Lecture 11: Bonds

Question 1

term bond

Answer 1

a bond that will pay the entire principal upon maturity at the end of the term

Question 2

Serial Bond

Answer 2

a bond in which the principal matures in installments

Question 3

Debenture Bond

Answer 3

unsecured bonds that are not supported by any collateral

Question 4

Stated, Face, Coupon, Nominal Rate

Answer 4

the rate printed on the bond. Represents the amount of cash the investor will receive every payment (Interest Income/ Cash Payment)

Question 5

Carrying Amount

Answer 5

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

Question 6

Effective Rate, Yield, Market Interest Rate

Answer 6

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.

Question 7

Premium Issued Bond

Answer 7

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.

Question 8

Discount Issued Bond

Answer 8

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.

Question 9

Convertible Bond

Answer 9

bond which the issuer has the right to redeem prior to its maturity date

Question 10

covenants

Answer 10

restrictions that borrowers must often agree to

Question 11

JE for Par Value Bond: 
FACE: 1,000,000
Term: 5 years
Stated Rate: 8%
Effective Rate: 8%

Answer 11

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

Question 12

JE for DISCOUNT Bond: 
FACE: 1,000,000
Term: 5 years
Stated Rate: 8%
Effective Rate: 10%

Answer 12

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)

Question 13

JE for PREMIUM Bond: 
FACE: 1,000,000
Term: 5 years
Stated Rate: 8%
Effective Rate: 6%

Answer 13

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               XX

Question 14

PV of the proceeds of the bonds, two amounts needed to be PV

Answer 14

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

Question 15

Percentage of face value for bonds sales price

Answer 15

101 would be 101% of the Face value where 98% would be 98% of face

Question 16

Present Value of Amount (lump sum)

Answer 16

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

Question 17

Present Value of Ordinary Annuity

Answer 17

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

Question 18

Present Value of Annity Due

Answer 18

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

Question 19

Future Values (Compound Interest)

Answer 19

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

Question 20

Converting from 1 annuity to another

Answer 20

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

Question 21

JE at Bond Issuance

Answer 21

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)

Question 22

Bond payable and un amortized discount or premium are reported where?

Answer 22

Noncurrent liability

Question 23

Accrued Interest Payable

Answer 23

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

Question 24

Bond Issue Cost

Answer 24

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

Question 25

Discount amortization

Answer 25

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

Question 26

Premium Amortizaiton

Answer 26

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

Question 27

Bond Retirement

Answer 27

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)

Question 28

Bond Snking Fund

Answer 28

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.

Question 29

Convertible Bonds (1 security)

Answer 29

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.

Question 30

Convertible Bonds: Book Value Method:

Answer 30

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,

Question 31

Convertible Bonds: Market Value Method

Answer 31

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`

Question 32

Detachable Stock Purchases ( 2 securities)

Answer 32

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

Question 33

Example of Detachable Warrant: 800 Par Value bonds with warrants issued for 900. The Relative FMV of bonds to warrants is 80% and 20%.

Answer 33

.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

Question 34

Bonds Under IFRS

Answer 34

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.

Question 35

Market Price or Selling Price of Bond is calculated by:

Answer 35

The PV of cash flows from interest (stated rate) and teh PV of the principal