Chapter 5 Section 3: Long-Term Liabilities and Bonds Payable

Question 1

Define bond indenture

Answer 1

The contract

Question 2

Define stated (nominal or coupon) interest rate

Answer 2

To be paid to investors. Specified in the contract

Question 3

Define market (effective) interest rate

Answer 3

Rate of interest actually earned by the bondholder - what they’d get for comparable contracts

Question 4

Define discount

Answer 4

Market rate > stated rate

Question 5

Define premium

Answer 5

Stated rate > market rate

Question 6

Define debenture

Answer 6

Unsecured bond

Question 7

Define mortgage bond

Answer 7

Secured by real property

Question 8

Define collateral trust bonds

Answer 8

Secured bond

Question 9

Define convertible bonds

Answer 9

Convertible into common stock by using either detachable or nondetachable warrants

Question 10

Define nondetachable warrant

Answer 10

The convertible bond must be converted into C/S

Question 11

Define detachable warrant

Answer 11

The bond isn’t surrendered upon conversion - the warrants can be bought and sold separately from the bond

Question 12

Participating bond

Answer 12

Participate in income

Question 13

Term bond

Answer 13

Have a single fixed maturity date where you pay the entire principal

Question 14

Serial bond

Answer 14

Multiple bonds that are callable by a serial number

Question 15

Income bonds

Answer 15

Only pay interest when income objectives are met

Question 16

What goes into the calculation of the fair value of a bond?

Answer 16

PV of future interest pmts at market rate

PV of principal at market rate

Question 17

What is the amount of interest the bondholder receives?

Answer 17

Stated rate x face value

Question 18

How is unamortized discount reported?

Answer 18

A contra liability that directly reduces the bond payable.

You get less, subtract.

Question 19

How is unamortized premium reported?

Answer 19

A direct addition to the bond payable

You get more, add

Question 20

Explain bond issue costs

Answer 20

They are transaction costs, and are a deferred charge (asset) and amortized by the person issuer

Question 21

What are the two methods for premium and discount amortization?
Which are allowed under GAAP and IFRS?

Answer 21

Straight line and effective interest are both good for GAAP

Only effective interest for IFRS

Question 22

Explain straight line amortization

Answer 22

premium or discount/periods bond is outstanding

interest expense = required amount - premium amortization or + discount amortization

always move toward the face

Question 23

Explain effective interest method

Answer 23

net carrying value x effective interest rate = int exp
bond face x coupon rate = int paid
int exp - int paid = amortization

Question 24

Define and classify bond sinking fund

Answer 24

Restricted cash pursuant to the indenture where the company puts in money each year so they have enough to repay it at maturity.
It’s a noncurrent asset

Question 25

What is the bonds outstanding method?

Answer 25

It’s for serial bond amortization

It’s like sum of the year’s digits. Take the fraction of the total bonds outstanding and multiply that by the premium.

Question 26

Are convertible bonds usually sold at more of less than face value? Why

Answer 26

More because of the value of the conversion feature

Question 27

What is the difference in how IFRS and GAAP report convertible bonds?

Answer 27

IFRS recognizes a debt and equity component always.

GAAP only does when it’s detachable,

Question 28

List and explain the two methods of accounting for convertible bonds

Answer 28

Book Value: no gain or loss. At conversion, write off the bond payable and premium or discount and credit stock at par. APIC is the plug.
Market Value: not GAAP. Recognizes gain or loss. Everything is the same, except APIC is only market price over par of the stock. Everything else is a gain or loss.

Question 29

What are the two methods for detachable warrants, and when is each used?

Answer 29

Warrants only - when only the FV of the warrants is known

Market value - when the FV of the warrant and bond is known