Bonds and Long-Term Notes

Times interest earned ratio

A measure of a company's solvency, calculated by dividing income before interest expense and taxes by interest expense

What does it mean that the bonds are "first mortgage" bonds? What effect does that have on financing?

A mortgage bond is backed by a lien on specified real estate owned by the issuer. This makes it less risky than unsecured debt.

Rate of return on assets

A profitability measure that is computed by dividing net income before taxes and interest expense by average total assets

Effective interest Method

Allocates interest expense over the bond life to yield a constant rate of interest; interest expense for a period is found by multiplying the balance of the liability at the beginning of the period by the bond market rate at issuance, also called interest method.

Callable

Allows the issuing company to buy back, or call, outstanding bonds from the bondholders before their schedule maturity date.

Premium

Arises when bonds are sold for more than face amount

Discount

Arises when bonds are sold or less than face amount.

Mortgage Bond

Backed by a lien on specified real estate owned by the issuer.

Why is the premium (or discount) unaffected by debt issue costs

Because the are recorded in a separate account.

How will a bond issue be priced:

By the marketplace to yield the market rate of interest for securities of similar risk and maturity.

Bond Indenture

Describes specific promises made to bondholders.

Periodic Interest

Effective Interest Rate Times the Amount of the debt outstanding during the interest period.

The rate of interest that actually is incurred on a bond payable is called:

Effective Rate

Rate of return on shareholders' equity

net income/owner's average equity * 100%

Cause for the stated rate to differ from the market rate is:

the inevitable delay between the date the terms of the issue are established and the date the issue comes to market.

Does the difference between the effective interest and the interest paid increases the liability.

yes

Sinking bond

a fund to which annual or semiannual deposits are made for the purpose of redeeming a bond

Straight-line method

Recording interest each period at the same dollar amount.

On January 1, 2016, an investor paid $292,000 for bonds with a face amount of $340,000. The state rate of interest is 8% while the current market rate of interest is 10%. Using the effective interest method, how much interest income is recognized by the investor in 2016 (assume annual interest payments and amortization)?

$29, 200 $292,000 x 10% = $29,200

During the year, Hamlet Inc. paid $24,000 to have bond certificates printed and engraved, paid $160,000 in legal fees, paid $11,000 to a CPA for registration information, and paid $230,000 to an underwriter as a commission. What is the amount of bond issue costs?

$425,000 Printing costs $ 24,000 Legal fees 160,000 CPA fees 11,000 Underwriting fees 230,000 Total bond issue costs $425,000

Auerbach Inc. issued 10% bonds on October 1, 2016. The bonds have a maturity date of September 30, 2026 and a face value of $500 million. The bonds pay interest each March 31 and September 30, beginning March 31, 2017. The effective interest rate established by the market was 12%. Assuming that Auerbach issued the bonds for $442,650,000, what would the company report for its net bond liability balance at December 31, 2016, rounded to the nearest thousand? (Do not round intermediate calculations.)

$443,430,000 This is the beginning liability of $442,650,000 + interest accrued for three months (3.00% of issue price) - interest payable of $12,500,000 ($500,000,000 × 10% × 3/12).

TMC issued $75 million of its 12% bonds on April 1, 2016, at 97 plus accrued interest. The bonds are dated January 1, 2016, and mature on December 31, 2035. Interest is payable semiannually on June 30 and December 31. What amount did TMC receive from the bond issuance? (Do not round intermediate calculations.)

$75.00 million $75 million x 0.97 = $72.75 million 12% x $75 million x 3/12 = $2.25 million $72.75 million + 2.25 million = $75.00 million

On January 1, 2016, Legion Company sold $280,000 of 4% ten-year bonds. Interest is payable semiannually on June 30 and December 31. The bonds were sold or $175,317, priced to yield 10%. Legion records interest at the effect rate. Legion should report bond interest expense for the six months ended June, 30 2016, in the amount of (round your answer to the nearest dollar amount)

$8,766 5.0% x $175,317 = $8,766

Straight-line amortization of bond discount or premium?

Provides the same total amount of interest expense over the life of the bond issue as does the effective interest method.

An amortization schedule for bonds issued at a premium:

Is as schedule that reflects the changes in the debt over its term to maturity.

Debt Issue Cost

Legal, Accounting, Printing. With either publicly or privately sold debt, the issuing company will incur costs in connection with issuing bonds or notes in addition to registration and underwriting fees.

A bond issue with a face amount of $500,000 bears interest at the rate of 8%. The current market rate of interest is 9%. These bonds will sell at a price that is:

Less than $500,000 because when the market rate of interest is higher than the bonds' stated rate the bonds will sell at a discount.

Would accounting differ if the debt were designated as notes rather than bonds?

No, other things being equal, whether they're called bonds, notes, or some other form of debt, the same accounting principals apply. They will be recorded at present value and interest will be recorded at the market rate over the term to maturity.

Bonds

Obligate the issuing corporation to repay a stated amount at a specified maturity date and periodic interest between the issue date and maturity. Divides a large liability into many smaller liabilities.

The method used to pay interest depends on whether the bonds are:

Registered or Coupon

Debenture Bond

Secured only by the"full faith and credit" of the issuing corporation.

Fair value

The amount for which the investment could be bought or sold in a current transaction between willing parties. The credit balance in the fair value adjustment increases the book value; the discount reduces it.

Subordinated Debenture

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

Registered bonds

These are regularly used today...years ago it was typical for bonds to be structured as coupon bonds or bearer bonds that were not registered and to collect interest the bond holder had to actually clip an attached coupon and redeem it in accordance with instructions in the indenture.

Debt to equity ratio

Total liabilities divided by stockholders' equity; measures a company's solvency risk

Depending whether the bonds are issued at a premium or discount, the outstanding balance becomes zero at maturity.

True

Other things being equal, the lower the perceived riskiness of the corporation issuing bonds, the higher the price those bonds will comand

True

Is more cash paid each period than the effective interest, the debt outstanding is reduced by the overpayment.

Yes

Should interest that has accrued since the last interest date must be recorded by an adjusting entry prior to preparing financial statements.

Yes

Convertible Bonds

bonds that can be exchanged at the owner's discretion into stock of the issuing company

Serial Bonds

bonds that require payment of the principal amount of the bond over a series of maturity dates - More structured but less popular

Convertible Bonds

corporate bonds that can be exchanged at the owner's discretion into common stock of the issuing company have features of both debt and equity because of the inseparability of their debt and equity features, the entire issue price of convertible bonds is recorded as debt, as if they are nonconvertible bonds.

Detachable stock purchase warrants

equity securities entitling the holder to acquire shares of stock at a fixed price for a specified period of time and that are issued along with bonds

Early Extinguishment of debt

issuer retires debt before its scheduled maturity date