Long Term Liabilities and Bonds Payable Flashcards
Long-term liabilities
Probable future expenditures associated with current obligations that are not payable w/in current operating cycle/reporting year
Bond indenture
Document describing the contract between issuer (borrower) and bondholders (lenders)
Face/Par value
Total dollar amount of bond and basis on which periodic interest is paid
Stated (nominal/coupon) interest rate
Interest to be paid to the investors
Specified in bond contract
Market (effective) interest rate
Rate of interest actually earned by the bondholder and is the rate of return for comparable contracts on date the bonds are issued
Discount
Market rate > stated rate => discount
Bond sells for less than the face amount to make up for the lower return being provided
Premium
Market rate < stated rate => premium
Bond sells for more than the face amount due to higher return offered
Debentures
Unsecured bonds
Mortgage bonds
Bonds that are secured by real property
Collateral trust bonds
Secured bonds
Convertible bonds
Convertible into common stock of the debtor at the option of the bondholder
Nondetachable warrants (convertible bonds)
Bond itself must be converted into capital stock
Detachable warrants (convertible bonds)
Bond is not surrendered upon conversion, only the warrants plus cash representing the exercise price of the warrants
Warrants can be bought/sold separately from bond
Participating bonds
Bonds that not only have a stated rate of interest but participate in income if certain earnings levels are obtained
Term bonds
Bonds that have a single fixed maturity date
Serial bonds
Pre-numbered bonds that the issuer may call and redeem a portion by serial number
Income bonds
Bonds that only pay interest if certain income objectives met
Zero coupon bonds
Deep discount bonds
Bonds sold with no stated interest but rather at a discount and redeemed at the face value w/out periodic interest payments
Commodity-backed bonds
Bonds that are redeemable either in cash or stated volume of commodity, whichever greater
Bonds payable overview
- In denominations of $1,000
- Price always quoted in 100’s (% of par value)
- Coupon rate = the stated interest rate on bond
- Bond interest (check amount) = coupon rate x face
- Principal payoff always the full face amount
- Premium/discount = result of buyer and seller “adjusting” the coupon rate to the prevailing market rate of interest
How is the price of the bond calculated?
Sum of the PV of future principal payment + PV of future periodic interest payments
Use market rate of interest
What is the recorded price of a bond?
Value of the bond at its current cash equivalent
FV of bond =
PV of future interest payments (at mkt rate) + PV of principal (at mkt rate)
When is a bond issued at a discount?
When the stated rate is less than the market rate at issue date
J/E for issuance of bond
Borrower:
Dr. Cash
Dr./Cr. Discount/Premium on bond payable
Cr. Bond payable
Investor:
Dr. Investment in bonds
Cr. Cash
When is a bond issued at a premium?
When the stated rate is greater than the market rate at issue date
What does the bond discount represent?
Additional interest to be paid to investors at the bond maturity
What does the bond premium represent?
Interest paid in advance to the issuer by bondholders who then receive a return of this premium in the form of larger periodic interest payments
Bond issuance costs
Transactions costs incurred when bonds are issued
i.e. legal fees, accounting fees, underwriting commissions, and printing
How are bond issuance costs accounted for under both GAAP and IFRS?
- Presented on the b/s as a direct reduction to carrying amount of the bond, similar to discounts
- When bonds issued, bond proceeds recorded net of bond issuance costs
- Bond issuance costs amortized as interest expense over life of bond using effective interest method
JE for the issuance of bond with issuance costs
Dr. Cash
Dr. Discount and bond issuance costs
Cr. Bonds Payable
Deferred bond issuance costs
Bond issuance costs incurred before the issuance of the bonds
JE’s for deferred bond issuance costs
Deferred cost incurred:
Dr. Deferred bond issuance costs
Cr. Cash
Issuance of bonds: Dr. Cash Dr. Discount and bond issuance costs Cr. Bonds payable Cr. Deferred bond issuance costs
What are the two methods of discount, premium, and bond issuance cost amortization?
- Straight line
2. Effective interest method**
What is the amortization period under GAAP?
The time period the bond is outstanding (from the date bonds are actually sold)
Contractual life
What is the amortization period under IFRS?
The expected life of the bond
How is interest expense calculated under the straight line method of amortization?
Premium/discount and bond issuance cost / Number of periods bond is outstanding = periodic amortization
Interest expense = (Face value x Stated interest rate) - Premium amortization or + Discount and bond issuance cost amortization
==> Check amount +/- Amortization = Interest Expense
JE for bond payments
Borrower:
Dr. Bond interest expense
Dr./Cr. Premium/Discount on bond payable
Cr. Cash
Investor:
Dr. Cash
Dr./Cr. Investment in bonds
Cr. Bond interest revenue
Effective interest method
Constant yield method
Required by both US GAAP and IFRS
Interest expense calculated by multiplying carrying value of bond at beginning of period by the effective interest rate
Interest expense calculation under the effective interest method
Interest expense = Carrying value at beginning of period x Effective interest rate
Discount/Premium amortization calculation under the effective interest method
Amortization of the discount = Interest Expense - Cash interest paid at the stated rate
Amortization of the premium = Cash interest paid at the stated rate - Interest expense
When a bond is issued between interest dates, what is the journal entry at issuance and at first payment date?
Bond issuance: Dr. Cash Dr./Cr. Discount/Premium on bonds payable Cr. Bonds payable Cr. Bond interest expense (payable)
First interest payment:
Dr. Bond interest expense (payable)
Cr. Cash
When the date of scheduled interest payment and the issuer’s year-end do not agree, how is the interest accrual calculated?
Interest payable = Face value x Coupon rate x Period
What are the journal entries related to year-end bond interest accrual?
Interest accrual:
Dr. Interest expense
Cr. Interest payable
Discount amortization:
Dr. Interest Expense
Cr. Discount on bonds payable
Bond sinking fund
A trustee fund (restricted cash) pursuant to the indenture wherein the company contributes money each year so that at maturity, there is a sum available to repay the entire liability
What is a bond sinking fund classified as?
A non-current (restricted) asset
What is the market price of a bond issued at a premium equal to?
The PV of its principal amount and the PV of all future interest payments, at the market interest rate
If the settlement price is greater than the face value of the debt and the face value is greater than the book value, what would be recorded if a company decides to retire the bond?
A loss in continuing operations (settlement price is greater than the book value)
Book value method of exchanging bonds for stock
The book value of the bonds is reallocated to the par value and the APIC accounts of the common stock
Where are gains/losses from extinguishment of debt included in the FS?
In continuing operations
What is generally associated with the terms of convertible debt securities?
An interest rate that is lower than nonconvertible debt
Under the book value method, when bond is converted to stock, what value is the stock issued at?
The carrying value of the bonds
What type of bonds in a particular bond issuance will not all mature on the same date?
Serial bonds
Under US GAAP, why is no value assigned to the conversion feature when convertible bonds are issued?
Because the conversion feature cannot be sold or transferred separate from the bonds themselves
Under IFRS and US GAAP, how are bond issuance costs accounted for?
They reduce the cash received from the bond issuance and are deducted from the carrying value of the liability
Under IFRS, how is convertible debt accounted for?
Both a liability (bond) and equity component (conversion feature) should be recognized
Bond liability = FV
Equity component = Actual proceeds received and FV of bond liability
What is the face rate of interest’s only job?
To compute the regular interest payments
Calculation of interest payable
Face value of the bond at the beginning of the period multiplied by contractual interest rate
Under US GAAP, what costs associated with the issuance of bonds should be capitalized and amortized over the outstanding term of the bonds since issue?
All costs
At the time detachable common stock warrants are exercised, how much does total shareholders equity increase by?
By the cash received upon exercise of the warrants (but not by the carrying amounts of the warrants)
Bond sinking fund
A trustee fund (restricted cash) pursuant to the indenture wherein the company contributes money each year so that at maturity, there is a sum available to repay the entire liability
Classification of a bond sinking fund
Generally a non-current (restricted) asset on FS of issuer
Current asset only to the extent that it offsets a current liability
How do you determine the periodic payments to be made into a bond sinking fund?
Future value of an annuity at $1 at an assumed rate is used because periodic deposits are earning interest
Serial bond
Bonds that have principals that mature in installments
Allow the issuer to match maturity dates w/org’s CF requirements
How are serial bonds calculated?
PV of each maturity in the series should be separately calculated with different discount/premium related to each maturity
What are the amortization methods on serial bonds?
- Effective interest method
2. Bonds outstanding method
Bonds outstanding method
Uses the percentage of decrease in outstanding debt each maturity period as the basis for calculating the related amount of premium/discount on the bonds
Convertible bonds issuance price under US GAAP
Issuance price allocated to the bonds with no recognition of conversion feature b/c it is difficult to assign a specific conversion feature
Book value method for conversion of bonds to stock
No gain or loss is recognized (no i/s impact)
C/S credited at par, APIC credited for excess of bond’s carrying value over stock’s par value less conversion costs
Market value method for conversion of bonds to stock
I/S impact (results in recognized gain/loss)
Bonds payable and related premium written off, C/S credited at par
APIC credited in excess of market price of stock over par value
Difference b/w market value of stock and BV of bonds is gain or loss
Methods to record issuance of detachable stock purchase warrants
- Warrants only method - when only FV of warrants is known
2. Market value method - used if FV of both warrants and bonds are known
What are the two conditions under which a liability is considered extinguished?
- Debtor pays
2. Debtor legally released
In-substance defeasance
Arrangement where a company places purchased securities into an irrevocable trust and pledges them for the future principal and interest payments on its LT debt
Calculation of gain or loss on extinguishment of debt
(Gain) or loss = Reacquisition price - Net carrying amount
