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FAR 5 > Long Term Liabilities and Bonds Payable > Flashcards

Long Term Liabilities and Bonds Payable Flashcards

1
Q

Long-term liabilities

A

Probable future expenditures associated with current obligations that are not payable w/in current operating cycle/reporting year

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2
Q

Bond indenture

A

Document describing the contract between issuer (borrower) and bondholders (lenders)

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3
Q

Face/Par value

A

Total dollar amount of bond and basis on which periodic interest is paid

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4
Q

Stated (nominal/coupon) interest rate

A

Interest to be paid to the investors

Specified in bond contract

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5
Q

Market (effective) interest rate

A

Rate of interest actually earned by the bondholder and is the rate of return for comparable contracts on date the bonds are issued

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6
Q

Discount

A

Market rate > stated rate => discount

Bond sells for less than the face amount to make up for the lower return being provided

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7
Q

Premium

A

Market rate < stated rate => premium

Bond sells for more than the face amount due to higher return offered

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8
Q

Debentures

A

Unsecured bonds

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9
Q

Mortgage bonds

A

Bonds that are secured by real property

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10
Q

Collateral trust bonds

A

Secured bonds

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11
Q

Convertible bonds

A

Convertible into common stock of the debtor at the option of the bondholder

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12
Q

Nondetachable warrants (convertible bonds)

A

Bond itself must be converted into capital stock

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13
Q

Detachable warrants (convertible bonds)

A

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

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14
Q

Participating bonds

A

Bonds that not only have a stated rate of interest but participate in income if certain earnings levels are obtained

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15
Q

Term bonds

A

Bonds that have a single fixed maturity date

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16
Q

Serial bonds

A

Pre-numbered bonds that the issuer may call and redeem a portion by serial number

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17
Q

Income bonds

A

Bonds that only pay interest if certain income objectives met

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18
Q

Zero coupon bonds

A

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

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19
Q

Commodity-backed bonds

A

Bonds that are redeemable either in cash or stated volume of commodity, whichever greater

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20
Q

Bonds payable overview

A
  • 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
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21
Q

How is the price of the bond calculated?

A

Sum of the PV of future principal payment + PV of future periodic interest payments

Use market rate of interest

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22
Q

What is the recorded price of a bond?

A

Value of the bond at its current cash equivalent

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23
Q

FV of bond =

A

PV of future interest payments (at mkt rate) + PV of principal (at mkt rate)

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24
Q

When is a bond issued at a discount?

A

When the stated rate is less than the market rate at issue date

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25
Q

J/E for issuance of bond

A

Borrower:
Dr. Cash
Dr./Cr. Discount/Premium on bond payable
Cr. Bond payable

Investor:
Dr. Investment in bonds
Cr. Cash

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26
Q

When is a bond issued at a premium?

A

When the stated rate is greater than the market rate at issue date

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27
Q

What does the bond discount represent?

A

Additional interest to be paid to investors at the bond maturity

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28
Q

What does the bond premium represent?

A

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

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29
Q

Bond issuance costs

A

Transactions costs incurred when bonds are issued

i.e. legal fees, accounting fees, underwriting commissions, and printing

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30
Q

How are bond issuance costs accounted for under both GAAP and IFRS?

A
  1. Presented on the b/s as a direct reduction to carrying amount of the bond, similar to discounts
  2. When bonds issued, bond proceeds recorded net of bond issuance costs
  3. Bond issuance costs amortized as interest expense over life of bond using effective interest method
31
Q

JE for the issuance of bond with issuance costs

A

Dr. Cash
Dr. Discount and bond issuance costs
Cr. Bonds Payable

32
Q

Deferred bond issuance costs

A

Bond issuance costs incurred before the issuance of the bonds

33
Q

JE’s for deferred bond issuance costs

A

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
34
Q

What are the two methods of discount, premium, and bond issuance cost amortization?

A
  1. Straight line

2. Effective interest method**

35
Q

What is the amortization period under GAAP?

A

The time period the bond is outstanding (from the date bonds are actually sold)

Contractual life

36
Q

What is the amortization period under IFRS?

A

The expected life of the bond

37
Q

How is interest expense calculated under the straight line method of amortization?

A

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

38
Q

JE for bond payments

A

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

39
Q

Effective interest method

A

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

40
Q

Interest expense calculation under the effective interest method

A

Interest expense = Carrying value at beginning of period x Effective interest rate

41
Q

Discount/Premium amortization calculation under the effective interest method

A

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

42
Q

When a bond is issued between interest dates, what is the journal entry at issuance and at first payment date?

A 
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

43
Q

When the date of scheduled interest payment and the issuer’s year-end do not agree, how is the interest accrual calculated?

A

Interest payable = Face value x Coupon rate x Period

44
Q

What are the journal entries related to year-end bond interest accrual?

A

Interest accrual:
Dr. Interest expense
Cr. Interest payable

Discount amortization:
Dr. Interest Expense
Cr. Discount on bonds payable

45
Q

Bond sinking fund

A

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

46
Q

What is a bond sinking fund classified as?

A

A non-current (restricted) asset

47
Q

What is the market price of a bond issued at a premium equal to?

A

The PV of its principal amount and the PV of all future interest payments, at the market interest rate

48
Q

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

A loss in continuing operations (settlement price is greater than the book value)

49
Q

Book value method of exchanging bonds for stock

A

The book value of the bonds is reallocated to the par value and the APIC accounts of the common stock

50
Q

Where are gains/losses from extinguishment of debt included in the FS?

A

In continuing operations

51
Q

What is generally associated with the terms of convertible debt securities?

A

An interest rate that is lower than nonconvertible debt

52
Q

Under the book value method, when bond is converted to stock, what value is the stock issued at?

A

The carrying value of the bonds

53
Q

What type of bonds in a particular bond issuance will not all mature on the same date?

A

Serial bonds

54
Q

Under US GAAP, why is no value assigned to the conversion feature when convertible bonds are issued?

A

Because the conversion feature cannot be sold or transferred separate from the bonds themselves

55
Q

Under IFRS and US GAAP, how are bond issuance costs accounted for?

A

They reduce the cash received from the bond issuance and are deducted from the carrying value of the liability

56
Q

Under IFRS, how is convertible debt accounted for?

A

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

57
Q

What is the face rate of interest’s only job?

A

To compute the regular interest payments

58
Q

Calculation of interest payable

A

Face value of the bond at the beginning of the period multiplied by contractual interest rate

59
Q

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?

A

All costs

60
Q

At the time detachable common stock warrants are exercised, how much does total shareholders equity increase by?

A

By the cash received upon exercise of the warrants (but not by the carrying amounts of the warrants)

61
Q

Bond sinking fund

A

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

62
Q

Classification of a bond sinking fund

A

Generally a non-current (restricted) asset on FS of issuer

Current asset only to the extent that it offsets a current liability

63
Q

How do you determine the periodic payments to be made into a bond sinking fund?

A

Future value of an annuity at $1 at an assumed rate is used because periodic deposits are earning interest

64
Q

Serial bond

A

Bonds that have principals that mature in installments

Allow the issuer to match maturity dates w/org’s CF requirements

65
Q

How are serial bonds calculated?

A

PV of each maturity in the series should be separately calculated with different discount/premium related to each maturity

66
Q

What are the amortization methods on serial bonds?

A
  1. Effective interest method

2. Bonds outstanding method

67
Q

Bonds outstanding method

A

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

68
Q

Convertible bonds issuance price under US GAAP

A

Issuance price allocated to the bonds with no recognition of conversion feature b/c it is difficult to assign a specific conversion feature

69
Q

Book value method for conversion of bonds to stock

A

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

70
Q

Market value method for conversion of bonds to stock

A

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

71
Q

Methods to record issuance of detachable stock purchase warrants

A
  1. Warrants only method - when only FV of warrants is known

2. Market value method - used if FV of both warrants and bonds are known

72
Q

What are the two conditions under which a liability is considered extinguished?

A
  1. Debtor pays

2. Debtor legally released

73
Q

In-substance defeasance

A

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

74
Q

Calculation of gain or loss on extinguishment of debt

A

(Gain) or loss = Reacquisition price - Net carrying amount

FAR 5 (3 decks)

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