Chapter 9

Default risk

the possibility that a company will be unable to pay the bond's face amount or interest payments as they become due.

Omar Inc. has 6%, $200,000 face amount bonds outstanding. The bonds were issued at a discount. At the end of the current fiscal period, unamortized bond discount is $4,500. The total bond-related liability reported on Omar's balance sheet should be:

$195,500

Times interest earned ratio =

(Net Income + Interest Expense + Tax Expense) / Interest Expense

equity financing

obtaining investment from stockholders (stockholders' equity)

Internal financing

profits generated by the company

In practice, most corporate bonds pay interest ___________ rather than paying interest monthly, quarterly, or annually.

semiannually

On January 1, year 1, Klondike issued 10-year bonds with a stated rate of 10% and a face amount of $100,000. The bonds pay interest annually. The market rate of interest was 12%. Calculate the issue price of the bonds. Round your answer to the nearest dollar.

(5.65022 x $10,000) + (0.32197 x $100,000) = $88,699

Debt to equity ratio =

(total liabilities)/(stockholders' equity)

When the issuing company buys back its bonds from the investors, we say the company has ________ those bonds.

Retired. The company can wait until the bonds mature to retire them , or frequently, the issuing company will choose to buy the bonds back from the investors early.

Lease

a contractual arrangement by which the lessor (owner) provides the lessee (user) the right to use an asset for a specified period of time

If the bonds' stated interest rate is more than market interest rate, then the bonds will issue

above face amount (premium)

debt financing

borrowing money from creditors (liabilities)

annuity

cash payments of equal amounts over equal time periods

The carrying value of a bond at maturity will equal their,

face amount.

Bond

formal debt instrument issued by a company to borrow money. The issuing company (borrower) receives cash by selling a bond to an investor (lender). In return, the issuing company promises to pay back the investor.

As the default risk of the bond increase, investors can ______ their rate of return over the life of the bond by paying a ________ price at the issue date.

increase; lower

Quattro Lending Company is considering lending a large sum to Eleance Inc. During its decision process, Quattro should especially consider Eleance's existing:

long-term liabilities

Dorothea Inc. is selling all of its bonds to a large pension fund. This an example of a(n)

private placement

private placement

sale of debt securities directly to a single investor. EX: when an issuing company chooses to sell a bond directly to a single investor in order to keep costs down.

Stated interest rate

the rate specified in the bond contract used to calculate the cash payments for interest.

Totito Inc. issues $100,000 face amount bonds at $98,000. The journal entry to record the issuance of the bonds should include debit(s) to:

-cash for $98,000 -discount on bonds payable for $2,000

Bond Characteristics

1. secured (bonds are backed by collateral) 2. unsecured (bonds are not backed by collateral) 3. term (bond issue matures on a single date 4. serial (bond issue matures in installments) 5. Callable (issuing company can pay off bonds early) 6. Convertible (investor can convert bonds to common stock)

The issue price of a bond =

the present value of the bond's face amount + the present value of its periodic interest payments

Cabot Inc. has 6%, $100,000 face amount bonds outstanding. The bonds were issued at a discount. At end of the current fiscal period, unamortized bond discount is $1,200.The balance sheet presentation of Cabot's bonds should include:

-less discount on bonds payable of $1,200 -bonds payable of $100,000

External financing

funds coming from outside of the company

market interest rate

implied rate based on the price investors pay to purchase a bond in return for the right to receive the face amount at maturity and periodic interest payments over the remaining life of the bond.

installment payment

includes both an amount that represents interest and an amount that represents a reduction of the outstanding balance

return on assets

measures the amount of income generated for each dollar of assets.

ABC Company issues a bond with a face value of $100,000 at face amount on January 1. ABC prepares financial statements only at December 31, so no adjusting entries are made during the year to accrue interest. If the bond carries a stated interest rate of 6% payable in cash on December 31 of each year, the journal entry to record the first bond interest payment includes ______.

-credit to cash of $6,000 -debit to interest expense of $6,000

On January 1, 2021, California Coasters issues $100,000 of 7% bonds, due in 10 years, with interest payable semiannually on June 30 and December 31 each year. Record the initial bond issue.

-debit cash $100,000 -credit bonds payable $100,000

What does the issuing company pay back to the investor?

1. a stated amount, referred to as the principal for face amount, at a specified maturity date 2. periodic interest payments over the life of the bond.

If the bonds' stated interest rate equals the market interest rate, then the bonds will issue

at face amount

If the bonds' stated interest rate is less than the market interest rate, then the bonds will issue

below face amount (discount)

The discount account is a _________ liability, which is deducted from _________ __________ in the balance sheet.

contra; bonds payable

On January 1, 2021, California Coasters issues $100,000 of 7% bonds, due in 10 years, with interest payable semiannually on June 30 and December 31 each year. Record the first semiannual interest payment.

-debit interest expense $3,500 -credit cash $3,500 ($100,000 x 7% x 1/2= $3,500)

On January 1, Year 1, Liang Corporation issues a $100,000 bond at a discount for $95,083. The coupon rate is 10% and the market interest rate is 12%. The bonds pay interest semiannually on June 30 and December 31. The journal entry to record the interest payment on June 30, Year 1 will include which of the following entries?

-debit interest expense $5,705 -credit cash $5,000 -credit discount on bonds payable $705

Totito Inc. issues $100,000 face amount bonds at $98,000. The journal entry to record the issuance should include:

-debit to discount on bonds payable for $2,000 -credit to bonds payable for $100,000

ABC Company issues a bond with a face value of $100,000 at face amount on January 1. The bond carries a stated annual interest rate of 6% payable in cash on December 31 of each year. If ABC issues monthly financial statements, it must make an adjusting entry on January 31 that includes ______.

-debit to interest expense of $500 -credit to interest payable of $500

Most corporate bonds are ______ and _______

callable; unsercured

Loans requiring periodic payments of interest and principle are referred to as

installment notes

A common reason for redeeming a bond prior to its maturity date is that

market interest rates decreased

early extinguishment of debt

when the issuing company retires debt of any type before its scheduled maturity date. EX: paying a car loan off early