H. LONG-TERM DEBT - 1. NOTES AND BONDS PAYABLE (BONDS) Flashcards
H. LONG-TERM DEBT - 1. NOTES AND BONDS PAYABLE
(BONDS)
Bonds (5 types)
Bonds
- Bonds and long-term notes use essentially the same principles.
Types of bonds:
Secured and unsecured:
- A secured bond has a claim to specific assets.
- Unsecured has no such claim and the bondholders are unsecured creditors
Serial bonds:
- bonds that mature at staggered intervals
Single maturity bond:
- Most CPA problems are this type of bond and it just means a bond with a single maturity date
Callable and redeemable bonds:
- Bonds that can be matured before the
maturity date a specified price
Convertible and non-convertible:
- a convertible bond can be converted into stock. Most bond problems will be “regular” bonds that are not convertible, and just have a single maturity date
H. LONG-TERM DEBT - 1. NOTES AND BONDS PAYABLE
(BONDS)
For bond problems you’ll need to know: (8)
Issue date
Face value- this is usually stated something like 10, $1,000 bonds for a total of $10,000 of bonds
Coupon rate or stated interest rate- this determines the cash interest paid
Effective rate or yield rate- this determines interest expense and bond price
Interest payment dates- this is usually twice a year
Maturity date of bond
- Again, if the market rate is greater than stated rate, there is a discount
- If the market rate is less than the stated rate, there is a premium
- If the market rate is the same as the stated rate, there is no premium or discount
- Bond price is the present value of future cash payments discounted at the yield rate
Premium on bonds = Cash proceeds - face amount
Discount on bonds = Face amount - cash proceeds
NOTE: For bond problems on the exam, they will usually give you the present value of the bond price. You won’t usually need to calculate the PV of a bond price yourself.
Or, they make it easy by saying something like, “ABC issued $100,000 of bonds at 97”. This means they issued the bonds at a discount, and you multiply 100,000 by .97 to get the present value of the bond price.
Bonds issued at “102 or 103, etc.” just mean there is a premium and you would multiply the bond price by 1.02 or 1.03 to get the present value.
H. LONG-TERM DEBT - 1. NOTES AND BONDS PAYABLE
(BONDS)
Discount Example:
Discount Example:
ABC issues $100,000 of 10% bonds at 97. ABC receives $97,000 in cash, so there is a discount of $3,000.
Entry to record bond issue would be:
Cash $97,000
Discount $3,000
Bonds payable $100,000
Premium Example:
ABC issues $100,000 of 10% bonds at 102. ABC received $102,000 in cash, so there is a premium of $2,000.
The entry to record the bond issue would be:
Cash $102,000
Bonds payable $100,000
Bond premium $2,000
When you’re figuring out interest payments and amounts, keep track of your dates and the number of payments each year.
If the stated rate is 10% and there is an interest payment twice each year, remember to either use 5% (half of 10) to get the payment, or to multiply the face amount by 10% and then divide it in half to get each payment.
If bonds are issued on something like Oct 1 and they ask you what the interest expense for the year was, remember that it’s only 3 months instead of 6 or 12.
Keep the dates in mind and the number of months that are applicable to the question being asked.
H. LONG-TERM DEBT - 1. NOTES AND BONDS PAYABLE
(BONDS)
Premium or Discount Amortization
Premium or Discount Amortization
- As each bond payment is made, the premium or discount is amortized.
- The actual cash payment is equal to the bond’s stated rate x the face amount. This doesn’t change from payment to payment.
- What does change is the carrying value of the bond and the premium or discount.
- With a bond discount, the portion of discount amortized with each payment is bringing the carrying value of the bond back up to its face amount by the bond’s maturity date.
- With bond premium, the portion of premium being amortized with each payment is bringing the carrying amount back down to the face amount by the bond’s maturity date.
Discount Example
Take ABC’s discounted bond where they received $97,000 with a face amount of $100,000, and the stated rate is 10%. Market rate is 11%.
see Image
You can see that the carrying value of the bond is being brought back towards the face amount of $100,000 as the discount is amortized.
Premium Example
Take ABC’s premium bond where they received $102,000 with a face amount of $100,000, and the stated rate is 10%. Market rate is 9%.
see Image
You can see that the carrying value of the bond is being brought down towards the face amount of $100,000 as the premium is amortized.
**These examples also illustrate the effective interest method, where interest expense is calculated on the carrying value using the market rate and is different from the actual cash payment attached to the face value and stated interest rate.
H. LONG-TERM DEBT - 1. NOTES AND BONDS PAYABLE
(BONDS)
Bond issue costs
Bond issue costs
Some problems will include bond issue costs:
- Bond issue costs are reported on the balance sheet as a deduction to the bond carrying amount.
- The issuance costs are amortized over the life of the bond to interest expense.
Bond issue costs include:
- accounting fees,
- legal fees,
- printing fees, and
- underwriting fees.
H. LONG-TERM DEBT - 1. NOTES AND BONDS PAYABLE
(BONDS)
Fair value option for bonds (or notes payable)
Fair value option for bonds (or notes payable)
A company can elect to record a bond at fair value - the fair value option. The election can never be changed, and it can apply to one or several bonds.
- The bond is recorded at fair value.
- The amortization of a premium or discount still applies.
- Any change in fair value is recognized in earnings as unrealized gains or losses.
- Increase in fair value means a loss: the company owes more.
- Decrease in fair value is a gain: the company owes less.
H. LONG-TERM DEBT - 1. NOTES AND BONDS PAYABLE
(BONDS)
Conversion of convertible bonds
Conversion of convertible bonds
Book value method: at conversion you just transfer the bond balances to stock accounts and no gain or loss is recorded
Market value method: at conversion the stock accounts are credited for the market value of the stock or bonds, the bond accounts are closed, and a gain or loss is recorded for the difference
You’re comparing the market value of the bonds to the market value of the stock, and the difference will be either a gain or loss.
H. LONG-TERM DEBT - 1. NOTES AND BONDS PAYABLE
(BONDS)
Bonds with warrants
Bonds with warrants
- A company can issue bonds that also give the bond purchaser stock warrants (stock rights).
- Both the bonds and the warrants need to be allocated a value.
- If the fair value of both the bonds and the warrants is known (this will be given to you in the problem), then you allocate the total bond price in proportion to the fair values.
- If only one fair value is known, you assign the fair value to that security and allocate the remaining bond price to the other security.
- When allocating a value to the warrants, this is recorded in equity, not debt.
H. LONG-TERM DEBT - 1. NOTES AND BONDS PAYABLE
(BONDS)
Notes payable
Notes payable
Notes payable and discounts/premiums work exactly like bonds.
With notes payable problems, you might be given two interest rates:
- The stated rate: this is the rate stated in the note and determines the actual cash payment of interest each period
- The effective rate, or yield rate, is the market rate of interest. If the note is to be reported at present value, then you use the effective rate
- When the effective rate is bigger than the stated rate, the note is issued at a discount.
- When the effective rate is lower than the stated rate, the note is issued at a premium.
A discount is a contra account to the note. A discount is amortized over the life of the note and the discount increases the liability of the note.
A premium is an adjunct account to the note. A premium is amortized over the life of the note and decreases the liability of the note.
