ACCT 314, Ch. 14

fair value adjustment

a credit balance increases the book value, while a debit balance decreases the fair value

bond

a form of debt consisting of separable units that obligates the issuing corporation repay a stated amount at a specific maturity date and to pay interest to bondholders between the issue date and maturity

callable

allows the issuing company to buy back, or call, outstanding bonds from the bondholders before their scheduled maturity date; this feature affords the company some protection against being stuck with relatively high cost in the event interest rates fall during the period before maturity

financial statements between interest dates

any interest that has accrued since the last interest date must be recorded by an adjusting entry prior to preparing financial statements; because interest is recorded for only a portion of the semiannual period, amounts recorded are simply shown in the amortization schedule times the appropriate fraction of the semiannual period; later, when semiannual interest is paid, the remainder of the interest is allocated to the next fiscal year

discount

arises when bonds are sold for less than face amount; stated interest rate < market interest rate

premium

arises when bonds are sold for more than their face amount; stated interest rate > market interest rate

long term liabilities

as a general rule, (blank) are reported at their rpesent values; the PV of a liability is the PV of its related cash flows (principal and/or interest payments), discounted at the effective rate of interest at issuance

mortgage bond

backed by a lien on specified real estate owned by the issuer

debenture bond

backed only by the "full faith and credit" of the issuing corporation; no specific assets are pledged as security

convertible bonds

bonds for which bondholders have the option to convert the bonds into shares of stock; because of the inseparability of their debt and equity features, the entire issue price is recorded as debt

sinking fund debenture

bonds that must be redeemed on a prespecified year-by-year basis; administered by a trustee who repurchases bonds in the open market

effective interest method

calculates interest revenue by multiplying the outstanding balance of the investment by the relevant interest rate

mix and match

companies can choose which financial instruments to report at fair value; the company must make the election when the item originates and is not allowed to switch methods once a method is chosen

IFRS convertible bonds

convertible debt is divided into its liability and equity components; the bond is recorded as a liability while the option is shareholders' equity

debt issue costs

costs of issuing debt securities are called (blank) and are accounted for the same way as bond discount; include legal and accounting fees, printing costs, and registration and underwriting fees

early extinguishment of debt

debt is retired prior to its scheduled maturity date; the account balances pertinent to the debt must be removed from the books; the difference between tech book value of the debt and the reacquisition price represents either a gain or loss on the (blank)

bond indenture

document that describes specific promises made to bondholders; held by a trustee, usually a commercial bank or other financial institution, appointed by the issuing firm to represent the rights of the bondholders

installment notes

equal amounts each period that include both an amount that represents interest and an amount that represents a reduction in the outstanding balance; the payment is easily calculated by dividing the amount of the loan by the appropriate discount factor for the PV of an annuity; at the maturity date, the outstanding balance of the note is zero

reporting changes in fair value

if a company chooses the optino to report at fair value, a change in fair vlaue will create a gain or loss. any portion of that gain or loss that is a result of a change in the "credit risk" of the debt, rather than a change in the general interest rates, is reported not as a part of net income but instead as other comprehensive income (OCI)

exercise of conversion of option

if and when the bondholder exercises his or her option to convert the bonds into shares of stock, the bonds are removed from the accounting records and new shares issued are recorded at the same amount (in other words, at the book value of the bonds)

financial statement disclosures

in the BS, long-term debt is usually recorded as a single amount net of discount/premiums; the fair value of financial instruments must be disclosed; the disclosure note for debt includes the nature of the company's liabilities, interest rates, maturity dates, call provisions, conversion options, restrictions imposed by creditors, and any assets pledged as collateral

induced conversion

investors are often reluctant to convert bonds into stock, even when share prices have risen significantly since the convertible bonds were purchased. this is because the market price of the convertible bonds will rise along with market prices of the stock; one way is through a call provision; when additional consideration is provided to induce conversion, the fair value of that conversion is considered an expense incurred to bring about the conversion

serial bonds

more structured (and less popular) way to retire bonds on a piecemeal basis; for a typical 30 year serial issue, 25 to 30 separate maturity dates might be assigned to specific portions of the bond issue

coupon bonds

name of the owner was not registered; the holder actually clipped an attached coupon and redeemed it in accordance with instructions of the indenture

determining selling price

other things being equal, the lower the perceived riskiness of the corporation issuing bonds, the higher the price those bonds will command; investors heavily rely on bond ratings; the price of a bond will be the PV of the periodic cash interest payments plus the PV of the principal payable at maturity, both discounted at the market rate

zero coupon bond

pays no interest but instead offers a return in the form of a "deep discount" from the face amount; an advantage of (blank) is that the corporation can deduct for cash purposes the annual interest expense but has no related cash outflow until the bonds mature

implicit rate of interest

rate implicit in the agreement; occasionally the stated interest rate is not indicative of the market rate at the time a note is negotiated. the value of the asset (cash or noncash) or service exchanged for the note establishes a market rate

fair value rises

rather than increasing the bonds payable account itself, we instead adjust it incorrectly with a credit to a valuation account

straight line metohd

recording interest each period at the same dollar amount; a company is allowed to use this method if doing so produces results that are not materially different from the usual (and preferable) interest method

subordinated debenture

the holder is not entitled to receive any liquidation payments until the claims of other specified debt issuers are satisfied

detachable stock warrants

the investor has the option to purchase a stated number of shares of common stock at a specified call price, within a given period of time; the issue price is allocated between two different securities on the basis of their fair values

private placement

the issuing company may choose to sell the debt securities directly to a single investor--often a pension fund or insurance company; issue costs are less because privately placed securities are not subject to the costly and lengthy process of registering the SEC that is required of public offerings

underwriting fee

the spread between the price the underwriter pays and the resale price

reasons for issuing convertible bonds

to sell the bonds at a higher price (which means a lower effective interest cost); to use a medium of exchange in mergers and acquisitions; to enable smaller firms or debt heavy companies to obtain access to hte bond market

debt to equity ratio

total liabilities/shareholders' equity; measures deafult risk

call provision

when the specified call price is less than the conversion value of the bonds (the market value of the shares), calling the convertible fond provides bondholders with incentives to convert. bondholders will choose the shares rather than the lower call price