acct 201 acct 201 acct 201 1 reporting and analyzing long-term liabilities uaa – acct 201...
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Reporting and Analyzing Long-Term Liabilities
UAA – ACCT 201 Principles of Financial
Accounting Dr. Fred Barbee
Chap
ter 1
0
Topic LO Read HW
Basics of BondsA1, C1
422-425
QS1
Bond IssuancesP1, P2, P3
425-436
E1,2,3, 4,5,6;
P1
Present Value of Bonds and Notes
C3, C4
445-448
None
Chapter 10 - Day 1 - Agenda
No Homework Due Today!
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Basics of Bonds
Bond
Bond Issue Date
Bond Certificateat Par Value
Bond Selling Price
Company Investors
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Basics of Bonds
Bond Issue Date
Company Investors
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Basics of Bonds
Bond Interest Payments
Interest Payment = Bond Par Value x
Stated Interest Rate
Bond Interest Payments
Bond Issue Date
Company Investors
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Basics of Bonds
Bond Par Value at maturity
date
Bond Maturity
Date
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Advantages of Bonds
Bond
Bonds do not affect
owner control.
Interest on bonds is
tax deductible.
Bonds can increase
ROE.
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Disadvantages of Bonds
Bond
Bonds require periodic
payment of interest.
Bonds require payment of principal at maturity.
Bonds can decrease ROE.
Types of
Bonds
Secured and
Unsecured
Registered and
Bearer
Term and Serial
Convertible and Callable
Bond market values are expressed as a percent of their par
value.
Bond Trading
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Bond Issuances
Bond
A trustee monitors the bond issue.
An investment firm called an underwriter.
A company sells the bonds to. . .
. . . investors
Bond Issuing Procedures
The underwriter The underwriter sells the bonds to . sells the bonds to . . .. .
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Interest Rates and the Issue Price
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The Market Rate . . .
The rate of interest currently being demanded in the market, i.e., the rate that investors expect to earn on their investment.
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The Market Rate . . .
The market rate is often referred to by other terms . . .
The Effective Rate
The Yield
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The Market Rate . . .
The rate used to compute the present values of the two components of the price of a bond:
The Present Value of the interest payments; and
The Present Value of the face value at maturity.
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The Contract Rate . . .
The interest rate specified on the face of the bond and in the bond indenture.
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The Contract Rate . . .
The contract rate is often referred to by other names:
The Stated Rate
The Nominal Rate
The Coupon Rate
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The Contract Rate . . .
The contract rate is used only to calculate the amount of interest to be paid to the bondholders at each interest period.
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Interest Rates and the Issue Price
What Determines the Market Rate?
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The Market Rate . . .
In most cases the market price of bonds is influenced by . . .
The riskiness of the bonds; and
The interest rate at which the bonds are issued.
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Riskiness of the Bonds
The risk factor is a combination of:
The general economic conditions; and
The financial status of the company selling the bonds,
Moody’s, or
Standard and Poors
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Interest Rate on the Bonds
The interest rate on the bonds is primarily determined by the riskiness of the bonds . . .
The higher the risk,
The higher the interest rate.
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Issuing Bonds Payable
What Determines the Issue Price?
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Issuing Bonds Payable
When issuing bonds payable, there are three possibilities. Bonds may be issued . . .
At face value (par);
At a discount (less than par); or
At a premium (greater than par).
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Bonds Issued at Face Value
If the market rate is equal to the contract rate, the bonds will sell at face value (i.e., at par).
EffectiveMarketYield
CouponContractNominal
Bonds will sell at
Market Rate = Contract Rate
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Issuing Bonds Payable
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Bonds Issued at a Discount
If the market rate is higher than the contract rate, the bonds will sell bonds will sell at a at a discountdiscount (less than face value).
Market Rate > Contract Rate
EffectiveMarketYield
CouponContractNominal
Bonds will sell at a
Issuing Bonds Payable
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Bonds Issued at a Premium
If the market rate is lower than the contract rate, the bonds will sell bonds will sell at a at a premiumpremium (more than face value)
Bonds will sell at
Market Rate < Contract Rate
EffectiveMarketYield
CouponContractNominal
Issuing Bonds Payable
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Example #1
Bonds Issued At Par Value
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Issuing Bonds at Par
Par Value = $1,000,000
Stated Interest Rate = 10%
Market Interest Rate = 10%
Interest Dates = 6/30 & 12/31
Bond Date = Jan. 1, 2002
Maturity Date = Dec. 31, 2021 (20 years)
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Bonds Issued at Face Value
If the market rate is equal to the contract rate, the bonds will sell bonds will sell at at face valueface value (i.e., at par).
GENERAL JOURNAL Page 34Date Description PR Debit Credit
Jan. 1 Cash 1,000,000
Bonds Payable 1,000,000
The journal entry to record the issuance of bonds at par.
Issuing Bonds at Par
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GENERAL JOURNAL Page 39Date Description PR Debit Credit
Jun. 30 Bond Interest Expense 50,000
Cash 50,000
$1,000,000 10%1/2
This entry will be made every six months until the bonds mature.
Issuing Bonds at Par
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The journal entry to record the six-month interest payment on June 30.
GENERAL JOURNAL Page 88Date Description PR Debit Credit
Dec. 31 Bonds Payable 1,000,000
Cash 1,000,000
On Dec. 31, 202, when the bonds mature, the following entry would be
made.
Issuing Bonds at Par
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Example #2
Bonds Issued at A Discount
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Issuing Bonds at a Discount
Par Value = $1,000,000, 5 YearsIssue Price = 92.6405% of par valueStated Interest Rate = 10%Market Interest Rate = 12%Interest Dates = 6/30 & 12/31Bond Date = Jan. 1, 2002Maturity Date = Dec. 31, 2006
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Bonds Issued at a Discount
If the market rate is higher than the contract rate, the bonds will sell bonds will sell at a at a discount (less than face value).
Par Value
Cash Proceeds Discount
1,000,000$ - 926,405$ = 73,595$
Amortizing the discount increases Interest Expense over
the outstanding life of the bond.
$1,000,000 92.6405%$1,000,000 92.6405%
Issuing Bonds at a Discount
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GENERAL JOURNAL Page 3Date Description PR Debit Credit
Jan. 1 Cash 926,405
Discount on Bonds Payable 73,595
Bonds Payable 1,000,000
Contra-LiabilityAccount
On Jan. 1, 2002, the bond issue would be recorded as follows.
On Jan. 1, 2002, the bond issue would be recorded as follows.
Issuing Bonds at a Discount
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Partial Balance Sheet as of Jan. 1, 2002
Long-term Liabilities: Bonds Payable 1,000,000$ Less: Discount on Bonds Payable 73,595 926,405$
Maturity Value
Carrying Value
Issuing Bonds at a Discount
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Using the straight-line method, the discount amortization will be $7,360 every six months.
$73,595 ÷ 10 periods = $7,360 (rounded)
Using the straight-line method, the discount amortization will be $7,360 every six months.
$73,595 ÷ 10 periods = $7,360 (rounded)
Partial Balance Sheet as of Jan. 1, 2002
Long-term Liabilities: Bonds Payable 1,000,000$ Less: Discount on Bonds Payable 73,595 926,405$
Issuing Bonds at a Discount
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$73,595 ÷ 10 periods = $7,360 (rounded)
$1,000,000 × 10% × ½ = $50,000
GENERAL JOURNAL Page 33Date Description PR Debit Credit
Jun. 30 Interest Expense 57,360
Discount on Bonds Payable 7,360
Cash 50,000
This entry will be made every six months to record the interest payment and the
amortization of the discount.
This entry will be made every six months to record the interest payment and the
amortization of the discount.
Issuing Bonds at a Discount
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Straight-Line Amortization TableA B C D E
Interest Interest Discount Unamortized CarryingDate Payment Expense Amortization* Discount Value
1/1/2002 73,595$ 926,405$ 6/30/2002 50,000$ 57,360$ 7,360$ 66,235 933,765
12/31/2002 50,000 57,360 7,360 58,875 941,125
$1,000,000 x 10% x
1/2$50,000 +
$7,360
$73,595/10 = $7,360 (rounded)
$66,235 - $7,360
$1,000,000 - $58,875
Straight-Line Amortization TableA B C D E
Interest Interest Discount Unamortized CarryingDate Payment Expense Amortization* Discount Value
1/1/2002 73,595$ 926,405$ 6/30/2002 50,000$ 57,360$ 7,360$ 66,235 933,765
12/31/2002 50,000 57,360 7,360 58,875 941,125 6/30/2003 50,000 57,360 7,360 51,515 948,485
12/31/2003 50,000 57,360 7,360 44,155 955,845 6/30/2004 50,000 57,360 7,360 36,795 963,205
12/31/2004 50,000 57,360 7,360 29,435 970,565 6/30/2005 50,000 57,360 7,360 22,075 977,925
12/31/2005 50,000 57,360 7,360 14,715 985,285 6/30/2006 50,000 57,360 7,360 7,355 992,645
12/31/2006 50,000 57,355 7,355 0 1,000,000 500,000$ 573,595$ 73,595$
What if the company used the effective interest method to
amortize the discount?
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Effective Interest Method
The effective interest method allocates bond interest expense over the life of the bonds in a way that yields a constant rate of interest.
Effective Interest Amortization TableA B C D E
Interest Interest Discount Unamortized PresentDate Payment Expense* Amortization* Discount Value1/1/2002 73,595$ 926,405$
6/30/2002 50,000$ 55,584$ 5,584$ 68,011 931,989 12/31/2002 50,000 55,919 5,919 62,092 937,908
$1,000,000 x 10% x
1/2
$931,989 x 12% x 1/2
$55,919 - $50,000
$1,000,000 - $62,092; or $931,989 + $5,919
$68,011 - $5,919
Effective Interest Amortization TableA B C D E
Interest Interest Discount Unamortized PresentDate Payment Expense* Amortization* Discount Value1/1/2002 73,595$ 926,405$
6/30/2002 50,000$ 55,584$ 5,584$ 68,011 931,989 12/31/2002 50,000 55,919 5,919 62,092 937,908 6/30/2003 50,000 56,274 6,274 55,818 944,182
12/31/2003 50,000 56,651 6,651 49,167 950,833 6/30/2004 50,000 57,050 7,050 42,117 957,883
12/31/2004 50,000 57,473 7,473 34,644 965,356 6/30/2005 50,000 57,921 7,921 26,723 973,277
12/31/2005 50,000 58,396 8,397 18,326 981,674 6/30/2006 50,000 59,426 8,900 9,426 990,574
12/31/2006 50,000 59,430 9,426 0 1,000,000 500,000$ 573,595$ 73,595$
* Rounded.
Comparing Straight-Line and Effective Interest Methods
$53,000
$54,000
$55,000
$56,000
$57,000
$58,000
$59,000
$60,000
6/30
/02
12/3
1/02
6/30
/03
12/3
1/03
6/30
/04
12/3
1/04
6/30
/05
12/3
1/05
6/30
/06
12/3
1/06
Straight-Line Method
Effective InterestMethod
An
nu
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nte
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Exp
ense
Both methods report the same amount of interest expense over the life of the bond.
Both methods report the same amount of interest expense over the life of the bond.
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Example #3
Bonds Issued at A Premium
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Issuing Bonds at a Premium
Par Value = $1,000,000
Issue Price = 108.1145% of par value
Stated Interest Rate = 10%
Market Interest Rate = 8%
Interest Dates = 6/30 & 12/31
Bond Date = Jan. 1, 2002
Maturity Date = Dec. 31, 2006 (5 years)
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Bonds Issued at a Premium
If the market rate is lower than the contract rate, the bonds will sell at a premium (more than face value)
Cash Proceeds Par Value Premium
1,081,145$ - 1,000,000$ = 81,145$
Amortizing the premium decreases Interest Expense
over the outstanding life of the bond.
$1,000,000 108.1145%$1,000,000
108.1145%
Issuing Bonds at a Premium
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GENERAL JOURNAL Page 3Date Description PR Debit Credit
Jan. 1 Cash 1,081,145
Premium on Bonds Payable 81,145
Bonds Payable 1,000,000
Adjunct-LiabilityAccount
On Jan. 1, 2002, the company would record the bond issue as follows.
On Jan. 1, 2002, the company would record the bond issue as follows.
Issuing Bonds at a Premium
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Using the straight-line method, the premium amortization will be $8,115 every six months.
$81,145 ÷ 10 periods = $8,115 (rounded)
Using the straight-line method, the premium amortization will be $8,115 every six months.
$81,145 ÷ 10 periods = $8,115 (rounded)
Partial Balance Sheet as of Jan. 1, 2002
Long-term Liabilities: Bonds Payable 1,000,000$ Add: Premium on Bonds Payable 81,145 1,081,145$
Issuing Bonds at a Premium
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$81,145 ÷ 10 periods = $8,115 (rounded)
$1,000,000 × 10% × ½ = $50,000
GENERAL JOURNAL Page 33Date Description PR Debit Credit
Jun. 30 Interest Expense 41,885
Premium on Bonds Payable 8,115
Cash 50,000
The semiannual interest payment over the life of the bonds.
The semiannual interest payment over the life of the bonds.
Issuing Bonds at a Premium
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Straight-Line Amortization TableA B C D E
Interest Interest Premium Unamortized CarryingDate Payment Expense Amortization* Premium Value
01/01/2002 81,145$ 1,081,145$ 06/30/2002 50,000$ 41,885$ 8,115$ 73,030 1,073,030 12/31/2002 50,000 41,885 8,115 64,915 1,064,915 06/30/2003 50,000 41,885 8,115 56,800 1,056,800 12/31/2003 50,000 41,885 8,115 48,685 1,048,685 06/30/2004 50,000 41,885 8,115 40,570 1,040,570 12/31/2004 50,000 41,885 8,115 32,455 1,032,455 06/30/2005 50,000 41,885 8,115 24,340 1,024,340 12/31/2005 50,000 41,885 8,115 16,225 1,016,225 06/30/2006 50,000 41,885 8,115 8,110 1,008,110 12/31/2006 50,000 41,890 8,110 0 1,000,000
500,000$ 418,855$ 81,145$
* Rounded.
Let’s look at the effective interest
method amortization table
for this bond.
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Effective Interest Method Amortization TableA B C D E
Interest Interest Premium Unamortized PresentDate Payment Expense* Amortization* Premium Value
01/01/2002 81,145$ 1,081,145$ 06/30/2002 50,000$ 43,246$ 6,754$ 74,391 1,074,391 12/31/2002 50,000 42,976 7,024 67,367 1,067,367 06/30/2003 50,000 42,695 7,305 60,062 1,060,062 12/31/2003 50,000 42,402 7,598 52,464 1,052,464 06/30/2004 50,000 42,099 7,901 44,563 1,044,563 12/31/2004 50,000 41,783 8,217 36,346 1,036,346 06/30/2005 50,000 41,454 8,546 27,800 1,027,800 12/31/2005 50,000 41,112 8,888 18,912 1,018,912 06/30/2006 50,000 40,756 9,244 9,668 1,009,668 12/31/2006 50,000 40,332 9,668 0 1,000,000
500,000$ 418,855$ 81,145$
* Rounded.
Accrued interest Earned interest
Investor pays bond purchase
price plus accrued interest.
Investor receives 6 months’ interest.
Jan. 1, 2002 Bond Date
Bond Issue Date
First Interest Payment
Apr. 1, 2002 June 30, 2002
Issuing Bonds Between Interest Dates
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Issuing Bonds Between Interest Dates
Par Value = $1,000,000Stated Interest Rate = 10%Market Interest Rate = 10%Interest Dates = 6/30 & 12/31Bond Date = Jan. 1, 2002Maturity Date = Dec. 31, 2006 (5 years)
How much cash will the company receive for the entire issue of the bonds?
Issuing Bonds Between Interest Dates
What does the $25,000 in accrued interest represent for the company?
Prepare the journal entry to
record the bond issue on April 1, 2002.
Prepare the journal entry to
record the bond issue on April 1, 2002.
Issuing Bonds Between Interest Dates
Here is the journal entry to record the bond issue on April 1, 2002.
GENERAL JOURNAL Page 33Date Description PR Debit Credit
Apr. 1 Cash 1,025,000
Interest Payable 25,000
Bonds Payable 1,000,000
Now, prepare the entry for June 30, 2002.
Issuing Bonds Between Interest Dates
Here is the entry to record the interest payment on June 30, 2002.
GENERAL JOURNAL Page 43Date Description PR Debit Credit
Jun. 30 Interest Payable 25,000
Interest Expense 25,000
Cash 50,000
$1,000,000 × 10% × ½ = $50,000$1,000,000 × 10% × ½ = $50,000
Issuing Bonds Between Interest Dates
Jan. 1 Apr. 1 Dec. 31
End of accounting
periodOct. 1
Interest Payment Dates
At year-end, an adjusting entry is necessary to recognize bond interest
expense accrued since the most recent interest payment.
At year-end, an adjusting entry is necessary to recognize bond interest
expense accrued since the most recent interest payment.
3 months’ accrued interest
Accruing Bond Interest Expense