F5: Long-Term Liabilities and Bonds Payable.
These are two separate transactions because Gold Corp.:
1. Sold Iron Corp. Bonds (an investment) for a loss, and 2. Bought back its own (Gold) Corp. Bonds (a debt) for a gain. This is not a "refinancing" (where one would sell new bond debt to buy back old bond debt outstanding). The gain from the purchase of its own bonds is an "extraordinary gain" because it meets the criteria of APBO No. 30 (per SFAS No. 145). The Iron Corp. transaction is a loss in "income before extraordinary items."
Bond Issue Price (cell F4): $1,081,105
Bond issue price = $675,560 PV principal + $405,545 PV interest = $1,081,105
Carrying value of bonds to be retired
Bonds at face value Add: Unamortized bond premium
Gain on bond retirement
Bonds at face value Add: Unamortized bond premium ________________________________ Carrying value of bonds to be retired Less: Cash paid (1,000 bonds at 102)
Interest Payable
Bonds payable Times Interest payable Times Duration
Interest expense
Carrying value Times Interest payment Times Duration
GAAP interest expense
Carrying value at the beginning of the period x effective periodic interest rate
Present Value—Principal (cell F2): $675,560 The present value of the principal is found using the following formula:
D2 × E2 = $1,000,000 principal × 0.67556 PV factor = $675,560
The issue price of a bond is a function of two different cash flows, one a lump sum and the other a regular stream of payments.
First, we need to present value the eventual return of principal using present value tables and factors at the market or effective rate of interest, also known as the yield. Second, we need to present value the regular interest payments, whether annual or semiannual, using present value of an annuity tables and factors at the same market or effective interest rate (yield).
Premium Amortization
Interest payment Less interest expense
On July 1, Year 1, York Co. purchased as a held-to-maturity investment $1,000,000 of Park, Inc.'s 8% bonds for $946,000, including accrued interest of $40,000.
Interest receivable ($1,000,000 x 8% x 6/12)
The amount of interest that has accrued since the last interest payment is added to the price of the bond.
The purchaser pays such interest and is reimbursed at the next payment date upon receipt of a full period's interest.
Amortization of a discount increase, not decreases, the carrying amount of the bond. Amortization of the discount or premium
always moves the carrying value closer to the face value.
Serial bonds
are bonds that mature in installments.
Bond issue costs
are booked as an asset under U.S. GAAP, not under IFRS. Under both IFRS and U.S. GAAP, the debit to cash is for the sale price less the bond issue costs.
Under IFRS, bond issue costs
are deducted from the carrying value of the liability and included in the debit entry to bond discount upon issuance. As part of the discount from par, bond issue costs are amortized over the life of the bond using the effective interest method.
The interest payable on a bond is
calculated by taking the face value of the bond at the beginning of the period and multiply this amount by the contractual interest rate.
Only sinking fund accounts (or the portion thereof) that are considered to offset current bond liabilities
can be included within current assets. The entire balance in the sinking fund account (deposits plus interest earned) in this example is shown as a noncurrent asset since all of the bonds mature in Year 10. The bond liability is not current, and the interest earned is also included in the sinking fund, a noncurrent asset.
Only sinking fund accounts (or the portion thereof) that are considered to offset current bond liabilities can be included within
current assets.The entire balance in the sinking fund account (deposits plus interest earned) in this example is shown as a noncurrent asset since all of the bonds mature in Year 10. The bond liability is not current, and the interest earned is also included in the sinking fund, a noncurrent asset.
End of period net carrying value (bond payable)
for discounted bond is increasing toward face value of the bond.
Gain or loss from Extinguishment could be
income from continuing operations (gross of tax) or extraordinary item (net of tax)
When a discount on a bond or note is amortized, the discount amortization
increases interest expense for the period. Pension plan interest is reported as a component of net periodic pension cost.
Allocate amounts separately to debt and detachable warrants according to their FMV at date of issuance. The amount allocated to warrants
is "paid-in capital."Any difference between the amount paid (proceeds) and the combination of FMVs of debt and warrants should be debited or credited to "discount or premium on bond payable." In this case, however, only the warrants had a known market value. The bonds have an "implied" market value which is equal to the difference between the cash received and the FMV of the warrants.
The unamortized discount on bonds payable
is a contra to bonds payable. It is presented on the balance sheet as a direct reduction from the face value of the bonds to arrive at the bond's carrying amount. As the discount is amortized, the discount decreases and the carrying value of the bond increases.
To determine the market price of a bond, the present value of the principal
is added to the present value of all interest payments, using the market interest rate.
At the time the warrants are exercised total shareholders equity
is increased by the cash received upon exercise of the warrants, but not by the carrying amount of warrants.
Interest expense
is less than the cash payment made to bondholders when a bond premium is amortized.
Because the stated rate of interest
is less than the effective interest rate when the bond is issued, this bond is issued at a discount.
Amortization of bond
is not accrued. There is no amortized bond payable.
Deferred compensation plan interest
is reported as a component of deferred compensation plan expense.
The interest expense of $43,244 on 6/30/Y1
is the beginning carrying amount of the bond (cell F2) times the semiannual market rate of 4% (8% market rate / 2 interest periods per year). Because the nominal interest rate is below market, the bonds will sell at a discount.
When the effective interest amortization method
is used to amortize a bond issued at a discount, the ending carrying amount of the bond is equal to the beginning carrying amount plus the discount amortized during the current period.
The stated interest rate
is used to calculate the amount of interest payment, but not the market price of the bond.
Under IFRS, both a liability (bond) and an equity component (conversion feature) should be recognized when convertible bonds are issued. The bond liability
is valued at fair value, with the difference between the actual proceeds received and the fair value of the bond liability recorded as a component of equity.The conversion feature is recognized as a component of equity under IFRS. No recognition is given to the conversion feature under U.S. GAAP
When bonds are issued with detachable warrants, the purchase price
must be allocated between the bonds and the warrants. Because only the fair value of the warrants is known, that fair value is allocated to APIC--Warrants and the remaining purchase price is allocated to the bonds.
Remember that the face rate of interest
only has one job, and this is to compute the regular interest payments. It's the market of interest that will determine the bond's selling price.
Under the book value method, the conversion of debt requires credits to common stock and paid-in capital equal to
the book (carrying) value of the bonds. No gain or loss is recorded. The journal entry would be: DR: Bonds payable DR: Bond premium CR: Common stock (par) CR: Add. paid-in capital (to balance)
The gain on the sale of bonds equals
the selling price minus the book value of the bonds.
At the date of issuance, "paid in capital" (stockholders' equity)
was increased (credited) by the amount allocated to warrants, which became the carrying amount of warrants.
The bond was issued at a discount, not a premium, because the stated rate
was less than the effective interest rate when the bond was issued.
Under IFRS, both a liability (bond) and an equity component (conversion feature) should be recognized
when convertible bonds are issued. The bond liability is valued at fair value, with the difference between the actual proceeds received and the fair value of the bond liability recorded as a component of equity.
Bond issue cost
will also be included into Face Value of the bond to calculate the carrying value of the bond.
The bond premium is amortized over the life of the bond with amortized amounts decreasing interest expense each period. If interest expense is not appropriately decreased, then interest expense
will be overstated. The overstating of interest expense will lead to the understatement of net income, which is then closed to stockholder's equity. This will result in the understatement of stockholder's equity.
When the first interest payment is made, the discount is amortized. The discount amortization
will increase interest expense for the period so that interest expense exceeds the interest payment to bondholders.
Not amortizing a bond discount
will lead to the understatement of interest expense and a subsequent overstatement of total stockholder's equity. Not amortizing a bond premium results in the overstatement of interest expense and understatement of total stockholder's equity.
Payment Amount—Principal (cell D2): $1,000,000 The principal payment amount is the $1,000,000 face amount of the bond. This is the amount that
would have been paid to investors on the maturity date of December 31, Year 5 if the bonds had not been called on June 30, Year 2.
Discount on issuance of bonds with warrants
Bonds payable at face value + A.P.I.C. Warrants- Bonds payable at fair value . >> A.P.I.C warrants = market value of each warrant x number of issues of bonds.
An investor purchased a bond classified as a long-term investment between interest dates at a discount. At the purchase date, the carrying amount of the bond
-The carrying value is less than the cash paid by the investor because accrued interest is included in the cash. -The carrying value is less than the face amount of the bond because it was purchased at a discount.
Interest Rate—Principal (cell C2): 0.040 The market rate of interest on the date the bond was issued was 8%. Because the bond pays interest semiannually, the semiannual market rate of 4% (8% annual rate / 2 interest payments per year =
4%) is used to calculate the present value of the principal payment.
Interest Rate—Interest (cell C3): 0.040 The market rate of interest on the date the bond was issued was 8%. Because the bond pays interest semiannually, the semiannual market rate of 4% (8% annual rate / 2 interest payments per year
= 4%) is used to calculate the present value of the interest payments.
Each $1,000 bond was issued with 50 detachable stock warrants, each of which entitled the bondholder to purchase one share of $5 par common stock for $25.
A.P.I.C Warrant = FMV of warrants x 50 x 1,000.
Eagle Corp. issued 600 of its 10%, $1,000 bonds at 99 plus accrued interest
Face Value = 600,000 Bond Issue proceed = 594,000
Calculate a coupon payment
Face Value x Interest Rate x Length Until Maturity.
The selling price equals
Face value + premiums of the bond.
The book value equals
Face value minus the unamortized discount.
Compounding Periods—Interest (cell B3): 10 The bond is a 5year bond that pays interest semiannually, so the number of compounding periods is equal to
10 (5 years × 2 interest payments per year = 10 periods).
Assume that the bonds are converted on January 1, Year 2 and Acorn uses the book value method to account for the conversion of bonds into common stock. Record the journal entry for the conversion.
Bonds payable $800,000 Premium on bonds payable 69,723 Common stock $80,000 Additional paid in capital 789,723
Assume that the bonds are converted on January 1, Year 2 and Acorn uses the market value method to account for the conversion of bonds into common stock. Assume the market price of the common stock on the date of conversion was $250.00 per share. Record the journal entry for the conversion.
Bonds payable $800,000 Premium on bonds payable 69,723 Loss on bond conversion 130,277 Common stock $80,000 Additional paid in capital 920,000 Additional paid in capital = $1,000,000 $ 80,000 = $920,000
Record the journal entry for the issuance of the convertible bonds on January 1, Year 1. Select "No entry" if no journal entry is required on this date.
Cash $875,500 Bonds payable $800,000 Premium on bonds payable 75,500
Present Value—Interest (cell F3): $405,545 The present value of the interest is found using the following formula:
D3 × E3 = $50,000 interest payment × 8.11090 PV factor = $405,545
Logan issued convertible bonds, which are common stock equivalents, for an amount in excess of the bonds' face amount.
DR: Cash CR: Bonds payable (Increase ) CR: Premium (Increase)
Logan declared and issued a 2% stock dividend.
DR: Retained earnings (D) CR: Common stock (I) CR: Additional paid-in-capital (I) A stock dividend merely reclassifies amounts from Retained earnings to Common stock and APIC at the fair value on the declaration date.
Loan 1 is %, five-year balloon loan for $3,000,000 with interest due and paid annually on December 31. Drake record interest annually on December 31. Drake incorrectly recorded the journal entry for the Year 1 interest expense and payment as a debit to accrued interest payable and a credit to cash. prepare the net journal entry to correct Year 1 and properly record the interest attributable to the loan as of the year ended December 31, Year 2.
Incorrect Entry: DR Accrued interest payable 120,000 CR Cash 120,000 The credit to cash is correct, but the debit to accrued interest payable is incorrect. To fix this, accrued interest payable should be credited and retained earnings should be debited. Entry to Fix Year 1: DR Retained earnings 120,000* CR Accrued interest payable 120,000 * 120,000 ($3,000,000 loan × 4%) Record interest for Year 2: DR Interest expense 120,000 CR Cash 120,000
Record the journal entries on December 31, Year 1 to recognize interest expense for the second half of Year 1.
Interest expense $13,090 Premium on bonds payable 2,910 Cash $16,000
Record the journal entries on June 30, Year 1 to recognize interest expense for the first six months of Year 1.
Interest expense $13,133 Premium on bonds payable 2,867 Cash $16,000
Discount
Purchase price, including discount @ 4/1/Year 1 Less: <Face value>
Purchase price, including discount
Purchase price, including interest Less: accrued interest receivable
Interest incurred to finance software developed for internal use
is capitalized as a component of computer software development costs.
The settlement price is greater than the face value of the debt and the face value is greater than the book value.
Therefore, the settlement price is greater than the book value and a loss would be recognized on the transaction. The loss would be classified as "extraordinary" because it meets the U.S. GAAP criteria.
The unamortized discount on bonds payable is a contra to bonds payable. It is presented on the balance sheet as
a direct reduction from the face value of the bonds to arrive at the bond's carrying amount. As the discount is amortized, the discount decrease and the carrying value of the bond increases.
Because the stated rate of interest is less than the effective interest rate when the bond is issued, this bond is issued at
a discount.When the first interest payment is made, the discount is amortized. The discount amortization will increase interest expense for the period so that interest expense exceeds the interest payment to bondholders.
At the time the warrants
are exercised total shareholders equity is increased by the cash received upon exercise of the warrants, but not by the carrying amount of warrants.
Bond issuance costs
are not booked as an asset under either U.S. GAAP or IFRS.
No gain or loss is recognized at conversion. At conversion, the bond payable and discount
are written off and common stock is credited at par. Additional paid in capital is credited for the excess of the bond's carrying value over the stock's par value. DR:Bond Payable DR: Unamortized discount CR:Common stock − par value CR: Additional paid in capital
The bond liability reported on the balance sheet is:
bond liability + net premium
The issue price of a bond
is a function of two different cash flows, one a lump sum and the other a regular stream of payments. First, we need to present value the eventual return of principal using present value tables and factors at the market or effective rate of interest, also known as the yield. Second, we need to present value the regular interest payments, whether annual or semiannual, using present value of an annuity tables and factors at the same market or effective interest rate (yield). Remember that the face rate of interest only has one job, and this is to compute the regular interest payments. It's the market rate of interest that will determine the bond's selling price.
When computing the ending carrying amount of a bond issued at a discount, the discount amortized during the current period
is added to, not subtracted from, the beginning carrying amount. Amortization is subtracted when computing the ending carrying value of a bond issued at a premium.
Under U.S. GAAP, because the conversion feature cannot be sold or transferred separate from the bonds themselves, no value
is assigned to the conversion feature when the bonds are issued.
Interest expense
is calculated from the date the bond is issued. Interest would be calculated from June 1 through December 31 (7 months).
Amortization
is calculated on the carrying amount of the bond, not the face value of the bond. The face value of the bond is received if there was no discount or premium.
Interest payable
is computed as the stated rate of 10% times the face amount of the bonds for six months. Interest expense is equal to the carrying value times the market rate of 9% for six months. The computed amortization reduces the premium and carrying value.
The interest payment of $50,000
is equal to the face amount of the bond (cell G2) times the semiannual stated rate of 5% (10% stated rate / 2 interest periods per year).
Not amortizing the bond premium
will result in the overstatement of interest expense, but not the overstatement of stockholder's equity.
A large stock divided might materially impact stock prices but most likely would have no effect on bond prices. Bond prices in the open market are not related to Lee's carrying amount of the bonds.If interest rates have declined, then the bonds' interest rate
would be even greater than market rates were then the bonds originally issued. The bonds would be selling at a premium rather than a discount.
Compounding Periods—Principal (cell B2): 10 The bond is a 5year bond that pays interest semiannually, so the number of compounding periods is equal to
10 (5 years × 2 interest payments per year = 10 periods).
Logan issued common stock when the convertible bonds in item 2 were submitted for conversion. Each $1,000 bond was converted into 20 common shares. The book value method was used for the early conversion.
DR: Bonds payable (Decrease) DR: Premium (Decrease) CR: Common stock CR: Additional paid-in-capital Under the book value method (which is GAAP), the stock issued is valued at the book value of the bonds being converted. There is no gain or loss recognized.
Logan issued bonds payable with a nominal rate of interest was less than the market rate of interest.
DR: Cash DR: Discount (Increase) CR: Bonds payable (Increase) The amount in excess of face is recorded as a premium. Under U.S. GAAP, no separate entry is made for the convertibility feature because it is not separable from the bonds.
Logan issued bonds, with detachable stock warrants, for an amount equal to the face amount of the bonds.
DR: Cash DR: Discount (I) CR: Bonds payable (I) CR: APIC (stock warrants) (I) The value of the warrants is credited to Additional paidincapital. Because the combination of bonds and warrants were issued for an amount equal to the face amount of the bonds, the bonds without the warrants must be valued at a discount.
Periodic Interest Rate
GAAP Interest Expense ____________________________ Carrying Value at the beginning of the period
On July 1, Year 1, York Co. purchased as a held-to-maturity investment $1,000,000 of Park, Inc.'s 8% bonds for $946,000, including accrued interest of $40,000. The bonds were purchased to yield 10% interest
Interest revenue ($906,000 x 10% x 6/12)
Under U.S. GAAP, all costs associated with the issuance of bonds should be capitalized and amortized over the outstanding term of the bonds since issue. Capitalized costs include:
Printing and engraving + Legal fees + Fees to accountants + Commissions to underwriter
he carrying amount of this investment
Purchase price, including interest Less accrued interest receivable _________________________________ Purchase price, including discount @ 4/1/Year 1 <Face value> ____________________________ Discount 15 months from purchase to maturity ________________________________________ Monthly amortization x 4/1/Year 1 to 10/31/Year 1 ? 7 months _________________________________________ Amortization to 10/31/Year 1 Purchase price, from above at 4/1/Year 1 __________________________________________ Carrying amount at 10/31/Year 1
Under IFRS and U.S. GAAP, bond issuance costs are
deducted from the carrying value of the liability and included in the debit entry to bond discount upon issuance. As part of the discount from par, bond issuance costs are amortized over the life of the bond using the effective interest method. The initial accounting entry upon issuance is: DR: Cash DR: Discount CR: Bonds payable
Bonds payable
is equal to the face value of the bonds, and premium at the time of sale is equal to the difference between the issue price and face value. The carrying value is the combined premium and face value.
The interest rate on convertible debt
is generally lower than nonconvertible debt because of the value of the conversion feature.
Under IFRS, sale-back lease
is not classified as operating lease and no interest revenue will be deferred.
Under the book value method of exchanging convertible bonds for stock, the book value of the bonds
is reallocated to the par value and the additional paid-in capital accounts of the common stock. Thus, stockholders' equity is increased.
When the book value method is used to account for the conversion of bonds to stock, the stock issued
is recorded at the carrying value of the bonds.
Under the book value method, the stock issued upon conversion of the bonds
is recorded at the carrying value of the converted bonds, not at the amount of the bond discount.
Under IFRS, bond issue costs
reduce the cash received from the bond issuance and are deducted from the carrying value of the liability.
Under IFRS, bond issuance costs
reduce the cash received from the bond issuance and are deducted from the carrying value of the liability. The bond issuance is recorded as follows: DR: Cash CR: Premium CR: Bond liability
Payment Amount—Interest (cell D3): $50,000 The semiannual interest payment is calculated using
the 10% stated rate and not the 8% market rate: Interest payments = Face amount × Stated rate (semiannual) = $1,000,000 × (10% / 2) = $50,000
When the effective interest amortization method is used to amortize a bond issued at a discount, the ending carrying amount of the bond is equal to
the beginning carrying amount plus the discount amortized during the current period.
When debt is issued at a discount, interest expense over the term of the debt equals
the cash interest paid plus amortization of the discount.
When debt is issued at a discount, interest expense over the term of the debt equals
the cash interest paid plus amortization of the discount. The Journal Entry for the amortization of the discount is as follows: DR: Interest expense CR: Amortization of bond discount CR: Cash (or interest payable)
If interest rates have increased, then the bond's interest rate
would be less attractive to investors now than when the bonds were originally issued. This would most likely cause a decline in the bonds' market value. Note that because the bond investment is classified as held-to-maturity, the investment will be reported at amortized cost, not fair value.