answer 11

Face x

PV of a lump sum using the EFFECTIVE interest method

Question 12

Present Value of the Interest

Answer 12

Annuity

Face x Stated Rate x Time = Interest x PV of an orrdinary annuity at the EFFECTIVE interest rate

• If semi-annual interest is being paid, take the years x 2 and the interest rate/2
  
  • For example, 5 year bonds at 10% semi-annual. USe the PV table for 10 periods at 5%

Question 13

Present Value of Amount (lump sum)

Answer 13

This is used to examine a single cash flow that will occur at a futrue date and determine its equivalent value today. The amount you need to invest today, for how many years, at what interest rate, to get $1 back in the future.

Question 14

Present Value of Ordinary Annuity

Answer 14

This refers to repeated cash flows on a systematic basis, with amounts being paid at the END of each period (aka annuity in arrears).

Bond interest payments are commonly made at the end of each period and use these factors.

Question 15

Present Value of Annuity Due

Answer 15

This refers to repeated cash flows on a systematic basis, with amounts being paid at the BEGINNING of each period (aka annuity in advance). Rent payments are commonly made at the beginning of each period and use these factors.

Rent payments are commonly made at the begining of each period and use these factors.

Question 16

Future Values (Compounded Interest)

Answer 16

These look at cash flows and project them to some future date and include all three variations applicable to present values. This is the amount that would accumulate at a future point in time if $1 were invested now. The future value factor is equal to 1/PV factor.

For example, an ivestment of $10,000 in 2 years at 10% would accumulate to the principal multiplied by the FV factor. In this case the $10,000 x 1/.8265 = $12,100

Question 17

Journal Entry at Issuance

Answer 17

3. Cash (% Face + Accrued Int - BIC)
4. BIC (contra liablity, will be absorbed into discount/premium)
   * 5. Discount (plug, increased by any BIC)*
   * 5. Premium (plug, decreased by any BIC)*
5. Bond Payable (FACE)
6. Accrued Interest Payable (Face x stated rate x time - since last interest paid)

Note: The carrying value of of the bonds is Bonds Payable(1), net of the discount or premium (5), and net of BIC (4).

Question 18

Accrued Interest Payable

Answer 18

A bond isn’t always sold when it is dated. the 8% bond dated 1/1/x1 might not be issued to the public until 4/1/x1. Even so, interest accrues from the date on the bond, so the buyer is immediately credited for 3 months of interest ($1,000x8%x3/12 of a year = $20) and will reeiave a full year of interest ($1,000 x 8% = $80) on 12/31/x1.

To be equitable, the buyer will be required to pay an additonal $20 on 4/1/x1 when purchasing the bond, and the issuer will reprot that amount as accrued interest payable, reported as a current liability. Assume that the bond itself sells for 93, the entry on 4/1/x1 will be:

Cash 950

Unamoritzed discount 70

Bonds Payable 1000

Accr. Int Payable 20

Question 19

Bond Issue Costs

Answer 19

Costs directly associated with the issuance of the bonds are a deduction from the carrying amount (contra liablity) of the bonds and are amortized over the period of time the bonds are outstanding using the effective interest method. As a general rule, BIC are amortized, along with discount/premium, as an adjustment to interest expense. BIC may include:

• Printing and engraving of the bond certificates
• legal and accounting fees
• underwriter commissions
• promotion costs (printing the prospectus)

Question 20

Bond Retirement

Answer 20

Bonds may be called or retired prior to maturity. WHen this happens, it is reported as a gain/loss on the issuer’s income statement as part of continuing operations. The JE is basically the opposite of the original issuance with a plug to balance the entry to gain/loss.

Question 21

Bond Sinking Funds

Answer 21

A fund set up for the retirement of bonds. The balance is treated as a noncurrent asset until the bonds mature. Any interest or dividends are added to the sinking fund balance and reported as income.

Question 22

Bonds with Detachable Stock Purchase Warrants

Answer 22

A warranty is a security that can be sold or exercised by the bondholder, while still keeping the bond. Since its sperable, it is as if two securites were issued, therefore a value must be given to both securities. The value for the warrant is included in APIC.

• if the FMV of both securities is known, the relatve FMV approach is used.
• if the FMV of only one security is known, the other is a Plug
• The amount for warrants is recorded in APIC - Warrants
• if Non-detachable stock purchase warrants, no separate value is given
• if the warrants expire, close them out into APIC

i.e $800 par value of bonds with warrants is issued for $900. The relative FMV of bonds to warrants is 80% bonds, 20% warrants.

Question 23

IFRS vs GAAP

Answer 23