FAR Module 13B Flashcards
Define the contract rate
This is the rate stated in the bond indenture and is the percentage you agree to pay bondholders
When must you consider PV & TVM
Whenever the cash flows are greater than 1 year
What do you use the contract rate for?
Only use the contract rate to calculate the interest payment for each period. Do not use the contract rate when looking up/calculating PV factors
The Stated Rate is another term for what?
The contract rate
The Coupon Rate is another term for what?
Contract rate
The Nominal Rate is another term for what?
The contract rate
The Bond Rate is another term for what?
Contract rate
The Face Rate is another term for what?
The contract rate
What is the market rate?
This is the rate that all other bond purchasers could get for a bond like yours selling in the market
The yield is another term for what?
The market rate
The YTM is another term for what?
The market rate
The Effective Rate is another term for what?
The market rate
The Real Rate is another term for what?
The market rate
Bonds sell at par when…
The contract rate = the market rate
Bonds sell at a discount when…
The contract rate is lower than the market rate
This is because you are offering to pay a lower interest rate than the buyer could find elsewhere for a similar bond on the market. To entice them to buy your bond anyway you sell the bond at a discount.
Why do bonds sell at a discount
This is because you are offering to pay a lower interest rate than the buyer could find elsewhere for a similar bond on the market (contract rate is less than the market rate). To entice buyers to buy your bond anyway you sell the bond at a discount.
A bond sells at a premium when…
The contract rate is higher than the market rate
Why do bonds sell at a premium
This is because you are offering to pay a higher interest rate than the buyer could find elsewhere for a similar bond on the market (contract rate is greater than the market rate). Many buyers want to buy your bond so you have the power to sell the bond at a premium.
When calculating/looking up PV factors what rate do you use?
ALWAYS use the market rate
What term word is used to describe unsecured bonds
A debenture bond
What term word is used to describe bonds with multiple due dates of usually equal amounts
A serial bond
What term word is used to describe bonds where the entire amount is due at one maturity (not multiple maturity dates)
A term bond
T/F
On the exam you assume everything to be material
TRUE
unless told otherwise, everything is material
Interest payments on bonds are recorded where
On the multiple step income statement under “minus other expenses/losses”
When looking at bonds payable, what point of view are you taking?
You are the issuer and are thus selling the bonds and paying them off
Why is the interest due date important?
If interest is due on 6/30 and 12/31 you will accrue interest and make the cash payment on the same day at the same time
If interest is due on 7/1 and 1/1 you accrue interest on 6/30 and 12/31 and have an interest payable that is then paid off with a cash payment the following day
T/F
in FAR we often use the Future Value factor
FALSE
in FAR we never use the FV factor! Only the PV factor
When looking at bond investments, what point of view are you taking
You are buying the bonds and thus receiving payments. You are the investor
As an issuer, what JE is made to show a bond issue
Debit Cash
Debit Bond Disc
Credit Bond Payable
Credit Bond Premium
As an issuer, what J/E is made to recognize the first cash payment and the corresponding amortization
Debit interest expense
Debit bond premium
Credit Cash
Credit bond discount
As an investor, what JE is made to show a bond issue
Debit bond investment
Credit Cash
As an investor, what J/E is made to recognize the first cash payment and the corresponding amortization
Debit cash
Credit interest revenue
Debit/Credit bond investment
If bonds are purchased between interest payment dates how is the initial J/E adjusted?
The purchaser will also include accrued interest through the purchase date in the total cash paid for the bonds (this is so that at the end of the first period they can be paid the normal interest payment and it will net out properly)
T/F
always credit bonds at face value
TRUE
How are bond issue costs treated
As deferred charges. They are amortized on a straight-line basis over the life of the bond
Give examples of bond issue costs (7)
Printing, engraving, registering with the SEC, advertising, doing financial statements, auditing financial statements, underwriter costs
Where do bond issue costs go on the balance sheet
Under “other assets” as a Deferred charge
Where does amortization expense of bond issue costs go on the financial statements
On the multi step income statement as a “minus other expenses and losses”
What are the two methods of amortization of bond issue costs
Effective interest method
straight-line method
Which method of amortization of bond issue costs has interest revenue and expense stay constant each period
Straight-line method
Which method of amortization of bond issue costs has changing interest revenue and expense each period
Effective interest method
Which method of amortization of bond issue costs has a constant interest rate each period
The effective interest method
Which method of amortization of bond issue costs has changes in the interest rate in each period
The straight-line method
Under the effective interest method how does interest revenue or expense affect both the discount and the premium
Discount increases each period
Premium decreases each period
Under the effective interest method how does the amount of amortization affect the discount and premium each period
Discount increases each period
Premium increases each period
Under the effective interest method how does the carrying amount of bonds payable or investments in bonds affect the discount and premium each period
Discount increases each period
Premium decreases each period
What are the two approaches when accounting for bond conversions
Valuing the transaction at cost
valuing the transaction at market
What approach is most common when accounting for bond conversions
Valuing the transaction at book value
To induce conversion of convertible bonds firms sometimes change the original conversion privilege or give additional consideration to the bondholders this is known as a sweetener. How should a sweetener be recognized
The fair value should be recognized as an expense upon conversion
Convertible bonds affect what areas of a balance sheet equation
The assets and liabilities
Bonds with detachable warrants affect what areas of the balance sheet equation
Assets, liabilities, and stockholders equity
T/F
under US GAAP when you sell bonds with detachable warrants you can split up the cash proceeds between liabilities and stockholders equity
FALSE
you MUST split these up
What are the two rules for allocating between liabilities and stockholders equity when dealing with detachable stock warrants
1) if given the fair value of both, allocate the CV based on a relative percentage of the FV
2) if given fair value for only one put it there and plug the other one
all gains and losses resulting from the extinguishment of debt should be recognized when
In the period of extinguishment
When dealing with an extinguishment of debt what side of the journal entry will be a loss or gain
Debit loss
Credit gain
How are bond sinking funds classified on the financial statements
As a long-term investment on the balance sheet this is a noncurrent asset
What does a bond sinking fund do
It accumulates cash in order to pay back a bond principal
How much money is put in a bond sinking fund
The terms are described in the bond indenture saying how much money must be put in the sinking fund each period to ensure that there will be money to pay off the bonds when they become due at maturity
What is the five-year disclosure rule for bond sinking funds
You must disclose the sinking fund requirements and bond maturities for five years after the balance sheet date
T/F
For ease of calculations you can net the sinking fund balance with the bond payable balance
FALSE
the sinking fund is a L/T asset
The bond payable is a L/T liability
NEVER SHALL THE TWO MEET
What are the three types of bonds as investments
Trading, available for sale, held to maturity
How are trading bonds treated
Gains and losses go to income from continuing operations.
This will either be in the section “plus other revenue and gain” or “minus other expenses and losses”
How are available for sale bonds treated
Usually you do not elect the fair value option and in that case the gain and loss goes to other comprehensive income, net of tax.
If you do elect the fair value option treat available for sale investments like trading investments are treated
How are held to maturity investments treated
You do not mark held to maturity investments at fair value because fair value is irrelevant for held to maturity therefore you do not have unrealized gains or losses and you keep these investments at carrying value.
If by some chance you do elect the fair value option, treat held to maturity investments like trading investments are treated
Under IFRS convertible bonds and bonds with detachable warrants are referred to with what terminology
Compound instruments
Under IFRS the fair value option is known as what
The fair value through profit or loss option (FVTPL)
T/F
When calculating net proceeds to be received from an issuance you subtract out the bond issuance costs
TRUE
When converting convertible bonds into stock, what journal entry will you make
Debit BP Debit Premium on BP Credit Discount on BP Credit Common Stock Credit APIC
A gain or loss on redemption of bonds is calculated how
Cash paid - Net BV of Bonds
When you issue bonds payable with a nominal interest rate that is less than the market interest rate what affect does this have on the Balance Sheet
Increase bond discount
Increase bond payable
When you issue convertible bonds (which are common stock equivalents) for an amount in excess of the bonds face amount what effect does this have on balance sheet accounts
Increase bond premium
increase bonds payable
This does not affect common stock or APIC because of the mutually exclusive option of the holder
When you issue common stock as a conversion from bonds what effect does this have on the balance sheet accounts
Increase common stock
Increase APIC
reverse the previous BP entry. This will mean a decrease in either a discount or premium as well as a decrease in BP
When you issue bonds with non-detachable warrants for an amount equal to the face amount of the bonds and the stock warrants do not have a determinable value what effect does this have on balance sheet accounts
Increased bond payable
When you issue bonds with detachable stock warrants for an amount equal to the face amount of the bond and the stock warrants have a determinable value how does this affect the balance sheet accounts
Increase bond discount
Increase bonds payable
increase APIC
There is a discount because you received an amount equal to the face amount of the bonds but did not receive an additional amount for stock warrants
When you redeem a bond issued at a discount for an amount that was over 100% of the face value how does this affect the balance sheet accounts?
This means that the bond was sold at a discount. When the bond are redeemed the bonds payable and the discount account must be removed from the records. In this situation the net carrying amount is less than the reacquisition price. Therefore there is a loss on the extinguishment of debt
decrease in bond discount
decrease in bonds payable
decrease in retained earnings (The loss on extinguishment of debt is considered an ordinary loss and will appear under retained earnings)
When you issue a bond payable with a nominal rate of interest that is higher than the market rate what balance sheet accounts are affected
Increase bond premium
Increase bonds payable
When you call a bond that was issued at greater than par when the market value of the bond is less than the carrying value how does this affect the balance sheet accounts
In other words the net carrying value is greater than the market value of the bond or the reacquisition price. Therefore there is a gain on the redemption of the bond
Decrease bond premium
decrease bond payable
increase retained earnings
T/F
Bond issue costs should be treated as deferred charges and amortized over the life of the bond
TRUE
T/F
Early extinguishment of debt is treated as an extraordinary item
FALSE
Early extinguishment of debt does not receive routine treatment as an extraordinary item. It must meet the test for an extraordinary item (infrequent and unusual) in order to receive extraordinary treatment
T/F
losses from extinguishment of debt should be amortized over the remaining life of the debt
FALSE
Losses should be recognized in the period of extinguishment
T/F
The straight-line method of amortization should be used for bonds due in less than five years
FALSE
The effective amortization method should be used
T/F
Bonds that mature on a single date are called serial bonds
FALSE
These are called term bonds
T/F
The effective interest is calculated by multiplying the maturity value of the bond by the coupon rate
FALSE
The effective interest is calculated by the carrying value times the effective rate
T/F
A bond premium represents a reduction of interest expense on the books of the issuer
TRUE
As the premium is amortized interest expense is decreased
T/F
when the contract or coupon rate is greater than the effective rate the bonds will sell at a premium
TRUE
What happens to a sinking fund when periodic additions are made to the fund and when revenue is earned on the investment held in the fund
The balance increases
What happens to a sinking fund when cash is used to purchase investments
The components of the fund change but the total fund balance is not affected
