Bonds

Chapter 13 from Financial Accounting

Bonds

A form of interest bearing note Requires periodic interest payments The face amount must be repaid at the

maturity date Bondholders are creditors of the issuing

corporation

Terminology

Bond Indenture Contract with

bondholders

Principal Face value of each bond

Types of Bonds

Term Bonds Serial Bonds Convertible bonds Callable bonds Debenture bonds

Present Value & Bonds

Price that buyers are willing to pay for the bonds dependent upon The face amount of the bonds Periodic interest to be paid Market rate of interest

Interest

Coupon rate – Rate of interest stated

on the bonds

Market or effective rate Interest determined by

market conditions

Interest rates

If the Market rate = coupon rate

BONDS sells at FACE If the market rate >

Coupon rate BONDS sells BELOW Face DISCOUNT

If the market rate < coupon rate

BONDS sells ABOVE face PREMIUM

Accounting for Bonds

Bonds issued at face value Cash DR

Bonds payableCR Interest exp DR

Cash CR

Bonds at Discount

Steps: Compute the PV of the face amount Computer the PV of the interest payments Add the amounts in the first two steps Face amount – selling price = discount

Bonds at Discount

Entry: Cash DR Discount DR

Bonds payable CR

Example: Corp sells $100,000 of 5 years bonds with a coupon rate of interest of 12% and market rate of interest of 13%. Interest is $6,000 is paid semiannually.

Example 3:

Selling Price of Bonds

PV of FACE ( 100,000, r = 13%/2, p = 5 X 2)

$100,000 X .53273 = $53,273

PV of Interest pay ($6,000, r = 6.5%, p =10)

$6,000 X 7.1883 = 43,130

Selling price of bonds 96,403

Example 3

Face value $100,000

Selling price 96,403

Discount 3,597

ENTRY:

Cash 96,403

Discount 3,597

Bonds payable 100,000

Example 4:

PV( $200,000, r 11%/2, p = 10)

$200,000 X .58543 = $117,086

PV ( $10,000, r 11%/2, p=10)

$10,000 X 7.53763 = 75,376

Selling price 192,462

Face 200,000

Discount 7,538

Example 4

Entry: Cash 192,462 Discount 7,538 Bonds payable 200,000

Amortization of Bond Discount

Two methods Straight line method

Discount amortized = Discount/# of interest payments Effective interest method

Example 5

Discount amortized = 3594/10 = $359.4 Interest expense 6,360

Discount 360

Cash 6,000

Example 6Interest exp 3780 discount 780 cash 3000

Discount amortized = 7800/10 = $780

Bonds issued at Premium

Same as discount Face amount – selling price = premium Entry:

Cash DR

Bonds payable CR

Premium CR

Example 3

Corporation sells $100,000 of 5 year bond with a coupon rate of interest of 12% and market rate of interest of 11%. Interest of $6,000 is paid semiannually.

Example 3

PV ( $100,000, r=11%/2, p =10)

$100,000 X .58543 = $58,543

PV($6,000, r=11%/2, p=10)

$6,000 X 7.53763 = 45,226

Selling price 103,769

Face 100,000

Premium 3,769

Example 3

Cash 103,769 Premium 3,769 Bonds payable 100,000

Example 4

PV( $200,000, p=10, r =5%) $200,000 * .61391 = $122,782 PV($11,000, p =10, r=%) $11,000 * 7.72174 = 89,939 Selling price 207,721 Face 200,000 Premium 7,721

Entry

Cash 207,721 Premium 7,721 Bonds payable 200,000

Premium Amortization

Straight line method Amortized = Premium/# of interest payment Example 5:

Amortized = 3594/10 = $360 Interest exp 5640Premium 360 Cash 6,000

Example 6

Amortized = 7800/10 = $780 Interest exp 7020 Premium 780 Cash 7800

Homework

EX 13-8 EX 13-9 Ex 13-11 EX 13-12 EX 13-13

Update

Wed 12/3: Review Test Three

Differential analysis Capital investment

analysis Cash flows Bonds Multiple choice/ short

problems

Monday 12/8 Homework due Test three

Wednesday 12/10 Review for final

examination

Monday 12/15 Final Examination