FAR 27 Flashcards
What are Term bonds
it is when principle is due in a single lump sum
Examples:
- unsecured debentures
- collateral bonds (convertible bonds)
what is the JE when a company issues a bond at 98?
Dr. Cash 49,000
Dr. Discount 1,000
Cr. Bonds Payable 50,000
What amount do you use to compute gain or loss on retirement of bonds
Example:
On June 2, 20X8, Tory, Inc. issued $500,000 of 10%, 15-year bonds at 98.8. Interest is payable semiannually on June 1 and December 1. Discount at issuance was $6,000. Tory uses the straight-line method to amortize the discount, which does not differ materially from GAAP in this instance. On June 2, 20X13, Tory retired half of the bonds at 98. What is the net amount that Tory should use in computing the gain or loss on retirement of debt
It is the face value less the unamortized discount:
example:
Answer
$248,000
As of 6/2/X13, 5 years of the bonds 15-year life has elapsed indicating that 1/3 of the discount would have been amortized. The carrying value of the bonds for retirement purposes equals the face of $500,000 less the unamortized discount of $4,000 for a net amount of $496,000. Since half of the bonds are being retired, the carrying value for the purpose of computing gain or loss will be $248,000.
How do you calculate Interest Payable
Face Value * Stated rate
What are the typical features of a convertible debt security
- the holder can convert into a common stock at a future date at a predetermined price
– the price is generally higher than the stock market price on the day of issuance
- the price MAY be lower than the market price when you are able to convert the bonds
- As a result convertible bonds generally bear interest at a rate that is lower than bonds that are not convertible
- A feature to subordinate the security to nonconvertible debt is not typical and can apply to all kinds of bonds - not just convertible
What is the market price of a bond issued at a discount or a premium
The market price of a bond, regardless of whether it is issued at a discount or a premium, is equal to the present value of all cash flows that the bond represents.
This includes the present value of the principal amount and the present value of all future interest payments.
The present value is computed using the bond’s effective rate of interest.
PV of all future cash flows:
PV of principle + PV of all future interest payments
What is the result of using the effective interest method versus straight-line method on interest expense and CV on a bond issued at a discount
Effective Interest: Result - Smaller changes to interest expense in early periods and larger changes in later periods
Straightline: result - equal changes to each period
Therefore the amortization under SL would be higher in early periods and bonds would be over stated 150,000 / 6 = 25K per year
effective interest would be smaller changes in early period = 22,000
So carry value S/L = 875K - overstated
effective interest CV = 872K - correct
At the time of maturity - the bond discount will have been fully amortized and CV will = face Value under both methods
When you issue a bond at a discount in the interest date what is the JE
dr. Interest expense 150
cr cash 100
cr unamortized discount 50
On a Notes Payable what is a discount considered
- it is a contra account to the note
- It is amortized over the life if the note
- The discount INCREASES the liability of the note
On a Notes Payable what is a premium considered
- It is considered an adjunct account to the note
- A premium is amortized over the life of the note
- A premium DECREASES the liability of a note
What is the difference between Modification of terms and Extinguishment of Debt
What can happen is that interest rates change and so the issuer of the debt will recall the debt and will then reissue it at the current interest rates
So when is it Extinguishment of the debt and when is it just a modification of the terms:
Extinguishment -
1) need to be a greater than 10% change in the PV of the cash flows vs old cash flows
2) if there are any embedded conversion options changed - YEs extinguishment
If neither 1 or 2 - then just a modification
What is trouble debt restructuring
This is when someone owes you money and they are in financial trouble for you allow them to pay you back less than than what you are owed:
Conditions:
- Debtor is experiencing financial difficulties
- Creditor grants a concession as a result of the financial difficulties
what is in substance defeasance
This is when when you place money in a trust that will completely satisfy the remaining liability of a bond you issue ($875,000)
You can then compare this amount to the carrying Value of the loan to determine gain or loss CV = 1.050,000
so there is a gain before tax of 1050 - 875 = $175,000
What are the JE to issue debt at a discount and then pay interest
At Issuance:
dr. cash 150
dr. discount 50
cr. Bonds Payable 200
When you pay Interest:
dr. Interest expense 20
cr. discount 5
cr. Cash 15
How do you calculate the PV of an amount to be received in the future
reverse the formula
PV of future amount = future amount * PV factor
so if you are give the present value amount and the factor you can calculate the future amount:
10,000 = future amount * .826
so - 10,000/.826 = 412,107
