Accounting Chapter 9

Discount amortization formula for DISCOUNT bonds [Column D]

= Interest payment - interest expense [no negatives] = [Column B] - [Column C]

Premium Amortization formula (for PREMIUM bonds) [COLUMN D]

= Interest payment - interest expense [no negatives] = [column B] - [column C]

The Bond Carrying Amount/Value formula (for PREMIUM bonds) [COLUMN F]

=(the maturity value) + (Premium Account Balance) =(the very last carrying value in the table) + (column E)

Premium Account Balance formula [COLUMN E]

= (Preceding Premium Account Balance value) - (Premium Amortization) = (Preceding column E value) - (Column. D)

The Discount Account Balance formula (for DISCOUNT bonds)

= (preceding Discount Account Balance value) - (Discount amortization) = (Preceding Column E) - (Column D)

Interest Payment formula for DISCOUNT AND PREMIUM bonds (semiannual) [column B]

(maturity value) x (interest rate) x (6/12) this value is fixed by contract

Reasons to retire bonds early?

- Can relieve high interest payments - can borrow at a lower interest rate.

stated interest rate

-AKA: coupon rate -the interest printed on the bond certificate, determines the amount of cash interest the borrower pays each year

market interest rate

-AKA: effective interest rate -the rate investors demand for loaning their money. this varies by the minute

discount on bonds payable is a

-contra account to bonds payable -and is a decrease in the companies liabilities

Bond certificate states:

-issuing company's name -principal - face value - maturity value -par value -maturity date -annual interest rate -interest payment dates

The effective-interest method

-most theoretically correct method -recognizes time value of money on interest expense -interest expense is DIFFERENT each period

Two interest rates that work to set the price of a bond

-stated interest rate -market interest rate

callable bonds

-the issuer can pay off at a PREARRANGED PRICE (OR CALL PRICE) whenever issuer chooses -the call price is often 1-2 percentage points above the par value (ex: 101 or 102) -create gain and loss* (in other words: Bonds that give the issuer the option to retire them at a stated amount prior to maturity.)

Steps for the effective-interest method

1. Determine the exact price of the bond at issuance 2. build amortization table The steps to the effective interest method are: Determine the exact price of the bonds at issuance, taking into account the market rate of interest, the periodic interest payments based on the face amount multiplied by the face interest rate, and the maturity value of the bonds. Build an amortization table showing interest payments, interest expense, discount or premium amortization, discount or premium balance, and carrying value of the bonds.

If the stated interest rate on a bond payable is LESS THAN the market interest rate the price is:

A discount price (price below face value)

Bond type: unsecured

AKA: debentures - backed only by the good faith of the borrower

Convertible Bonds/Convertible Notes

Bonds that may be converted into stock

For Bonds payable issued at a PREMIUM The semiannual interest payment is [constant, increasing, or decreasing] AND the amount of interest expense[constant, increasing, or decreasing] as the discount bond marches toward maturity.

CONSTANT DECREASES

BOND AT DISCOUNT JOURNAL ENTRY: to pay semiannual interest and amortize bond DISCOUNT (with straight line amortization)

DEBIT: Interest expense (Cash + Discount on Bonds Payable) CREDIT: Discount on Bonds Payable CREDIT: Cash

With convertible bonds and notes, investors benefit from:

Convertible bonds combine the safety of: -assured receipt of interest and principal on the bonds -potential for gains on the stock Convertible bonds are VERY ATTRACTIVE to investors and often accept lower interest rate than they would for nonconvertible bonds The lower cash interest payments benefit the issuer

BOND AT PREMIUM JOURNAL ENTRY: to issue bonds at a. PREMIUM (with EFFECTIVE INTEREST amortization)

DEBIT: Cash (the market value) CREDIT: Bonds Payable (what the company issues for) CREDIT: Premium on Bonds Payable (Cash debited - bonds payable credited)

BOND AT PREMIUM JOURNAL ENTRY: to pay semiannual interest and amortize bond PREMIUM (with EFFECTIVE INTEREST amortization)

DEBIT: Interest expense DEBIT: Premium on Bonds Payable CREDIT: Cash

BOND AT PREMIUM JOURNAL ENTRY: to pay semiannual interest and amortize bond PREMIUM (with straight line amortization)

DEBIT: Interest expense (Cash - Premium on Bonds Payable) DEBIT: Premium on Bonds Payable CREDIT: Cash

BOND AT DISCOUNT JOURNAL ENTRY: to accrue semiannual interest and amortize bond DISCOUNT (with EFFECTIVE INTEREST amortization)

DEBIT: Interest expense (sum of two credited values) CREDIT: Discount on bonds payable CREDIT: Interest Payable At maturity, the discount will have been amortized to zero and the bond's carrying amount will have a face value of $100,000.

BOND AT DISCOUNT JOURNAL ENTRY: to pay semiannual interest and amortize bond DISCOUNT (with EFFECTIVE INTEREST amortization)

DEBIT: Interest expense (sum of two credited values) CREDIT: Discount on bonds payable CREDIT: cash The credit to Discount on Bonds Payable accomplishes two purposes: Adjusts the carrying value of the bonds as they march upward toward maturity value Amortizes the discount to interest expense

BOND AT PAR JOURNAL ENTRY: to pay bonds payable at maturity

DEBIT: bonds payable CREDIT: cash

BOND AT PAR JOURNAL ENTRY: issuing a bond at par

DEBIT: cash CREDIT: bonds payable

BOND AT DISCOUNT JOURNAL ENTRY: to issue bonds at a discount

DEBIT: cash (__% of maturity value) DEBIT: discount on bonds payable (bonds payable credited - cash debited) -aka: balancing amount -contra account to bonds payable CREDIT: bonds payable (maturity value)

BOND AT PAR JOURNAL ENTRY: to pay semiannual interest

DEBIT: interest expense [ (FIRST PRICE*****) x (interest rate) x (6 (months passed) / 12 (months in the year)) ] CREDIT: cash

BOND AT PAR JOURNAL ENTRY: to accrue interest

DEBIT: interest expense [ (FIRST PRICE*****) x (interest rate) x (6 (months passed) / 12 (months in the year)) ] CREDIT: interest payable

The Bond Carrying Amount [is constant, increases, or decreases] from issuance to maturity as the PREMIUM is amortized [COLUMN F]

DECREASES

Premium Account Balance [is constant, increases, or decreases] when amortized through bond's life [COLUMN E]

DECREASES (because its subtracting the premium amortization from the preceding premium account balance)

For Bonds payable issued at a PREMIUM Carrying value is [constant, increasing, or decreasing] AND Premium Amortization is [constant, increasing, or decreasing] as the discount bond marches toward maturity.

DECREASES INCREASES because they are inversely related

Straight line amortization divides the bond discount into:

Equal amounts over bond's term

With straight line amortization, when issuing bonds payable at a discount the INTEREST EXPENSE:

INCREASES over each period

When would the bondholders will convert the bonds into stock?

If the market price of the issuing company's stock gets high enough

An amortization table does 2 things which are:

It determines the periodic interest expense (Column C). It shows the bond carrying amount (Colum F).

In practice, bond premiums are [COMMON OR RARE]

RARE because few companies issue their bonds to pay cash interest above their market interest rate.

Balance sheet for liabilities with bonds payable and discount on bonds payable (straight line amortization)

Subtract discount on bonds payable from bonds payable

The Interest Payment and Interest expense formulas for PREMIUMS are [THE SAME OR DIFFERENT] from/as the formulas for DISCOUNTS

THE SAME

Balance sheet for BOND AT PREMIUM (bonds payable vs premium on bonds payable)

Unlike Discounts, the "Premium on bonds payable" is ADDED to the "bonds payable" to determine the carrying ammount

Interest expense formula for DISCOUNT AND PREMIUM bonds (semiannual) [column C]

[(market interest rate at time of issue) / 2] x [preceding bond carrying value]

Bond prices are quoted as

a percentage of their maturity value. (For example, a $1,000 bond quoted at 100 is bought or sold for $1,000, which is 100% of its face value. The same bond quoted at 101.5 has a market price of $1,015 (101.5% x 1,000 = 1,015). Additionally, a $1,000 bond quoted at 88.375 is priced at $883.75.)

If the stated interest rate on a bond payable is GREATER THAN the market interest rate the price is:

a premium price (price above face value)

Straight-Line Amortization

a simplified method of amortizing a bond discount or premium that allocates an equal dollar amount to each interest period

Bond type: term

all mature at the same time

with straight-line amortization, each semiannual cash interest payment is set by the:

bond contract and remains constant over the life of the bond

For Bonds payable issued at a DISCOUNT The semiannual interest payment is [constant, increasing, or decreasing] AND the amount of interest expense[constant, increasing, or decreasing] as the discount bond marches upward toward maturity.

constant increasing

What are bonds?

debts of an issuing company (*)

Interest expense is [constant, increasing, or decreasing] as the premium bond approaches maturity

decreases

The Discount Account Balance [increase or decrease] when amortized (for DISCOUNT bonds)

decreases

Bond type: secured

give the bondholder the right to assets of the issuer if the company defaults

Interest expense [column C] __________ as the DISCOUNT bond approaches maturity

increases

For Bonds payable issued at a DISCOUNT Carrying value is [constant, increasing, or decreasing] AND Discount Amortization is [constant, increasing, or decreasing] as the discount bond marches upward toward maturity.

increases decreases

The Bond Carrying amount [increases or decreases] from issuance to maturity by the amount of ______________ each period (for DISCOUNT bonds)

increases discount amortization [Column D]

For Bonds payable issued at a PREMIUM Bond Carrying value is [constant, increasing, or decreasing] AND Premium Amortization is [constant, increasing, or decreasing] as the discount bond marches upward toward maturity.

increasing increasing

Bond Premium

issued above face value (credit balance) a premium decreases toward its face value as the maturity date approaches

bond discount

issued below face value (debit balance) a discount bond increases towards its face value as maturity date approaches

The face value, par value, and maturity value is the ____ number

last ex: 100,000

a bonds present value

market price (which is the amount investors will pay for the bond)

Bond type: serial

mature in installments over time

For Bonds PREMIUM, the interest expense is affected by the:

preceding carrying amount

Amortization table

provides a payment-by-payment detail of how each dollar paid on a loan is allocated

the market price/bond's present value is equal to:

the present value of the principal payment of the bond at the end of its term plus the present value of the stream of cash interest payments from the date of issuance until the maturity date (**)

If the stated interest rate on a bond payable EQUALS the market interest rate the price is:

the price of face (par, or maturity) value

interest is usually paid _______ times a year

two (semiannually)