Bonds

A newly issued bond has a dated date when it begins to accrue interest. The issue date—the date when the bond is actually sold—can be different from the dated date.

If the dated date precedes the issue date, the purchase amount includes accrued interest because the buyer will receive the entire interest payment on the next scheduled coupon date.

When recording interest payments, premium amortization reduces interest expense. If there is no premium amortization, interest expense and shareholder equity is overstate/understated?

interest expense is overstated; net income and shareholders' equity are understated.

Under the effective interest method, a bond's interest expense is calculated as

as its carrying value × the effective interest rate (ie, yield) × the number of months outstanding during the year divided by 12 months.

A gain or loss on early retirement of debt is recognized as a component of

income from continuing operations.

When bonds are redeemed prior to maturity, the difference between the bond's carrying value (CV) and the amount paid is reported as a gain/loss on the issuer's income statement.

CV equals the bond's face value less any unamortized discount and bond issue costs.

Debentures vs. Collateralized

Debentures: backed by borrower's general credit Collateralized: backed by specific assets

In general, IFRS requires a financial liability to be reported at amortized cost. Only certain financial liabilities, such as derivatives, are recognized at fair value.

IFRS does, however, allow an entity to make an irrevocable election to report financial liabilities at fair value through profit or loss. As a result, a bond may be reported at either amortized cost or fair value through profit and loss.

On January 1 of the current year, Lean Co. made an investment of $10,000. The following is the present value of $1.00 discounted at a 10% interest rate: Periods Present value of $1.00 discounted at 10% 1 = .909 2 = .826 3 = .751 What amount of cash will Lean accumulate in two years?

Present Value = Future Amount x Factor. $10,000 = Future Amount x .826 or Future Amount = $10,000/.826 = $12,107.

Over the term of a bond, total interest expense will be equal to the excess of total amounts paid over the proceeds from issuance. Payments will equal interest, calculated at the stated rate, plus the face amount of the bonds.

When bonds are issued at a discount, the amount received is less than the face amount and the difference increases interest expense over the bond term. When bonds are issued at a premium, the amount received is greater than the face amount and the difference reduces interest expense over the bond term.

The proceeds of bonds issued with detachable warrants are allocated

between the bonds and the warrants based upon their relative FMV at the time of issuance.

When bonds are retired prior to maturity, the difference between the

carrying value of the bonds and the amount paid to retire the debt is reported as a gain/loss.

The straight-line method to amortize bond discounts or premiums is allowed when the difference with the effective interest method is not material.

When bonds are retired prior to maturity, the difference between the carrying value of the bonds and the amount paid to retire the debt is reported as a gain/loss.

When bonds are issued with detachable stock purchase warrants, the proceeds are allocated between the bonds and warrants. The allocation is generally based on their relative fair market values.

When only the fair market value of one or the other is known, however, that amount is allocated to that security with the remainder allocated to the other.

Interest incurred on a bond in the current period and paid in a future period is recorded as interest payable until paid.

When reporting dates fall between bond interest payments, interest payable equals the bond's face value × the stated rate × the time period.

IFRS provides that financial liabilities may be reported at amortized cost or at the fair value through profit or loss (FVTPL).

If FVTPL is elected, the resulting gain or loss is recognized in profit or loss for the period.

Convertible:

bonds can be converted into equity securities at the option of the buyer

Callable:

bonds can be repurchased by issuer before maturity

Sinking Fund Bond:

bonds can be repurchased in limited quantities periodically at specified prices

The straight-line method of bond discount/premium amortization is not in accordance with GAAP. If it is used instead of the effective interest method, it will result in .

different annual amortization during the bond's life. However, at maturity, both methods will fully amortize the discount/premium and have the same total amortization amount

Under the effective interest method, a bond's interest expense is calculated as

its carrying value × the effective interest rate (ie, yield) × the number of months outstanding during the year divided by 12 months.

Serial bond:

matures in stated amounts at regular intervals

When detachable warrants are issued with a bond, the sales proceeds must be allocated between the warrants and the bond based on relative fair values on the issue date. If only one fair market value is known, that amount is allocated first and the remainder is assigned to the other instrument.

The portion of the proceeds assigned to the warrants is recorded as paid-in capital (equity), and the remainder to the bond payable (a liability).

Bond issue costs are the fees associated with the issuance of bonds to the public including accounting and legal fees, commissions, printing, registration, and underwriting. They are included with any discount or premium and amortized over the life of the bond.

Advertising fees are not considered bond issue costs, and they are expensed when incurred.

When detachable stock warrants are issued with bonds, the sales proceeds must be allocated between the warrants and the bonds based on relative fair values. If only one fair market value is known, that amount is allocated first and the remainder is assigned to the other security.

Although bonds may sell for a price above face value, allocating a portion of the proceeds to the warrants could result in an amount less than face (par) value assigned to the bonds.

On January 2, 2015, West Co. issued 9% bonds in the amount of $500,000, which mature on January 2, 2025. The bonds were issued for $469,500 to yield 10%. Interest is payable annually on December 31. West uses the effective interest method of amortizing bond discount. In its June 30, 2015 balance sheet, what amount should West report as bonds payable? $469,500 $470.475 $500,000

Answer: $470,475 Although the question is vague, the most likely answer would be the net book value, not the face value.

Convertible debt securities give the security holder the option of converting the bond into common stock at a future date and at a predetermined price, which is generally higher than the stocks market price on the date of issuance, but may be lower in the future while the bonds are convertible.

As a result of the benefit associated with the conversion feature, convertible bonds generally bear interest at a rate that is lower than bonds that are not convertible.

If a premium on a bonds payable transaction is not amortized, what are the effects on interest expense and total stockholders' equity?

If there is no premium amortization, interest expense is overstated. Overstating interest expense understates net income. Since net income is closed out to retained earnings, shareholders' equity is understated.

The present value of the bond's expected future cash inflows discounted at the market rate of interest equals the bond's price.

It is the sum of the present value of the bond at maturity (ie, lump sum) and the present value of the interest payments (ie, ordinary annuity).

Bond issue costs include those costs a company incurs in order to be able to issue bonds.

Promotion costs, engraving and printing, and underwriters' commissions would all be included

Bond proceeds are calculated using present values on cash flows at the effective rate (ie, market rate). The bond maturity is a lump sum, and the interest payments are ordinary annuities (ie, paid at the end of each period).

The face value minus the sale proceeds is the premium or discount used to determine the net bonds payable.

Term bond:

single maturity date at end of term

Since a discount reduces the carrying value of a bond,

the carrying value increases as the discount is amortized.

Bond interest expense is incurred based on

the entire amount of time bonds were outstanding during the year regardless of when the interest payments are made.