Lecture 17 Flashcards
similarity b/w long-term notes and bonds
borrower’s obligation is to make payments in accordance w/ contractual agreement
principal & interest
bond
2 kinds of cash payments
1. lump sum payment due on day the contract expires (par value, face value, maturity value, principal amount)
- equal payments @ regular intervals over contract term; determined by par value and coupon (nominal, stated, contractual) rate
coupon payment =
par value * (nominal coupon rate / #coupon payments per year)
issue price
price @ which bond originally issued
amount received by firm from lenders @ date of issue
PV of future maturity payments & coupon payments discounted at market rate of interest @time bond was issued
historical interest rate
interest rate the market demanded when the bond was issued
historical interest rate per period =
annual market rate @issuance / # payments per year
current interest rate
interest rate @which the bonds are currently trading in the market
premium (discount) at issue =
issue price - par value
net book value =
PV of all remaining future cash flows using the HISTORICAL interest rate
current market value =
PV of all remaining future cash flows using the CURRENT market interest rate
interest expense (per compounding period) =
NBV @start of period * Historical interest rate per period
historical interest rate =
(Issue price? / Market price) - 1
effective interest method
requires that interest expense each period is based on the effective interest rate implicit in the lending arrangement when it was initiated (historical market interest rate)
proceeds at issuance depend on…
FV of bond
Coupon interest rate
effective interest rate at issuance (market rate when issued)
Cash proceeds =
PV Principal + PV Annuity Coupon
*use semi-annual coupon rate
Journal entry for bonds issued @par
cash
bonds payable
bond issued @discount
when market rate > coupon rate
journal entry for bond issued @discount
cash
discount on bonds payable
bonds payable
interest payments for bonds not issued at par
- cash paid - does NOT change
2. interest expense - CHANGES over time
cash payments =
face value * coupon rate
interest expense =
NBV * historical rate
journal entry for interest payment @par
int exp
cash
journal entry for interest payment @discount
int exp
cash discount on bonds payable
journal entry for bond retirement
bonds payable
cash
NBV for bond @discount =
face value - total unamortized discount
bond issued @premium
when market rate
journal entry for bond issued @premium
cash
bonds payable
premium on bonds payable
the coupon rate is used ONLY FOR…
determining coupon payment, NOTHING ELSE!
NBV of bond issued @premium =
face value + total unamortized premium
early retirement of debt
if amount paid to retire LT liability is different from book value, firm recognizes a gain or loss from transaction
journal entry for interest payments @premium
int exp
premium on bonds payable
cash
journal entry for gain on debt retirement for bond issued @discount
bonds payable
cash
gain on debt retirement
discount on bonds payable
interest expense for par
= interest payments
interest exp for discount
> interest payments
interest exp for premium
balance sheet carrying value for par
= face value
balance sheet carrying value for discount
= face value - discount
balance sheet carrying value for premium
= face value + premium
interest payments
USE COUPON RATE FOR ALL 3 TYPES
interest rate for par
coupon = market
interest rate for discount
coupon
interest rate for premium
coupon > market
cost of borrowing for all 3 types
effective rate (market rate at time of issuance)
cash proceeds - par
= face value
cash proceeds - discount
cash proceeds - premium
> face value
discount on bonds payable is a ___ acount
contra liability
EB book value of bond
BB + Int exp - coupon payment
