acct test 3 - ch 14
A bond represents a promise to pay (2)
(1) a sum of money at a designated maturity date, plus (2) periodic interest at a specified rate on the maturity amount (face value).
off balance sheet financing: In addition, the SEC, in response to the Sarbanes-Oxley Act, now requires companies to provide related information in their management discussion and analysis sections. Specifically, companies must disclose (2)
(1) all contractual obligations in a tabular format and (2) contingent liabilities and commitments in either a textual or tabular format.
selling price: The investment community values a bond at the *present value of its expected future cash flows*, which consist of (2)
(1) interest and (2) principal.
3 forms of off balance sheet financing
1 non consolidated subsidiary 2 special purpose entity (SPE) 3 operating leases
In these circumstances, the company measures the present value of the debt instrument by the fair value of the property, goods, or services or by an amount that reasonably approximates the fair value of the note.(3)
1.No interest rate is stated, or 2.The stated interest rate is unreasonable, or 3.The stated face amount of the debt instrument is materially different from the current cash sales price for the same or similar items or from the current fair value of the debt instrument.
Sometimes, companies may receive property, goods, or services in exchange for a note payable. When exchanging the debt instrument for property, goods, or services in a bargained transaction entered into at arm's length, the stated interest rate is presumed to be fair unless: (3)
1.No interest rate is stated, or 2.The stated interest rate is unreasonable, or 3.The stated face amount of the debt instrument is materially different from the current cash sales price for the same or similar items or from the current fair value of the debt instrument.
The indenture or agreement often includes the amounts authorized to be issued, interest rate, due date(s), call provisions, property pledged as security, sinking fund requirements, working capital and dividend restrictions, and limitations concerning the assumption of additional debt.
Generally, long-term debt has various *covenants* or *restrictions* that protect both lenders and borrowers.
off balance sheet financing: A company creates a _____ to perform a special project. To illustrate, assume that Clarke Company decides to build a new factory. However, management does not want to report the plant or the borrowing used to fund the construction on its balance sheet. It therefore creates an ____, the purpose of which is to build the plant. (This arrangement is called a *project financing arrangement*.) The ____ finances and builds the plant. In return, Clarke guarantees that it or some outside party will purchase all the products produced by the plant. (Some refer to this as a *take-or-pay contract*.) As a result, Clarke might not report the asset or liability on its books. The accounting rules in this area are complex. We discuss the accounting for SPEs in Appendix 17B. (same)
SPE
A legal entity created to perform a special activity (such as issue securities, complete a project, perform R&D activities). The company that creates the SPE guarantees that it or some outside party will eventually perform the activity. Use of the SPE enables the company that created it to avoid reporting any assets or liabilities related to the activities on its balance sheet.
SPE Special purpose entity
Companies usually make bond interest payments semiannually, on dates specified in the bond indenture. When companies issue bonds on other than the interest payment dates, *buyers of the bonds will pay the seller the interest ___ from the last interest payment date to the date of issue.*
accrued
The difference between the face value and the present value of the bonds determines the ____ that buyers pay for the bonds. This difference is either a discount or premium
actual price
As indicated earlier, noncurrent liabilities, such as bonds and notes payable, are generally measured at ___ (face value of the payable, adjusted for any payments and amortization of any premium or discount).
amortized cost
The issuing company records the difference between the face amount and the present value (cash received) as a discount and ____ that amount to interest expense over the life of the note.
amortizes
Companies should show any assets pledged as security for the debt in the ____ section of the balance sheet.
assets
Bonds without the name of the owner, which may be transferred from one owner to another by mere delivery.
bearer (coupon) bodns
A ___ or ___ bond, however, is not recorded in the name of the owner and may be transferred from one owner to another by mere delivery.
bearer or coupon bond
Generally, long-term debt has various covenants or restrictions that protect both lenders and borrowers. The indenture or agreement often includes the amounts authorized to be issued, interest rate, due date(s), call provisions, property pledged as security, sinking fund requirements, working capital and dividend restrictions, and limitations concerning the assumption of additional debt. Companies should describe these features in the ____ of the financial statements or the ____ if important for a complete understanding of the financial position and the results of operations.
body or notes
Discount on bonds payable is *not an asset*. It does not provide any future economic benefit. In return for the use of borrowed funds, a company must pay interest. A ____ means that the company borrowed less than the face or maturity value of the bond. It therefore faces an actual (effective) interest rate higher than the stated (nominal) rate.
bond discount
The difference between the face value of a bond and its selling price when the bond sells for less than face value.
bond discount
A bond arises from a contract known as a ___
bond indenture
A contract for a bond that represents a promise to pay a sum of money at a designated maturity rate, plus periodic interest at a specified rate on the maturity amount (face value).
bond indenture
The difference between the face value of a bond and its selling price when the bond sells for more than face value.
bond premium
Noncorporate and small corporate enterprises issue notes as their long-term instruments. Larger corporations issue both long-term notes and ___s.
bonds
The main purpose of ____ is to borrow for the long term when the amount of capital needed is too large for one lender to supply.
bonds
The investors receive interest at the stated rate computed on the face value, but they actually earn at an effective rate that exceeds the stated rate because they paid less than face value for the bonds.
bonds sell at less than face value (discount)
Usually this occurs because the investors can earn a greater rate on alternative investments of equal risk. They cannot change the stated rate, so they refuse to pay face value for the bonds. Thus, by changing the amount invested, they alter the effective rate of return.
bonds sell at less than face value (discount)
___ bonds give the issuer the right to call and redeem the bonds prior to maturity.
callable
Bonds that give the issuer the right to call and retire the bonds prior to maturity.
callable bonds
The effective-interest method produces a periodic interest expense equal to a constant percentage of the ____ of the bonds.
carrying value
The face amount of a bond minus any unamortized discount, or plus any unamortized premium. Synonymous with the term book value.
carrying value
Accounting for notes and bonds is quite similar. Like a bond, a note is valued at the present value of its future interest and principal ____.
cash flows
If a company issues a zero-interest-bearing (non-interest-bearing) note solely for cash, it measures the note's present value by the ____
cash received
Two types of bonds have been developed in an attempt to attract capital in a tight money market
commodity backed bonds deep-discount bonds
(also called asset-linked bonds) are redeemable in measures of a commodity, such as barrels of oil, tons of coal, or ounces of rare metal.
commodity backed bonds (asset linked bonds)
Bonds that are redeemable in measures of a commodity (e.g., barrels of oil, tons of coal, or ounces of rare metal). Also called asset-linked bonds. The accounting problem for such bonds is to project their maturity value in markets where commodity prices fluctuate.
commodity backed bonds (asset linked bonds)
Long-term debt that matures within one year should be reported as a ____, unless using noncurrent assets to accomplish redemption.
current liability
If (mortgage) it is payable in installments, Harrick shows the current installments due as ____, with the ____ as a long-term liability.
current liability remainder
Unsecured bonds, which are issued against the general credit of the borrower (issuer).
debenture bond
JCPenney Company sold the first publicly marketed long-term debt securities in the United States that do not bear interest.
deep discount bonds
Long-term, unsecured debt securities that do not bear interest. They are sold at a discount that provides the buyer's total interest payoff at maturity. Also called zero-interest debenture bonds.
deep discount bonds
Finally, companies must ____ future payments for sinking fund requirements and maturity amounts of long-term debt during each of the next five years. -These disclosures aid financial statement users in evaluating the amounts and timing of future cash flows.
disclose
As a response to off-balance-sheet financing arrangements, the FASB has increased disclosure (note) requirements. This response is consistent with an "efficient markets" philosophy: The important question is not whether the presentation is off-balance-sheet or not, but whether the items are ____ at all.
disclosed
The fair value of the long-term debt should also be ____ if it is practical to estimate fair value.
disclosed
If the bonds sell for less than face value, they sell at a ___
discount
-Amortization of a ____ increases interest expense. -Amortization of a____ decreases interest expense.
discount premium
The ____ method is required, unless the results obtained from using another method are not materially different from those that result from the effective-interest method.
effective interest
payment of debt
extinguishment of debt
As discussed in Chapter 7, the FASB believes that ____ measurement for financial instruments, including financial liabilities, provides more relevant and understandable information than amortized cost. It considers ____ to be more relevant because it reflects the current cash equivalent value of financial instruments. (same)
fair value
current liabilities: However, companies have the option to record ____ in their accounts for most financial assets and liabilities, including bonds and notes payable.
fair value
If a general change in interest rates occurs (for example, the Federal Reserve changes the long-term interest rates on government bonds), the fair value of a company's financial liabilities changes as well.
fair value (net income)
With the Edmonds bonds, we assumed that the decline in value of the bonds was due to a market interest rate increase.
fair value (net income)
How to report these changes is controversial. Some support reporting changes in the fair value of the bonds payable for a decline in creditworthiness in income, noting that the debtholders' loss is the shareholders' gain. That is, the shareholders' claims on the assets of the company increase when the value of the debtholders' claims declines. -Others question how Edmonds can record a gain when its creditworthiness is becoming worse.
fair value (other comprehensive income)
If its creditworthiness declines, its bond investors are receiving a lower rate relative to investors with similar-risk investments.
fair value (other comprehensive income)
In other situations, the decline may occur because the bonds become more likely to default. That is, if the creditworthiness of Edmonds Company declines, the value of its debt also declines.
fair value (other comprehensive income)
If companies choose the ____, noncurrent liabilities, such as bonds and notes payable, are reported at fair value.
fair value option
The recording of financial assets or financial liabilities at fair value, with unrealized holding gains and losses reported as part of net income.
fair value option
Lenders have partially replaced the traditional ____ with alternative mortgage arrangements.
fixed rate mortgage
Whether the early redemption or other extinguishment of outstanding bonds is a nonrefunding or a refunding situation, a company should recognize the difference (____ or ____) between the reacquisition price and the net carrying amount of the redeemed bonds in income of the period of redemption.
gain or loss
The ____ is the rate that equates the cash received with the amounts to be paid in the future.
implicit interest rate
The process of interest-rate approximation, which occurs when a company cannot determine the fair value of the property, goods, services, or other rights, and if the note has no ready market.
imputation
in determining market interest rate: if a company cannot determine the fair value of the property, goods, services, or other rights, and if the note has no ready market, the problem of determining the present value of the note is more difficult. -To estimate the present value of a note under such circumstances, a company must approximate an applicable interest rate that may differ from the stated interest rate. -This process of interest-rate approximation is called ____, and the resulting interest rate is called an ____
imputation imputed interest rate
The prevailing rates for similar instruments of issuers with similar credit ratings affect the choice of a rate. Other factors such as restrictive covenants, collateral, payment schedule, and the existing prime interest rate also play a part. Companies determine the ____ when they issue a note; any subsequent changes in prevailing interest rates are ignored.
imputed interest rate
The result of interest-rate approximation, which occurs when a company cannot determine the fair value of the property, goods, services, or other rights, and if the note has no ready market.
imputed interest rate
As indicated, unrealized gains and losses due to changes in credit risk will not affect ____
income
Bonds that pay no interest unless the issuing company is profitable.
income bonds
pay no interest unless the issuing company is profitable
income bonds
_____ bonds are evidenced by a paper certificate and typically have a $1,000 face value.
individual
If there is no stated rate of interest, the amount of____ is the difference between the face amount of the note and the fair value of the property.
inteterest
By issuing bonds in $100, $1,000, or $10,000 denominations, a company can divide a large amount of long-term indebtedness into many small investing units, thus enabling more than one ____ to participate in the loan.
lender
When bonds sell at ____ than face value, it means that investors demand a rate of interest higher than the stated rate.
less
consists of probable future sacrifices of economic benefits arising from present obligations that are not payable within a year or the operating cycle of the company, whichever is longer.
long term debt
Mortgages may be payable in full at maturity or in installments over the life of the loan. If payable at maturity, Harrick classifies its mortgage payable as a ____on the balance sheet until such time as the approaching maturity date warrants showing it as a current liability.
long term liability
As you might expect, accounting for ____ parallels accounting for long-term notes receivable as was presented in Chapter 7.
long term notes payable
Similar in substance to bonds payable, in that both have fixed maturity dates and carry a stated or implicit interest rate, but notes do not trade as readily as bonds in the organized public securities market.
long term notes payable
____ are similar in substance to bonds in that both have fixed maturity dates and carry either a stated or implicit interest rate.
long term notes payable
Companies that have large amounts and numerous issues of ____ frequently report only one amount in the balance sheet, supported with comments and schedules in the accompanying notes.
long-term debt
In note transactions, the effective or ____ is either evident or determinable by other factors involved in the exchange, such as the fair value of what is given or received.
market interest rate
The difference between current notes payable and long-term notes payable is the ____.
maturity date
The borrower usually receives cash for the face amount of the ____. In that case, the face amount of the note is the true liability, and no discount or premium is involved.
mortgage note
When the lender assesses "points," however, the total amount received by the borrower is less than the face amount of the note.
mortgage note
The most common form of long-term notes payable is a ___
mortgage note payable
a promissory note secured by a document called a mortgage that pledges title to property as security for the loan.
mortgage note payable
Individuals, proprietorships, and partnerships use ___ more frequently than do corporations. (As noted in the opening story, corporations usually find that bond issues offer advantages in obtaining large loans.)
mortgage notes payable
On the balance sheet, Harrick should report the mortgage note payable as a liability using a title such as "____" or "____," with a brief disclosure of the property pledged in notes to the financial statements.
mortgage payable notes payable- secured
When the Edmonds bonds mature or are extinguished, any accumulated other comprehensive gains and losses due to changes in interest rates are reclassified to ____
net income
off balance sheet financing: Under GAAP, a parent company does not have to consolidate a subsidiary company that is less than 50 percent owned. In such cases, the parent therefore does not report the assets and liabilities of the subsidiary. All the parent reports on its balance sheet is the investment in the subsidiary. As a result, users of the financial statements may not understand that the subsidiary has considerable debt for which the parent may ultimately be liable if the subsidiary runs into financial difficulty.
non consolidated subsidiary
If the company plans to refinance debt, convert it into stock, or retire it from a bond retirement fund, it should continue to report the debt as ____. However, the company should disclose the method it will use in its ____
noncurrent liquidation
____ generally indicate the nature of the liabilities, maturity dates, interest rates, call provisions, conversion privileges, restrictions imposed by the creditors, and assets designated or pledged as security.
note disclosures
___do not trade as readily as bonds in the organized public securities markets.
notes
Second, loan covenants often limit the amount of debt a company may have. As a result, the company uses ____ because *these types of commitments might not be considered in computing the debt limitation*
off balance financing
As a result, any company that uses ____ today risks investors dumping the company's stock. Consequently, the company's share price will suffer.
off balance sheet financing
It has become an issue of extreme importance. Many allege that Enron, in one of the largest corporate failures on record, hid a considerable amount of its debt off the balance sheet.
off balance sheet financing
Nevertheless, a considerable amount of ____ continues to exist. As one writer noted, "The basic drives of humans are few: to get enough food, to find shelter, and to keep debt off the balance sheet."
off balance sheet financing
Similarly, many loan covenants also attempt to account for these complex arrangements. -Nevertheless, many companies still believe that benefits will accrue if they omit certain obligations from the balance sheet.
off balance sheet financing
Third, some argue that the asset side of the balance sheet is severely understated. For example, companies that use LIFO costing for inventories and depreciate assets on an accelerated basis will often have carrying amounts for inventories and property, plant, and equipment that are much lower than their fair values. As an offset to these lower values, some believe that part of the debt does not have to be reported. In other words, *if companies report assets at fair values*, less pressure would undoubtedly exist for ___ arrangements.
off balance sheet financing
We believe that recording more obligations on the balance sheet will enhance financial reporting. Given the problems with companies such as Enron, Dynegy, Williams Company, Chesapeake Energy, and Calpine, and the Sarbanes-Oxley requirements, we expect that less ____ will occur in the future.
off balance sheet financing
Whether the arguments above have merit is debatable. The general idea of "out of sight, out of mind" may not be true in accounting. Many users of financial statements indicate that they factor these _____ arrangements into their computations when assessing debt-to-equity relationships.
off balance sheet financing
an attempt to borrow monies in such a way to prevent recording the obligations.
off balance sheet financing
What do Krispy Kreme, Cisco, Enron, and Adelphia Communications have in common? They all have been accused of using ____ financing to minimize the reporting of debt on their balance sheets.
off-balance sheet
Borrowing funds in a way that avoids recording the obligations. Examples of such arrangements are nonconsolidated subsidiaries, special-purpose entities, and operating leases. Companies engage in off-balance-sheet financing as a way to remove debt from the balance sheet or bypass loan covenants. In response to off-balance-sheet financing gone bad (e.g., Enron), the FASB has tightened the rules that allow off-balance sheet accounting and increased disclosure (note) requirements related to this type of financing.
off-balance-sheet financing
off balance sheet financing: Another way that companies keep debt off the balance sheet is by leasing. Instead of owning the assets, companies lease them. Again, by meeting certain conditions, the company has to report only rent expense each period and to provide note disclosure of the transaction. SPEs often use leases to accomplish off-balance-sheet treatment. Note that expected lease accounting changes will bring these lease obligations on-balance-sheet. We discuss accounting for lease transactions extensively in Chapter 21.
operating leases
The FASB now requires that the credit-risk portion of gains or losses on a financial liability be reported in ____
other comprehensive income
1 percent of the face of the note.
point
____ raise the effective-interest rate above the rate specified in the mortgage note.
points
Conversely, if bonds sell at a____, the effective yield is lower than the stated rate.
premium
If the bonds sell for more than face value, they sell at a ___
premium
____ on bonds payable has no existence apart from the related debt. The lower interest cost results because the proceeds of borrowing exceed the face or maturity amount of the debt.
premium
Note that it is often advantageous for the issuer to acquire the entire outstanding bond issue and replace it with a new bond issue bearing a lower rate of interest. The replacement of an existing issuance with a new one is called ____
refunding
Why do companies engage in off-balance-sheet financing? A major reason is that many believe that ____ enhances the quality of the balance sheet and permits credit to be obtained more readily and at less cost.
removing debt
____ are those that companies expect to pay within a year or the operating cycle, whichever is longer.
short term notes payable
Method for computing bond amortization. Under the straight-line method, companies amortize a constant amount each year. Although the FASB recommends the effective-interest method, companies may use a straight-line method if the results obtained are not materially different from those produced by the effective-interest method.
straight line method
amortizes a constant amount each interest period
straight line method
Bond issues that mature on a single date are called ____
term bonds
Bond issues that mature on a single date.
term bonds
Alternatively, the issuing company may sell the bonds directly to a large institution, financial or otherwise, without the aid of an ____ (private placement).
underwriter
fair value option: An _____ is the net change in the fair value of the liability from one period to another, exclusive of interest expense recognized. -As a result, the company reports the liability at fair value each reporting date.
unrealized holding gain or loss
fair value option: In addition, companies report _____ as part of net income or in other comprehensive income, depending on the circumstances.
unrealized holding gain or loss
A debenture bond is ____
unsecured
Generally, the ____ lenders adjust the interest rate at either one- or three-year intervals, pegging the adjustments to changes in the prime rate or the U.S. Treasury bond rate.
variable rate (mortgage) lenders
Most lenders offer ____ (also called floating-rate or adjustable-rate mortgages) featuring interest rates tied to changes in the fluctuating market rate.
variable rate mortgages
Long-term, unsecured debt securities that do not bear interest. They are sold at a discount that provides the buyer's total interest payoff at maturity. Also called deep-discount bonds.
zero-interest debenture bonds
A company may sell an entire bond issue to an ____, which acts as a selling agent in the process of marketing the bonds. In such arrangements, ____s may either underwrite the entire issue by guaranteeing a certain sum to the company, thus taking the risk of selling the bonds for whatever price they can get (firm underwriting). Or they may sell the bond issue for a commission on the proceeds of the sale (best-efforts underwriting). (same)
investment bank
A "____" is unsecured and also very risky, and therefore pays a high interest rate. Companies often use these bonds to finance leveraged buyouts.
junk bond
Bonds payable, long-term notes payable, mortgages payable, pension liabilities, and lease liabilities are examples of ____
long term debt (liabilities)
A corporation, per its bylaws, usually requires approval by the board of directors and the stockholders before bonds or notes can be issued. The same holds true for other types of ____arrangements.
long-term debt
Probable future sacrifices of economic benefits arising from present obligations that are not payable within a year or the operating cycle of the company, whichever is longer. Examples are: bonds payable, long-term notes payable, mortgages payable, pension liabilities, and lease liabilities.
long-term debt
The excess of the reacquisition price over the net carrying amount is a ___
loss from extinguishment
Although it would seem that these covenants provide adequate protection to the long-term debtholder, many bondholders suffer considerable ____ when companies add more debt to the capital structure.
losses
Several variables affect the bond's price while it is outstanding, most notably the ____ rate of interest. There is an inverse relationship between the____ interest rate and the price of the bond. (same)
market
The replacement of an existing bond issue with a new one. A company may find it advantageous to acquire its entire outstanding bond issue and replace it with a new bond issue bearing a lower rate of interest. The company should recognize as income the gain from the refunding in the period of redemption.
refunding
Bonds issued in the name of the owner are _____ and require surrender of the certificate and issuance of a new certificate to complete a sale.
registered bonds
Bonds issued in the name of the owner. At redemption or in a sale of the bond, they require surrender of the certificate.
registered bonds
The issuer may call some bonds at a stated price after a certain date. This call feature gives the issuing corporation the opportunity to reduce its bonded indebtedness or take advantage of lower interest rates. -Whether callable or not, a company must ____ any premium or discount over the bond's life to maturity because early redemption (call of the bond) is not a certainty.
amortize
At the time of reacquisition, the unamortized premium or discount, and any costs of issue applicable to the bonds, must be ____ up to the reacquisition date.
amortized
To illustrate, Sunshine Mining, a silver-mining company, sold two issues of bonds redeemable with either $1,000 in cash or 50 ounces of silver, whichever is greater at maturity, and that have a stated interest rate of 8½ percent. The accounting problem is one of projecting the maturity value, especially since silver has fluctuated between $4 and $40 an ounce since issuance.
commodity backed bonds (asset linked bonds)
Conceptually, discount on bonds payable is a liability valuation account. That is, it reduces the face or maturity amount of the related liability. This account is referred to as a ____ account.
contra
Bonds that permit holders to exchange them for ("convert them to") other securities of a corporation (typically common stock) for a specified time after issuance.
convertible bonds
If bonds are convertible into other securities of the corporation for a specified time after issuance, they are ____ bonds.
convertible bonds
Bonds that pay interest from specified revenue sources (e.g., airports, school districts, counties, toll-road authorities, and governmental bodies).
revenue bonds
so called because the interest on them is paid from specified revenue sources, are most frequently issued by airports, school districts, counties, toll-road authorities, and governmental bodies
revenue bonds
The rate used to compute the present value of these cash flows is the interest rate that provides an acceptable return on an investment commensurate with the issuer's ____ characteristics.
risk
Bonds backed by a pledge of some sort of collateral. For example, mortgage bonds are secured by a claim on real estate; collateral trust bonds are secured by stocks and bonds of other corporations.
secured bonds
secured bonds are backed by a pledge of some sort of collateral: -____ bonds are secured by a claim on real estate. -____ bonds are secured by stocks and bonds of other corporations
-mortgage -collateral trust
Under the effective-interest method, companies: (2)
1.Compute bond interest expense first by multiplying the carrying value (book value) of the bonds at the beginning of the period by the effective-interest rate. 2.Determine the bond discount or premium amortization next by comparing the bond interest expense with the interest (cash) to be paid.
The purchasers of the bonds, in effect, pay the bond issuer in advance for that portion of the full six-months' interest payment to which they are not entitled because they have not held the bonds for that period. *Then, on the next semiannual interest payment date, purchasers will receive the full six-months' interest payment.*
accrued interest payments
Conceptually, premium on bonds payable is a liability valuation account. It adds to the face or maturity amount of the related liability. This account is referred to as an ____ account.
adjunct
If bonds sell at a ____, the effective yield exceeds the stated rate.
discount
Consider what can happen to bondholders in leveraged buyouts (LBOs), which are usually led by management. In an LBO of RJR Nabisco, for example, solidly rated 9⅜ percent bonds plunged 20 percent in value when management announced the leveraged buyout. Such a loss in value occurs because the additional debt added to the capital structure increases the likelihood of default. Although ____ protect bondholders, these investors can still suffer losses when debt levels get too high.
covenants
Generally, long-term debt has various ____ or ____ that protect both lenders and borrowers.
covenants or restrictions
also referred to as zero-interest debenture bonds, are sold at a discount that provides the buyer's total interest payoff at maturity.
deep discount bonds
The preferred procedure for amortization of a discount or premium is the ____ (also called present value amortization)
effective interest method
The preferred procedure for computing the amortization of a discount or premium. Under this method, companies compute bond interest expense (revenue) at the beginning of the period by the effective-interest rate) and then subtract bond interest paid (calculated as the face amount of the bonds times the stated interest rate); the result is the amortization amount.
effective interest method
The rate of interest the bondholders actually earn on a bond (and which takes into account the frequency of compounding). If bonds sell at a discount, the effective yield exceeds the stated rate; if bonds sell at a premium, the effective yield is lower than the stated rate.
effective yield (market rate)
The rate of interest actually earned by the bondholders is called the ___ or ____.
effective yield or market rate
Both the effective-interest and straight-line methods result in the same total amount of interest expense over the term of the bonds. However, when the annual amounts are materially different, generally accepted accounting principles require use of the ____
effective-interest method
Since the percentage is the effective rate of interest incurred by the borrower at the time of issuance, the ____ method provides a more relevant measure of interest expense than the straight-line method.
effective-interest method
The payment of debt. If a company holds a debt security to maturity, it does not compute any gains or losses; the carrying amount will equal the maturity (face) value of the bond. If a company extinguishes debt prior to maturity, it must calculate any gain or loss from extinguishment (based on comparison of the carrying value of the debt to amount paid to extinguish the debt) and report such gain or loss in net income.
extinguishment of debt
companies report bond discounts and bond premiums as a direct deduction from or addition to the ____ amount of the bond.
face
If the rate employed by the investment community (buyers) differs from the stated rate, the present value of the bonds computed by the buyers (and the current purchase price) will differ from the ____ of the bonds.
face value
On a bond, the amount of capital that must be repaid at maturity. The terms face value, par value, principal amount, or maturity value are used interchangeably.
face value
The stated rate is expressed as a percentage of the ____ of the bonds (also called the par value, principal amount, or maturity value).
face value
When a company issues bonds on an interest payment date at par (____), it accrues no interest. No premium or discount exists. The company simply records the cash proceeds and the face value of the bonds.
face value
On any specified date, the *net carrying amount* of the bonds is the amount payable at maturity, adjusted for unamortized premium or discount. Any excess of the net carrying amount over the reacquisition price is a ____
gain from extinguishment
record extinguishment of debt: If a company ___ the bonds (or any other form of debt security) to maturity, the answer is straightforward: The company does not compute any gains or losses. It will have fully amortized any premium or discount at the date the bonds mature. As a result, the carrying amount will equal the maturity (face) value of the bond. As the maturity or face value will also equal the bond's fair value at that time, no gain or loss exists.
holds
Recall from our earlier discussion that because of its relation to interest, companies amortize the discount and charge it to ____ over the period of time that the bonds are outstanding.
interest expense
In some cases, a company extinguishes debt before its maturity date.8 The amount paid on extinguishment or redemption before maturity, including any call premium and expense of reacquisition, is called the ____
reacquisition price
The ____ of a bond issue is set by the supply and demand of buyers and sellers, relative risk, market conditions, and the state of the economy.
selling price
The issuance and marketing of bonds to the public does not happen overnight. It usually takes weeks or even months. First, the issuing company must arrange for underwriters that will help market and sell the bonds. Then, it must obtain the Securities and Exchange Commission's approval of the bond issue, undergo audits, and issue a prospectus (a document which describes the features of the bond and related financial information). Finally, the company must generally have the bond certificates printed. Frequently, the issuing company establishes the terms of a bond indenture well in advance of the sale of the bonds. Between the time the company sets these terms and the time it issues the bonds, the market conditions and the financial position of the issuing corporation may change significantly. Such changes affect the marketability of the bonds and thus their ____
selling price
Companies usually make bond interest payments ____, although the interest rate is generally expressed as an ____ rate.
semiannually annual
Bond issues that mature in installments. School or sanitary districts, municipalities, or other local taxing bodies that receive money through a special levy frequently use serially maturing bonds.
serial bonds
Issues that mature in installments are called ____ bonds
serial bonds
____ maturing bonds are frequently used by school or sanitary districts, municipalities, or other local taxing bodies that receive money through a special levy.
serially
The interest rate written in the terms of the bond indenture (and often printed on the bond certificate) is known as the ____ -The issuer of the bonds sets this rate.
stated, coupon, or nominal rate
The interest rate written in the terms of the bond indenture (and often printed on the bond certificate). The issuer of the bonds sets this rate, expressed as a percentage of the bond's face value.
stated, coupon, or nominal rate
Bonds not backed by collateral are ____
unsecured
