Chapter 14- Bonds Flashcards
what is a bond
written promise to pay par value and interest
par value
(face value)- amount paid at maturity
interest
annual simple contract rate nominal rate coupon rate -paid semiannually, annually, or quarterly. I=PRT
advantages of bonds
- doesnt effect share holders equity
- increase return on equity
- interest is tax deductible
disadvantages of bonds
- require payment of interest and par value at maturity
- decrease return on equity
types of bonds
secured unsecured term serial registered bearer convertible callable redeemable
issuing bonds
- sold to underwriter who sells to public/ investors
- must be approved by board of directors and shareholers
bond indenture
legal document that identifies rights and obligations of bond and bondholders
Pricing of bonds
fair value uses market value effective interest rate
-the issue price of a bond is equal to the present value of the bonds future cash payments calculated using market interest rates
Market price of a bond
Equal to (at par)
less than
or more of face value
above market rate bond sells at?
premium which is greater than 100 % if face value
Equal to market price, bond sells at?
at par 100% of face value
below market rate, bond sells at?
a discount less than 100% of face value
at par issuance share entry
dr cash
cr bond payable
interest payment journal entry
dr bond interest expense
cr cash
Journal entry of maturity date of bond
dr bonds payable
cr cash
issuing bonds between interest dates
-bonds sold at a date other than interest payment date, the purchaser pays the purchase price and the interest.– the issuing company repays back the interest on the next interest date.
Journal entry for issuing bonds between interest dates
Dr cash
cr bonds payable
cr interest payable
Interest date
Dr interest payable
dr bond interest expense
cr cash
issuing bond at a discount, what does it mean?
- below market rate, so the contract rate is below market rate- you pay lower interest payments that what the market says therefore you give the purchaser a discount
- Market rate> contract rate
- purchaser pays less than face value
How to determine issue price if market rate is greater than contract rate (discount) with table
issue price= pv of principle x pv interest payments
cashflow\table\table value\ amount\ pv
par value
interest payments
- first interest payment = par value x contract rate x fraction of year then multiply that by number of payments
how to determine issue price using financial calculator
- determine interest payment use face value x contract rate x fraction of year
then use the interest payment in an annuity and use calculator to solve for present value - using calculator
fv= face value n=number of payments
i/y= market rate p/y= number of pmts per year
pmt= amount you already calculated
compute pv
balance sheet presentation of bond at discount
non-current liabilities
bonds payable, 8% due dec 31 2024
less: discount on bonds payable
The book value is the CARRYING VALUE
effective interest method
-allocates discount and interest over life of bond.
discount expensed over each period
*uses market rate on issue date
1. calculate periodic interest amount using contract rate, this is the cash paid to the purchaser and its face value x contract rate x time period
2. periodic interest expense = carrying value x market rate x fraction of year
periodic interest expense vs cash amount paid to interest rate
periodic interest expense > cash amount paid
this is because you credit discount on bonds payable, the discount is paid when you pay the face value therefore you only pay the purchaser the regular amount of interest you just allocate the discount as an expense with the interest
amortization table
period ending/ cash interest payment/ period interest expense/ discount amortized/ unamortized discount/ carrying value
Entry for issuing bond at discount
dr cash
dr discount on bond payable
cr bonds payable
entry for interest expense (discount)
dr bond interest expense
cr `discount on bond payable
cr cash
Year end interest accrual (discount)
dr bond interest expense
cr discount on bonds payable
cr interest payable
Year end interest accrual payment (discount)
Dr interest payable
dr bond interest expense
cr discount on bonds payable
cr cash
