MGMT 200 - Chapter 9 (online)
how do we record the interest expense for after 6 months?
add the previous balance of discount on bonds payable to the carrying value recalculate new difference (discount on bonds payable)
convertible bonds
allow the investor to convert each bond into a specified number of shares of common stock
what is the current portion of debt?
amount of the loan that will be settled WITHIN ONE YEAR of the balance sheet date
what does each installment payment include?
an amount that represents interest expense and an amount that represents a reduction in the carrying value (remaining loan balance)
what is the relation between default risk of the bond and rate of return?
as the default risk of the bond increases, investors can INCREASE their rate of return over the life of the bond by paying a LOWER price at the issue date.
how is a lease recorded?
asset and a liability for the user to use the asset for a period of time
what is the accounting equation? (resources/claims?)
assets = liabilities + stockholders' equity (resources) = (creditors claims) + (owners claims)
carrying value
begins with original cost of loan & by the end of the loan, carrying value will equal $0 with each cash payment, portion assigned to interest expense becomes less and the portion that reduces the carrying value becomes more
what is the difference though between bonds and notes?
bonds = for greater amounts and are issued to many lenders notes = issued to a single lender usually (like a bank)
unsecured bonds
bonds that are NOT supported by specific assets pledged as collateral
secured bonds
bonds that are supported by specific assets pledged as collateral
what is more common - callable or convertible?
callable
most corporate bonds are ____
callable (redeemable)
do callable bonds benefit the issuing company or the investing company? what about convertible bonds?
callable = issuing convertible = both!
examples of when you have monthly installments rather than a single amount at maturity?
car/house loan borrowing cash (often)
what is the value of a bond at maturity?
carrying value at maturity will equal their face amount
what does a bond amortization schedule summarizes?
cash paid for interest, interest expense, and changes in the bond's carrying value for each semiannual interest period
decrease in carrying value
cash paid in excess of interest expense reduces the carrying value (remaining loan balance)
external funding
companies must rely on funds from those outside the company to pay for operations and expansion
what kind of account is the discount account?
contra liability - so it is deducted from bonds payable
lease examples?
contractual arrangement by which the lessor (owner) provides the lesse (user) the right to use an asset for a specified period of time ex: car, apartment, buildings, etc.
unsecured bonds are also known as what?
debentures
what are the two sources of external financing?
debt financing and equity financing
what kind of companies use debt financing and what kind of companies use equity financing?
debt financing: amusement parks - for their financing equity financing: high-tech companies - finance their asset growth
premium of bonds payable
difference between the selling price and the face amount of a bond that is sold for more than the face amount
the stated rate is [less than/equal to/greater than] for discount, face amount, and at premium
discount = less than face amount = equal to premium = greater than
you [do/do not] record a lease at its actual value?
do not - record at present value not the actual value that the monthly payments would actually add up to
does the company need to pay back the issue price (carrying amount) or face amount at the end of the life of the bond? how is this done?
face amount!! increase the carrying amount by eliminating the discount as we record each period's interest payment
bond example: assume that company wants to raise money for new project by issuing $100,000 of bonds paying interest of 7% each year. bonds are due in 10 years, which interest payable semiannually on Jun 30 and Dec 31 each year. how much will investors in this company's bonds receive?
face amount: $100,000 at the end of the 10 years interest payments: $3,500 (100,000 *.07 * 1/2 year) every six months for 10 years in total = $170,000 (100,000 + 70,000)
at what value is a long-term lease recorded with?
for the present value of payments
bond
formal debt instrument issued by a company to borrow money
when interest rates go down, bond prices ___
go up & visa versa
higher times interest earned ratio = ?
higher ability of a company to meet its interest obligations
are convertible bonds at a higher or lower price? what about interest rate?
higher price lower interest rate
higher market rate for bonds that have a [lower/higher] default risk
higher!!
market interest rate
implied rate based on the price investors are willing to 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
most notes payable require periodic ______ _______
installment payments
is interest expense tax-deductible? what about dividends? [yes/no]
interest expense = YES dividends = NOT
what is the difference between interest expense and the cash paid for interest? what is the difference between the two?
interest expense = carrying value times market rate cash paid for interest = face amount times the stated rate so the discount on bonds payable is the difference between the two
effective interest method
interest expense is the current CARRYING VALUE times the MARKET RATE
what happens if the company defaults on payments?
invester is entitled to the borrowers assets that were pledged as collateral
sinking fun
investment fund to which an organization makes payments each year over the life of its outstanding debt
what is the amount investors pay to the company known as?
issue price
how does a bond work?
issuing company (borrower) sells a bond to investor (lender) and the borrower receives cash
what is the #1 method of external financing by US companies?
leasing
how do you record a loss on a bond? how do you record a gain on a bond?
loss = left side gain = right side ??
what is example of a gain or loss on loans when retiring them early?
loss: owe $5000 on car loan but have to pay $5200 to pay it off early, then a loss of $200 is recorded gain: owe $5000 on car loan but only have to pay $4700, then record a gain of $300
capital structure
mixture of liabilities and stockholders' equity in a business
cash paid
monthly payments remain the same over the loan period
bonds are similar to ____
notes
what are the three primary sources of long-term debt financing?
notes, leases, and bonds
how does the issuing company pay back the investor?
pay back the face amount at a specified maturity date & periodic interest payments over the life of the bond
date
payments are made at the end of each month
how is the note paid using installment payment?
periodic reduction of the balance so that at maturity, the note is fully paid
issue price of the bonds = _____ + _____
present value of the face amount + present value of interest payments
how can a company keep the cost down?
private placement
internal financing
profits generated b the company
how are callable bonds beneficial?
protect issuing company against future decreases in the interest rates if interest rates decline, company can buy back the high-interest-rate bonds at a fixed price and issue new bonds at the new, lower interest rate.
amortization schedule
provides a table format detailing: - the cash payment each period - the portions of each cash payment that represent interest and the change in carrying value - and the balance of the carrying value
stated interest rate
rate specified in the bond contract used to calculate the cash payments for interest
debt financing
refers to borrowing money from creditors (liabilities)
equity financing
refers to obtaining investment from stockholders (stockholders' equity)
when a bond is issued at face amount, the carrying value and the corresponding interest expense __________ over time
remain constant
term bonds
require payment of the full principle amount of the bond at a single maturity date
serial bonds
require payments in installments over a series of years
private placement
sale of bonds directly to a single investor, such as a large investment fund / insurance company
what kind of bond characteristics are there
secured or unsecured term or serial callable convertible
how does an issuing company insure ensure that sufficient funds are available to pay back bonds at the end of the loan term?
sinking fund
how is debt classified?
split into current and long-term portions for financial reporting
how do you record the interest expense after 6 months?
subtract the previous premium of bonds payable balance from the carrying value recalculate the new difference (premium on bonds payable)
why would a company borrow money rather than issue additional stock in the company?
taxes!!
are most bonds term bonds or serial bonds?
term bonds
what are debentures / unsecured bonds secured with then?
the "full faith and credit" of the issuing company
what does the additional payment (difference between actual and present value) represent?
the cost of borrowing over the years
discount on bonds payable
the difference between the face value of a bond and its selling price when a bond is sold for less than its face value
how much does a company pay back at the end of the bonds maturity when its on premium? how?
the face value carrying value will decrease from the issue price to the face amount by eliminating the premium through the interest payments
early extinguishment of debt
the issuer retires debt before its scheduled maturity date
default risk
the risk that a company will be unable to pay the bond's face amount or interest payments as they become due
how often is interest on bonds paid?
twice a year (semiannually) on designated interest dates beginning 6 months after original bond issue date
when a bond is sold what is it known as?
underwritten
what are most bonds like though?
unsecured bonds
how do you determine what is current and long-term debt?
whatever is going to be paid in this year of the loan = current, and everything that will be settled in the next year or later = long-term liability
how does a company retire bonds?
when issuing company buys back its bonds from the investors
what is an example of secured bonds?
when you buy a house and finance your purchase with a bank loan, you sign a mortgage agreement assigning your house as collateral - so if you don't make the payments, the bank is entitled to take your house!
do most bonds have this characteristic? [yes/no]
yes
how do you calculate present value of a lease? (or what are the inputs)
you need a financial calculator or a Excel but the inputs are: future value (FV), lease payment (PMT), number of payments (N), and interest rate (I) FV = $0 PMT = monthly amount being paid N = number of months I = % annual rate * (1/12 periods)
what is an example of serial bonds?
$20 million in serial bonds, of which $2 million is due EACH YEAR for the next 10 years
why do many companies lease rather than buy? (4 reasons)
1. leasing reduces the upfront cash needed to use an asset 2. lease payments are often lower than installment payments 3. leasing offers flexibility and lower costs when disposing of an asset 4. leasing may offer protection agains the risk of declining asset values
how do you calculate present values (4 things)
1. the face amount of the bond 2. the interest payment of each period based on the stated interest rate of the bond 3. the number of periods until the bond matures 4. the market interest rate per period
times interest earned ratio
= (net income + interest expense + tax expense) / interest expense measures a company's ability to meet interest payments as they become due
return on assets
= net income / average total assets measures the amount of net income generated for each dollar invested in assets
interest expense
= the prior month's carrying value times the interest rate
debt to equity ratio
= total liabilities / stockholder's equity measures a company's risk
discount
a bond's issue price is below the face amount
what is an example of using sinking fund?
a company borrows $20 million by issuing a bond due in 10 years. the company might put $2 million each year into a sinking fund so at the end of 10 years they are able to pay back the bonds on the due date.
what kind of costs does a company pay for underwriting services?
a fee for underwriting services legal, accounting, registration, and printing fees
annuity
a series of equal amounts over equal time periods
features of amortization schedule:
- date - cash paid - interest expense - decrease in carrying value - carrying value
What are the distinguishing characteristics of bonds
- whether they are backed by collateral (secured or unsecured) - due at a single date or over a series of years (term or serial) - can be redeemed prior to maturity (callable) - can be converted into common stock (convertible)
how do you record interest expense to reduce the premium?
Dr. Interest Expense (using the effective interest method) Dr. Premium on Bonds Payable (difference) Cr. Cash (actual interest using face value times stated interest rate)
how do you determine a company's capital structure?
BALANCE SHEET debt capital = higher portion of liabilities than stockholders equity equity capital = higher portion of stockholders equity than liabilities
how do you record semiannual interest payment?
Dr. Interest Expense Cr. Cash
how do you record interest expense to increase the carrying amount?
Dr. Interest Expense (using the effective interest method) Cr. Discount on Bonds Payable (difference) Cr. Cash (the actual interest using the face amount and stated interest rate)
how do you record a long-term lease?
Dr. Lease Asset Cr. Lease Payable FOR THE PRESENT VALUE OF THE LEASE PAYMENTS
when a bond is issued at a premium, the carrying value and the corresponding interest expense __________ over time
DECREASE
how does a company record the issuance of a bond?
Dr. Cash Cr. Bonds Payable amount is face value
how do you record a bond with discount?
Dr. Cash Dr. Discount on Bonds Payable Cr. Bonds Payable the cash amount is the carrying value (after the discount from the original amount)
how do you record a bond with premium?
Dr. Cash (carrying value) Cr. Bonds Payable (face value) Cr. Premium on Bonds Payable (difference between the carrying and face value)
when a bond is issued at a discount, the carrying value and the corresponding interest expense __________ over time
INCREASE
who are the three largest bond underwriters?
JPMorgan Chase, Citigroup, and Bank of America
is a gain or loss recorded for bonds retired at maturity?
NO
amortization schedule example how does a company record the issuance of $25,000 note on November 1, 2021 & the first two monthly payments. (interest is 6% per month)
Nov 1, 2021: Dr. Cash ($25,000) Cr. Notes Payable ($25,000) Nov 30, 2021 Dr. Interest Expense ($125) Dr. Notes Payable (difference) ($462.13) Cr. Cash (monthly payment) ($587.13) Dec 31, 2021 Dr. Interest Expense ($122.69) Dr. Notes Payable (difference) ($464.44) Cr. Cash (monthly payment) ($587.13)
*SEE THE TEXTBOOK FOR HELP ON THIS DISCOUNT AND PREMIUM SHIT*
PART B
what is the value of the issue price of a bond?
PRESENT VALUE of the bond's face amount plus the PRESENT VALUE of its periodic interest payments
callable bonds
a bond feature that allows the borrower to repay the bonds before their scheduled maturity date at a specified call price
premium
a bond's issue price is above the face amount