CH14: Bond and LT. Notes

Question 1

As a general rule in accounting for liabilities, what is effective periodic interest?

Answer 1

It is the effective interest rate times the amount of the debt outstanding during the interest period.

Question 2

What is a bond indenture?

Answer 2

It describes the specific promises made to bondholders.

Question 3

List and briefly describe the various types of bonds!

Answer 3

1. Debenture bonds: secured by the “full faith and credit “ of the company ONLY. No collateral.
2. Mortgage bonds: backed by a lien on property.
3. Subordinated debenture: last to receive any liquidation payments.
4. Coupon bonds: the holder of the coupon gets the interest payments, regardless of whether he owns it or not.
5. Registered bonds: the owner is registered w/ the company and solely receives interest payments.
6. Callable bonds: gives the right to issuers to call/buy back the bond before maturity.
7. Serial bonds: retires a bond on a piece-meal basis (aka in structured installments).
8. Convertible bonds: bonds holder could convert them to stocks

Question 4

Determining bond prices:

a. If coupon rate > market rate
b. If coupon rate< market rate

Answer 4

a. Premium

b. Discount

Question 5

What is zero-coupon bond, and who benefits from it and who invests in it?

Answer 5

it is a bond that doesn’t pay interest, instead it offers discount from the face amount.
It benefits the issuer, since they deduct for tax purposes the annual interest expense although they don’t pay it, until maturity,
It disadvantages the creditor since they pay taxes on interest revenue although they don’t receive it until the bond matures.
Usually tax exempt funds, such as pension funds and IRAs, invest in it.

Question 6

Straight-line method in accounting for interest expense or revenue:

Answer 6

basically determining the discount or premium and dividing it by the period. This yields a single constant amount of interest each period. It is faster and easier. yet not applicable if the difference between the amortization and straight-line method is material!

Question 7

Debt issue costs are:

Answer 7

recorded as an asset (Debt Issue Costs) separately and are amortized over the term of the related debt. (such costs are: legal, accounting fees, and printing)

Question 8

Why is it less likely to have premiums and discounts on notes, as opposed to bonds?

Answer 8

Because the stated rate is more likely to equal the market rate because the rate is negotiated at the time of the loan.