Leases, Liabilities, and Bonds

Question 1

How to work out if bond retirement resulted in gain or loss?

Answer 1

Compare settlement price to book value. If price paid to settle debt is higher, than a loss must be recognized.

Question 2

What is the ‘warrants only’ method vs. the ‘market value’ method?

Answer 2

Use ‘warrants only’ if only FV of warrants is known. Use ‘market value’ if FV of both warrants and bonds are known.

E.g. market value:
Bonds sale price: 1081
market value bonds: 1100
market value warrants: 150

Allocate sales price proportionally to bonds & warrants. Bonds = 1081 * (1100/1250)
Warrants = 1081 * (150/1250)

Question 3

How is a bond sinking fund accounted for?

Answer 3

Include investment + revenue (dividend & interest) - expenses (admin)

Question 4

If an investor purchases a bond between interest payment dates at a discount, will the carrying amount be greater than or less than a.) cash paid to seller and b.) face amount of bond?

Answer 4

Carrying amount will be less than:

• cash paid to seller (because accr interest incl in cash)
• face amount of bond (because purchased at discount)

Question 5

How do you calculate stated interest rate and effective interest rate of bonds?

Answer 5

Effective interest rate: GAAP interest expense*/carrying value at beginning of period
*problem gave JE as dr interest expense cr cash, they were different amounts, and paid in June. Need to multiply % by 2 in this case to get a full period’s rate.

Stated interest rate: Amount stated on bond/cash paid
*JE was from June, needed to mulitply % by 2 to get full period

Question 6

How do you account for bonds converted into stock using the book value method?

Answer 6

Stock issued must be recorded at carrying value of bond (ignore market value). Face value - discount = carrying value.

Question 7

What is a characteristic of convertible debt under IFRS?

Answer 7

It should be recognized upon issuance (recognize as proceeds - FV of bond libaility).

Question 8

When purchasing a bond, PV of the bond ‘s net future cash inflows discounted at market interest rate tells you what about the bond?

Answer 8

It tells you the issue price. As a buyer, need to understand its worth today so need to PV both the principal @ market rates (also known as effective interest rate or yield). Add to that the PV of interest payments @ market rates to get market value.

PV of principal - use PV table and factors. E.g. 800k 10% bonds, market interest 8% with interest payable semiannnually (2x/year) & maturing in 5 years = 800 * 8.11 (n=10 because 2x/year & i = 4% because 2x/year)
PV of interest - use PV of an annuity table & factors. Per above example, i=4% * face value 800k = 40k. 40k * 8.11091 (PV of annuity of $1, n-10 because 2x/year & i=4% because 2x/year).

Question 9

When using effective interest for amortization on bonds issued @ premium, interest payable for a period is calculated by multiplying what?

Answer 9

FV of bonds at beginning of pd x contractual interest rate.

Interest expense = carrying value * market rate/effective rate

Question 10

What costs should be capitalized and amortized over the term of the bond upon bond issue?

Answer 10

All costs associated with bond issuance should be capitalized, e.g.

• Printing & engraving
• Legal fees
• Fees to accountants
• Commissions to underwriter

Question 11

What are serial bonds and what are debenture bonds?

Answer 11

Serial bonds are redeemed pro-rata over the life of the issue, e.g. 9.375% registered bonds maturing annually. They mature in instalments. Pre-numbered bonds that issuer may call & redeem a portion by serial number.

Debenture bonds are unsecured.