Chapter 14: Long-Term Liabilities Flashcards
What is a bond?
Debt security with two promises: promise to pay back amount borrowed after some period of time (principal) and a promise to make periodic interest payments
How are cash flows from a bond determined?
From the face amount of the bond and the stated rate of interest
How is a bond’s value/price determined?
From the present value of the future cash flows
Secured vs. Unsecured Bonds
Unsecured bonds are debentures and are more risky (no form of collateral), Secured bonds have collateral
Term vs. Serial Bonds
Term bonds (scheduled payments), serial bonds (stagger payments)
Callable Bonds
At the option of the company, principal can be paid early making it less attractive to investors
Convertible Bonds
At option of investor, exchange the bond for some other security
Commodity-backed bonds
At investor’s option, can take payment of principal in commodity
Deep discount bond
Issued at interest rate significantly less than market rate
Registered vs. Coupon Bonds
Registered (know who should be paid), Coupon (anyone who holds bond can redeem it)
Income vs. Revenue Bonds
Income (only pay interest when have income), Revenue (government bonds that guarantee revenue of some project and only paid when revenue is made on that project)
What drives the price at which debt is issued?
The market rate of interest plus risk
What is the price of a bond?
The present value of future payments of principal and interest discounted at the market rate of interest on day of issue
Formula for Bond Proceeds/Price
PV of single amount + PV of annuity
When is a bond issued at a discount?
When the bond is issued at a price below its face value, market rate of interest is higher than the coupon rate
When is a bond issued at a premium?
When a bond is issued at a price above its face value and the market rate of interest is lower than the coupon rate
Calculation of discount or premium on bond
Face value - Proceeds = Discount, Proceeds - Face Value = Premium
Recording of bond being issued at discount/premium
Discount on Bonds payable (contra account) debited, Premium on bonds payable (adjunct account) credited
How are bonds recorded on the books?
At their face value
Calculation of Book Value of Bond
Face Value +/- Premium/Discount
How are premiums and discounts amortized?
Using the effective interest method
Calculation of interest expense
Book value of the bond x the market rate of interest at issue date
Calculation of amortization of the discount or premium
Cash interest paid - Interest Expense
Method used when apportioning interest between periods
Straight Line Amortization (Number of months in the period/Months between payments)
What is the market value of bonds at any point a function of?
Time remaining and market rate of interest
Debt extinguishment
Paying off bond early
Recording of debt extinguishment
Accrue interest to date of exchange, Bring amortization schedule up to date, and recognize gains and losses
Process of debt being exchanged for non-cash assets
Value asset at discounted value of debt principle and interest unless there is a high degree of certainty about FMV of asset
Are are notes payable valued?
At the present value f their future interest and principal cash flows
How are discounts and premiums on notes amortized?
Over the life of the notes
Deep discount notes
Bear no interest and are sold at discount substantially below principal amount
Recording of deep discount note
Note recorded for principal value and discount for different in principal amount and proceeds
How is the discount on notes payable amortized?
Using the effective interest method
Recording of notes issued for property with stated interest rate
Record property at the PV of the note
Recording of notes issued for property with no interest rate
Record property at fair value of asset and record discount for difference between fair value of asset and face value of note
Installment notes
Payment consists of part principal and part interest
Recording of installment notes
recognize interest expense and amortize principal at each payment
How are installment notes amortized?
Directly, no premium or discount account
