Chapter 2 (Unit 2 Pt 2) Long-Term Liabilities Flashcards
What is the difference between the stated interest rate and the market rate of a Bond?
Stated, coupon, or nominal rate = Rate written in the terms of the bond indenture.
~ Bond issuer sets this rate
~ Stated as a percentage of bond face value (par)
Market rate or effective yield = Rate that provides an acceptable return commensurate with the issuer’s risk.
~ Rate of interest actually earned by the bondholders.
When are bonds issued at a discount?
When are bonds issued at a premium?
If the bond sells for less than face value, they issue at a discount.
If the bond sells for more than face value, they sell at a premium.
a) How do you calculate the amount of interest that is actually paid to the bondholder each period?
b) How do you calculate the amount of interest this is actually recorded as interest expense by the issuer of the bond?
a) Stated Rate x Face Value of the Bond
b) Market Rate x Carrying Value of the Bond
Buchanan Company issues at par 10-year term bonds with a par value of $800,000, dated January 1, 2020, and bearing interest at an annual rate of 10 percent payable semiannually on January 1 and July 1.
a) What is the journal entry on date of issue, Jan. 1, 2020?
b) What is the journal entry to record first semiannual interest payment on July 1, 2020 (and EVERY interest payment date until maturity)?
a) Cash 800,000
Bonds Payable 800,000
b) Interest Expense 40,000
Cash 40,000
[(800,000 * 10%) / 2]
If Buchanan Company issues $800,000 of bonds on January 1, 2020, at 97, and bearing interest at an annual rate of 10 percent payable semiannually on January 1 and July 1.
a) What is the journal entry on date of issue, Jan. 1, 2020?
b) What is the journal entry to record first semiannual interest payment on July 1, 2020 (and EVERY interest payment date until maturity)?
a) Cash 776,000
Discount on Bonds Payable 24,000
Bonds Payable 800,000
[800,000 * 97%]
b) Interest Expense 41,200
Cash 40,000
Discount on Bonds Payable 1,200
[Assuming the use of the straight-line method, $1,200 of the discount is amortized to interest expense each period for 20 periods ($24,000 / 20)]
If Buchanan Company issues $800,000 of bonds on January 1, 2020, at 103, and bearing interest at an annual rate of 10 percent payable semiannually on January 1 and July 1.
a) What is the journal entry on date of issue, Jan. 1, 2020?
b) What is the journal entry to record first semiannual interest payment on July 1, 2020 (and EVERY interest payment date until maturity)?
a) Cash 824,000
Premium on Bonds Payable 24,000
Bonds Payable 800,000
[800,000 * 103%]
b) Interest Expense 38,800
Premium on Bonds Payable 1,200
Cash 40,000
[Assuming the use of the straight-line method, $1,200 of the discount is amortized to interest expense each period for 20 periods ($24,000 / 20)]
Evermaster Corporation issued $100,000 of 8% term bonds on January 1, 2020, due January 1, 2025, with interest payable each July 1 and January 1. Investors require an effective-interest rate of 10%
a) What is the journal entry on date of issue, Jan. 1, 2020?
b) What is the journal entry on July 1, 2020?
c) What is the journal entry on December 31, 2020?
a
Evermaster Corporation issued $100,000 of 8% term bonds on January 1, 2020, due January 1, 2025, with interest payable each July 1 and January 1. Investors require an effective-interest rate of 6%
a) What is the journal entry on date of issue, Jan. 1, 2020?
b) What is the journal entry on July 1, 2020?
c) What is the journal entry on December 31, 2020?
a) Cash 108,530
Premium on Bonds Payable 8,530
Bonds Payable 100,000
[Cash = PV function on calculator;
Bonds Payable = PAR
Premium = Plug]
b) Interest Expense 3,256
Premium on Bonds Payable 744
Cash 4,000
[Cash = 100,000 * 0.08 * (6/12) = 4,000;
Interest Expense = 108,5300.06(6/12); current carrying value = 108,530]
c) Interest Expense 3,234
Premium on Bonds Payable 766
Cash 4,000
[Interest Expense = (108,530 - 744)*0.06 *(6/12); the current carrying value has decreased, it includes the original PV minus the amortization that has already been done]
What happens when a bond is paid off at the maturity date? (3)
-Premium/discount fully amortized
-Carrying amount = face amount (par value)
-No gain, no loss
What happens when a bond is paid off before the maturity date? (3)
- Reacquisition price > Net carrying amount = Loss
- Net carrying amount > Reacquisition Price = Gain
- At time of reacquisition, unamortized premium or discount, and any costs of issue applicable to the bonds, must be amortized up to the reacquisition date
What is a Zero-Interest-Bearing Note?
A company may issue a zero-interest-bearing note instead of an interest-bearing note. A zero-interest-bearing note does not explicitly state an interest rate on the face of the note. Interest is still charged, however. At maturity, the borrower must pay back an amount greater than the cash received at the issuance date. In other words, the borrower receives in cash the present value of the note. The present value equals the face value of the note at maturity minus the interest or discount charged by the lender for the term of the note. In essence, the bank takes its fee “up front” rather than on the date the note matures.
Extinguishment of Debt
On January 1, 2013, General Bell Corp. issued at 95 bonds with a par value of $800,000, due in 20 years. Eight years after the isue date, General Bell calls the entire issue at 101 and cancels it. At that time, the unamortized discount balance is $24,000.
What is the journal entry to record the transaction and compute the loss on redemption (extinguishment)?
Bonds Payable 800,000 (remove account from books)
Loss on Redemption of Bonds 32,000 (plug to compute loss)
Discount on Bonds Payable 24,000 (remove unamortized bal)
Cash 808,000 (800,000 *1.01)
How is a bond priced?
The price of the bond at issuance is the present value of the future cash flows of the principal (PV single sum) plus interest (PV annuity)
When is the Straight-Line method allowed for amortizing the discount or premium to interest expense?
The Straight-Line method is allowed only if results are not materially different from effective interest method.
Bond Issued between Interest Dates
100, 5%, $1,000 bonds are issued at 94. The bonds are dated 1/1/x1 and issued on 3/1/x1. The bonds have an 8 year term and pays interest on June 30 and December 21 of $2,500 ($100,000 x .05 x 6/12). The discount can be amortized using the straight line method.
a) What is the journal entry on 1/1/x1?
b) What is the journal entry on 3/1/x1?
c) What is the journal entry on 6/30/x1?
d) What is the journal entry on 12/31/x1?
a) Bond Date: Bond is registered and ready for sale but not yet issued. No entry.
b) Issue Date: Bond is purchased by the bond holder. Price includes 2 months of interest
DR: Cash 94,833 (100,000 x 0.94) + (100,000 x .05 x 2/12)
DR: Discount 6,000
CR: Bond Payable 100,000
CR: Accrued Interest Payable 833
c) Six months of interest is paid to the bond holder
DR: Interest Expense 1,923
DR: Accrued Interest Payable 833
CR: Discount 256
CR: Cash 2,500
Discount amortized over 94 months (7 years and 10 months because the bond was issued two months after the bond date). $6,000/94 = 64/month. $64 x 4 months = $256
d) Six months of interest is paid to the bond holder
DR: Interest Expense 2,884
CR: Discount 384
CR: Cash 2,500
$64 x 6 months = $384
This is the same entry for the remaining 14 payments
