Lecture 11: Bonds Flashcards
term bond
a bond that will pay the entire principal upon maturity at the end of the term
Serial Bond
a bond in which the principal matures in installments
Debenture Bond
unsecured bonds that are not supported by any collateral
Stated, Face, Coupon, Nominal Rate
the rate printed on the bond. Represents the amount of cash the investor will receive every payment (Interest Income/ Cash Payment)
Carrying Amount
the net amount at which the bond is being REPORTED on the BS. This equals the Face Value plus the premium (Bond issued above Face value) or minus the discount ( bond issued below face value). Also known as, the BOOK VALUE or REPORTED amount. It will initially be the same as the issue price, but gradually approaches the Face Value as time passes since the premium or discount is amortized over the life of the bond
Effective Rate, Yield, Market Interest Rate
this is the actual rate of interest the company is paying on the bond based on the issue price. The effective rate is often called the market rate of interest or yield.
Premium Issued Bond
the effective rate is below the stated rate, the cash interest and the principal repayment are based on Face, but the company actually received more money than this.
Discount Issued Bond
the effective rate will be higher than the stated rate. the company must pay cash interest and principal based on a higher amount than the funds actually received upon issuance.
Convertible Bond
bond which the issuer has the right to redeem prior to its maturity date
covenants
restrictions that borrowers must often agree to
JE for Par Value Bond: FACE: 1,000,000 Term: 5 years Stated Rate: 8% Effective Rate: 8%
Bond Issuer records
Dr. Cash 1,000,000
Cr. Bonds Payable 1,000,000
Interest payment each year:
Dr. Interest Expense 80,000 (FaceXStated)
Cr. Cash 80,000
JE for DISCOUNT Bond: FACE: 1,000,000 Term: 5 years Stated Rate: 8% Effective Rate: 10%
Dr. Cash 900,000 (Discounted price)
Dr. Discount 100,000
Cr. Bonds Payable 1,000,000 (ALWAYS FACE)
Interest Payment Each Year:
Dr. Interest Expense XX (Based on PV Tables)
Cr. Discount XX
Cr. Cash XX (Cash payment)
JE for PREMIUM Bond: FACE: 1,000,000 Term: 5 years Stated Rate: 8% Effective Rate: 6%
Dr. Cash 1,100,000
Cr. Premium 100,000
Cr. Bonds Payable 1,000,000
Premium will be Amortized over the life of the Bond:
Dr. Interst Expense XX
Dr. Premium XX
Cr. Cash XXPV of the proceeds of the bonds, two amounts needed to be PV
PV of the face of the bond
PV of the interest as an annuity
The sum of these two represent the PV of the bonds
Percentage of face value for bonds sales price
101 would be 101% of the Face value where 98% would be 98% of face
Present Value of Amount (lump sum)
used to examine a singe cash flow that will occur at a future date and determine its equivalent value today. The amount you need to invest today, for # years, at what interest rate, to get back $1 in the future
Present Value of Ordinary Annuity
Repeated cash flows on a systematic basis, with amounts being paid at the END of each period (“annuity in arrears”) Bond interest payments are commonly made at the end of each period and use these factors
Present Value of Annity Due
Repeated cash flows on a systematic basis with amounts being paid at the BEGINNING of each period (“annity in advance”) Rent payments are commonly made at the beginning of each period and use these factors
Future Values (Compound Interest)
these look at cash flows and project them to some future date. This is the amount that would accumulate at a future point in time if $1 were invested now. The future value is equal to 1 divided by the PV factor. Investment of 10,000 in 2 years at 10% would accumulate to principal multiplied by the future value factor. In thise case the 10000 x 1/.8265= 12100
Converting from 1 annuity to another
If only givien the table to PV of annuity due, use the factor for 1 more period and subtract 1.0 from it OR use the factor for the number of periods and divide it by 1 + the interest rate
JE at Bond Issuance
DR. Cash (% face + Accrued Interst +BIC)
BIC
Discount (plug)
CR. Bond Payable (FACE)
Accrued Interest Payable ( face x (stated rate)X (time-since last paid interest)
Premium (Plug)Bond payable and un amortized discount or premium are reported where?
Noncurrent liability
Accrued Interest Payable
When bonds are not sold on issue date, interest accrues from the date so buyer is credited for this interest and will recieve a full year of interest. Dated 1.1 and bought on 4.1 and pay interest on 12.31 will initially charge 3/12 months of the payment in the purchase price and then at year end pay out the full cash payment
Bond Issue Cost
Costs directly associated with the issuance of the bonds are a noncurrent asset (deferred charge) and are amortized straight-line over the period of time the bonds are outstanding
Discount amortization
face - Discount = CV X Effective Interest Rate = Interest Expense - Cash Payment (face X stated X time) = Amortizaiton of Discount
*The interest expense increases each year, the amortization of the discount increases each year, CV increases
Premium Amortizaiton
Face + Premium = CV x Effective Interest Rate = Interest Expense - Cash Payment = Amortization of Premium
* the interest expense decreases each year, the amortization of premium increases, CV decreases
Bond Retirement
Bonds are called or retired prior to maturity, gain/loss on Income Statement as a part of Continuing operations. JE is the opposite of bond issuance:
Dr. Bonds Payable (Face)
Premium (Unamortized)
Loss (Plug)
Cr. BIC
Discount
Cash (Amount to retire)
Gain (plug)Bond Snking Fund
fund set up for the retirement of bonds. The balance is a noncurrent asset until the bonds mature, interest or dividends earned are added to the sinking fund balance and reported as income.
Convertible Bonds (1 security)
Bondholder has the option to convert the bond into CS and are normally issued at more than par value due to this option. The interest rate is generally lower than nonconvertible debt.
Convertible Bonds: Book Value Method:
NO gain/loss recorded. GAAP
Dr. Bond Payabe (Face)
Dr. Premium
Cr. BIC
Cr. CS (Par Value)
Cr. APIC (Plug)
*All accounts for the remaining balances are eliminated,
Convertible Bonds: Market Value Method
Gain/Loss goes to Ordinary and reported in INcome Dr. Bond Payable Dr. Premium Dr. Loss (Plug) Cr. BIC Cr. CS Cr. APIC Cr. Gain (plug)
*CS + APIC should be the FMV of the stock issued`
Detachable Stock Purchases ( 2 securities)
a security that can be sold or exercised by the bondholder, while still keeping the bond.
- Use relative FMV approach if both securities are known
- If only one is known, the other is the plug
- the amount for warrants is APIC-Warrants
- if non-detachable stock warrant than no seperate value is given
- If warrants expire, close them to APIC
Example of Detachable Warrant: 800 Par Value bonds with warrants issued for 900. The Relative FMV of bonds to warrants is 80% and 20%.
.8900= 720
.2900=180
=900
Dr. Cash 900
Dr. Discount 80
Cr. Bond Payable 800 (cv of bond is 800-80=720)
Cr. APIC Warrants 180
Bonds Under IFRS
Bonds are accounted for under Amortized cost with the effective interest method or FVTPL.
- Convertible bonds must be treated as a liability and an equity component. The liability is recognized at FV and the equity is recognized at the residual amount, net proceeds less the amount allocated to the liability component
- BIC reduces the CV of the bonds and are amortized over the life under the effective interest method.
Market Price or Selling Price of Bond is calculated by:
The PV of cash flows from interest (stated rate) and teh PV of the principal
