Bonds & PV tables

Question 1

what is a term bond?

Answer 1

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

Question 2

what is a serial bond?

Answer 2

a bond in which the principal matures in installments

Question 3

what are debenture bonds

Answer 3

unsecured bonds that are not supported by any collateral

Question 4

what is the stated, face, coupon, nominal rate?

Answer 4

rate that is printed on the bond, represents the amount of cash the investor will receive every payment.

Question 5

what is the carrying amount of a bond?

Answer 5

the net amount at which the bond is being reported on the B/S and equals the face value of the bond plus the premium (when the bond was issued above face) or minus the discount (when the bond was issued below face value). it is also called the “book value” or “reported amount.” it will initially be the same as issue price but gradually approaches the face value as time passes since the premium or discount is amortized over the life of the bond.

Question 6

what is the effective, yield or market rate (all mean the same)

Answer 6

the actual rate of interest the company is paying on the bond based on the issue price. the effective rate is often called the market rate of interest or yield.

Question 7

what happens when a bond is issued at a premium?

Answer 7

the effective rate is lower than the stated rate, since cash interest and principal repayment are based on face value, but the company actually received more money than that

Question 8

what happens when a bond is issued at a discount?

Answer 8

the effective rate of interest will be higher than the stated rate since the company must pay cash interest and principal based on a higher amount than the funds actually received upon issuance.

Question 9

what are convertible bonds?

Answer 9

a bond that is convertible into common stock of the debtor at the bondholders option

Question 10

what are callable bonds

Answer 10

a bond which the issuer has the right to redeem prior to is maturity date

Question 11

what are bond covenants

Answer 11

restrictions that borrowers must often agree to

Question 12

when will the effective interest method of bond amortization NOT be used?

Answer 12

when the company elects the Fair Value option for reporting financial assets and liabilities, in particular w/bonds (financial liabilities) are reported @ fair value at the end of each reporting period.

Question 13

what is the journal entry when a bond is issued and the market & stated rate are the same?

Answer 13

bond is issued @ Par
debit- cash
credit- bonds payable

Interest payments

• debit: Interest expense (face amnt X stated rate)
• credit: cash (face amount X stated interest rate on bonds)

** for interest expense calculations; Cash is ALWAYS credited for the same amount each period and it is ALWAYS for the face amount X stated rate of interest

Question 14

what is the journal entry when a bond is issued and the market is HIGHER THAN the stated rate?

Answer 14

the bond is issued at a discount so they will receive less cash.
@ issuance:
“debit” - cash (face amount less discount)
“debit” - discount on bond (amount at PV factor)
“credit”- bonds payable (face amount of bond)

recording of interest expense
debit-interest expense
credit- discount
credit -cash

Note the discount must be amortized over the life of the bond.

remember cash is always the face value X stated amount of interest on the bond

Question 15

what is the journal entry when bonds are issued @ a premium?

Answer 15

debit-cash (face value + premium amount)
credit-premium (amount above face value)
credit-bonds payable (face amount of bond)

same rules apply as w/a bond discount. premium must be amortized over the life of the bond to bring the value down to the face amount

Question 16

when amortizing a discount what happens to interest expense & the amortization amount of the discount?

Answer 16

Interest expense increases each year and the amortization amount increases each year.

Question 17

when amortizing a premium what happens to interest expense & the amortization amount of the discount?

Answer 17

when amortizing a premium the interest expense decreases each year and the amortization premium increases each year.

Question 18

what is the formula for calculating the discount or premium amortization over multiple years?

Answer 18

Year 1:
face amount of bond minus the discount (discount amount -face amount of bond) = the carrying value of the bond

Carrying value is then multiplied by the effective interest rate will equal the interest expense for that year.

interest expense is subtracted from the cash payment of interest which will always be the face of the bond multiplied by the stated interest rate on the bond multiplied by time.

the difference between the interest expense and the cash payment will be the amount of the amortization.

year 2:
the amortization amount is added to the carrying value if it is a discount on subtracted from the carrying value if it is a premium then the process is repeated

Note: the goal is to increase a discount to the face amount of the bond & decrease a premium to the face amount.

Question 19

how do you calculate the present value of the proceeds

Answer 19

two amounts needed

• pv of the face of the bond (face X PV of a lump sum using the effective interest rate)
• pv of the interest as an annuity (face amount X stated interest rate X time = the interest expense. The interest expense amount is then multiplied by the PV of an ordinary annuity rate at the EFFECTIVE INTEREST RATE.

The sum of these two amounts represents the PV of the bonds

Question 20

how is interest paid semi annually calculated?

Answer 20

• # of years multiplied by 2

- the interest rate divided by 2

Question 21

what is compound interest

Answer 21

future values of interest - these look at cash flows and project them to some future date and the formula is as follows:
future value factor (the amount that you use to get the future value) is equal to 1 divided by the present value factor.

for example 10,000(future value factor) X 1/.8265 (1 divided by present value factor)

Question 22

how do you convert from an annuity due (one due at the beginning of the period) to an ordinary annuity (one that is due at the end of the period)

Answer 22

-use the factor from one more period than you need then subtract 1 from that rate

Question 23

how do you convert from an ordinary annuity (one that is due at the end of the period to an annuity due (one due at the beginning of the period)

Answer 23

-use the factor for one LESS period and ADD 1.0 to it.

Question 24

what is the journal entry at the issuance of a bond?

Answer 24

debit- cash (face + accrued interest-bond issuance cost)
debit- bond issuance cost
discount- (plug)
credit- bonds payable
credit - accrued interest payable (face amount of bond X stated rate of interest X time since LAST interest amount was paid)

Question 25

where are bonds payable and unamortized discount/premium reported on the financial statements

Answer 25

-in the NONCURRENT LIABILITIES section

Question 26

what are bond issue cost

Answer 26

**costs directly associated w/the issuance of the bonds are a NONCURRENT ASSET (DEFERRED CHARGE) and are amortized straight line over the period of time the BONDS ARE OUTSTANDING.

• printing and engraving of bond certificate
• legal and accounting fees
• underwriter commissions
• promotion costs
• printing the prospectus

initially recorded as follows:
debit - to deferred bond issue cost
credit - a payable

in year 2:
debit-bond issue expense
credit-deferred bond issue cost

Question 27

what is the journal entry to retire a bond?

Answer 27

-reported as a gain or loss on the income statement as part of CONTINUING OPERATIONS unless determined to be both unusual & infrequent in which case it will be an extraordinary item net of taxes.

debit - bond payable (face amount)
debit - premium @ unamortized amount 
debit - loss (plug)
credit- BIC
credit- Discount
credit- Cash (amnt to retire)
credit- gain (plug)

Question 28

what are convertible bonds

Answer 28

bonds that give the bondholder the option of converting the bond into common stock and are normally ISSUED AT MORE THAN PAR VALUE because of this option. they are treated as a SINGLE SECURITY AND NO VALUE is given to the convertible feature.

Question 29

which method is GAAP when recording convertible bond?

Answer 29

BOOK VALUE method is GAAP & the market value method is not.

Question 30

how are convertible bonds accounted for under the book value method?

Answer 30

all accounts for the remaining balances are eliminated, credit common stock for PAR VALUE, and the plug is APIC

Question 31

bonds w/detachable warrants are accounted for how?

Answer 31

as two separate securities and the VALUE OF THE WARRANT IS INCLUDED IN APIC

Must use the relative FMV approach in order to value each security.

Question 32

what disclosures under GAAP are required for bonds in general?

Answer 32

disclosure about the combined aggregate amount of maturities and sinking fund requirements for all long-term borrowings for each of the next 5 years and in the aggregate.

Question 33

what is the J/E for detachable stock purchase warrants

Answer 33

debit-cash
debit-discount
credit-bond payable
credit-APIC -Warrants

Question 34

how are compound instruments accounted for under IFRS

Answer 34

they are separated into their liability and equity components and the straightline method of amortization is NOT allowed

Question 35

how is BIC accounted for under IFRS?

Answer 35

BIC cost reduce the carrying value of bonds and are amortized under the effective interest method.

Question 36

market price of a bond is accounted for how

Answer 36

the market price of a bond regardless of whether it is issued at a discount or premium, is equal to the present value of all cash flows that the bond represents. this includes the present value of the principal amount and the present value of all future interest payments. the present value is computed using the bonds’s effective rate of interest

Question 37

how is interest payable calculated?

Answer 37

interest payable is calculated by multiplying the face amount of the bonds by the stated rate, which gives the annual payment. divide the annual amount by 12 then multiply by the number of months SINCE the LAST interest payment.

Question 38

How do you calculate the relative fair market value approach when you have bonds w/stock warrants?

Answer 38

Bonds fair value w/o warrants + warrants fair value = total value.
Divide the Bonds FV by the total value to get the % that represents the bonds
Divide the warrants FV by the total value to the the % that represents the warrants.

If you are looking for the bonds payable amount: take the bonds % and multiply it by the total issue price