1 / 64

Bonds and Long-Term Notes

Bonds and Long-Term Notes. 14. Learning Objectives. Identify the underlying characteristics of debt instruments and describe the basic approach to accounting for debt. LO1. Nature of Long-Term Debt. Loan agreement restrictions. Mirror image of an asset.

harding-fry
Download Presentation

Bonds and Long-Term Notes

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Bonds and Long-Term Notes 14

  2. Learning Objectives Identify the underlying characteristicsof debt instruments and describe thebasic approach to accounting for debt. LO1

  3. Nature of Long-Term Debt Loan agreement restrictions Mirror image of an asset Obligations that extend beyond one year or the operating cycle, whichever is longer Reported at present value Accrue interest expense

  4. Bond Selling Price Bond Certificate Subsequent Periods Interest Payments Company Issuing Bonds Investor Buying Bonds Face Value Payment at End of Bond Term Bonds At Bond Issuance Date Company Issuing Bonds Investor Buying Bonds

  5. The Bond Indenture The indenture is the written specific promises made by the company to the bondholders. Types of Bonds Debenture Bond Mortgage Bond Serial Bonds Sinking Fund Subordinated Debenture Callable Coupon Bonds Convertible Bonds

  6. Interest 10% Face Value $1,000 6/30 & 12/31 BOND PAYABLE Bond Date 1/1/06 Maturity Date 12/31/15 Bonds 1. Face value (maturity or par value) 2. Maturity Date 3. Stated Interest Rate 4.Interest Payment Dates 5. Bond Date Other Factors: 6. Market Interest Rate 7. Issue Date

  7. Learning Objectives Account for bonds issued at par, at a discount,or at a premium, recording interest at the effective rate or by the straight-line method. LO2

  8. On 1/1/06, Matrix, Inc. issues 1,000 bonds at face value to Apex, Inc. The market interest rate is 10%. The bonds have the following terms: Face Value = $1,000 Maturity Date = 12/31/10 (5 years) Stated Interest Rate = 10% Interest Dates = 6/30 & 12/31 Bond Date = 1/1/06 Recording Bonds at Issuance Record the issuance of the bonds on 1/1/06.

  9. Matrix, Inc. - Issuer Apex, Inc. - Investor Recording Bonds at Issuance

  10. 6/30/06 1/12/06 1/1/06 BondsDated BondsSold First InterestPayment Date Bonds Issued Between Interest Dates Interest begins to accrue on the date the bonds are dated. If the bonds are issued after the day they are dated, the investor would be asked to pay the company accrued interest. On the interest payment date, the investor will receive a check for the full period’s interest.

  11. Bonds Issued Between Interest Dates On 1/12/06, Matrix, Inc. issues 1,000 bonds at face value plus accrued interest to Apex, Inc. The market interest rate is 10%. The bonds have the following terms: Face Value = $1,000 Maturity Date = 12/31/10 (5 years) Stated Interest Rate = 10% Interest Dates = 6/30 & 12/31 Bond Date = 1/1/06

  12. Matrix - Issuer Apex - Investor Bonds Issued Between Interest Dates Accrued Interest$1,000,000 × 10% = $100,000 ÷ 360 days = $277.78 interest per day 11 days × $277.78 = $3,055.56

  13. Matrix - Issuer Apex - Investor Bonds Issued Between Interest Dates At the first interest date$1,000,000 × 10% × ½ = $50,000 cash

  14. Determining the Selling Price

  15. Determining the Selling Price On 1/1/06, Matrix, Inc. issues 1,000 bonds at face value to Apex, Inc. The market interest rate is 12%. The bonds have the following terms: Face Value = $1,000 Maturity Date = 12/31/10 (5 years) Stated Interest Rate = 10% Interest Dates = 6/30 & 12/31 Bond Date = 1/1/06 What is the selling price of these bonds?

  16. Bonds issued at a discount. Determining the Selling Price n = 5 years × 2 payments per year = 10i = 12% ÷ 2 payments per year = 6%Interest annuity = $1,000,000 × 10% ÷ 2 = $50,000

  17. Matrix, Inc. - Issuer Apex, Inc. - Investor Determining the Selling Price

  18. Effective Interest Method(Effective rate multiplied by the outstanding balance of the debt) $926,395 × 6% $55,584 - $50,000 $926,395 + $5,584 Determining Interest

  19. Effective Interest Method(Effective rate multiplied by the outstanding balance of the debt) Determining Interest

  20. Matrix, Inc. - Issuer Apex, Inc. - Investor Determining Interest

  21. These bonds do not pay interest. Instead, they offer a return in the form of a “deep discount” from the face amount. Those who invest in zero-coupon bonds usually have tax-deferred or tax-exempt status. Zero-Coupon Bonds

  22. Bonds Sold at a Premium On 1/1/06, Matrix, Inc. issues 1,000 bonds at face value to Apex, Inc. The market interest rate is 8%. The bonds have the following terms: Face Value = $1,000 Maturity Date = 12/31/10 (5 years) Stated Interest Rate = 10% Interest Dates = 6/30 & 12/31 Bond Date = 1/1/06 What is the selling price of these bonds?

  23. Bonds issued at a premium. Bonds Sold at a Premium n = 5 years × 2 payments per year = 10i = 8% ÷ 2 payments per year = 4%Interest annuity = $1,000,000 × 10% ÷ 2 = $50,000

  24. Matrix, Inc. - Issuer Apex, Inc. - Investor Bonds Sold at a Premium

  25. Bonds Sold at a Premium

  26. Matrix, Inc. - Issuer Apex, Inc. - Investor Financial Statements Prepared Between Interest Dates Assume that in our previous example, Matrix, Inc. and Apex, Inc. both have fiscal years that end on September 30. Let’s look at the June 30 entry:

  27. Year-end is on September 30, 2006, before the second interest date of December 31. Matrix, Inc. - Issuer Financial Statements Prepared Between Interest Dates $42,974 × ½ = $21,487 (3 months interest)$ 7,026 × ½ = $ 3,513 (3 months amortization) Apex, Inc. - Investor

  28. Apex, Inc. - Investor Financial Statements Prepared Between Interest Dates The entries at December 31, 2006. Matrix, Inc. - Issuer

  29. The discount or premium is allocated equally to each period over the outstanding life of the bond. Straight-Line Method Consideredpracticaland expedient.

  30. Straight-Line Method In our last example, straight-line premium amortization would be: $81,105 ÷ 10 = $8,111 every six months.

  31. Straight-Line Method

  32. Legal Accounting Underwriting Commission Engraving Printing Registration Promotion Debt Issue Costs

  33. These costs should be recorded separately and amortized over the term of the related debt. Straight-line amortization is often used. Debt Issue Costs

  34. Learning Objectives Characterize the accounting treatment of notes including installment notes, issued for cash or for noncash consideration. LO3

  35. Present value techniques are used for valuation and interest recognition. The procedures are similar to those we encountered with bonds. Long-Term Notes

  36. On 1/1/06, Matrix, Inc. issued a $100,000, 3-year, 6% note in exchange for equipment owned by Apex, Inc. Interest is paid every 12/31. The equipment does not have a ready market value. The appropriate rate of interest for notes of this type is 9%. Let’s determine the present value of the note. Notes Exchanged for Assets or Services

  37. Notes Exchanged for Assets or Services

  38. Notes Exchanged for Assets or Services Amortization Schedule Let’s prepare the entries on January 1.

  39. Apex, Inc. - Seller Notes Exchanged for Assets or Services Matrix, Inc. - Purchaser

  40. Entries for the first interest period. Apex, Inc. - Seller Notes Exchanged for Assets or Services Matrix, Inc. - Purchaser

  41. To compute cash payment use present value tables. Interest expense or revenue: Effective interest rate × Outstanding balance of debt Interest expense or revenue Principal reduction: Cash amount – Interest component Principal reduction per period Installment Notes

  42. PV of annuity of $1, n = 4, i = 9% Installment Notes On January 1, 2006, Matrix, Inc. purchased a truck by issuing a 4-year note payable to Apex Motors. The truck cost $50,000 and is financed at a 9% interest rate. Payments are made at the end of each of the next four years. Let’s calculate the annual payment. $50,000 ÷ 3.23972 = $15,433 (rounded)

  43. Installment Notes Here is our loan amortization table.

  44. Apex Motors - Seller Installment Notes The entries on date of purchase are: Matrix, Inc. - Purchaser

  45. Apex Motors - Seller Installment Notes Date of first payment. Matrix, Inc. - Purchaser

  46. Learning Objectives Describe the disclosures appropriateto long-term debt in its various forms. LO4

  47. Financial Statement Disclosures Long-Term Debt For all long-term borrowing, disclosures should include the aggregate amounts maturing and sinking fund requirement, if any, for each of the next five years.

  48. Rate of return on shareholders’ equity Net incomeShareholders’ equity = Decision Makers’ Perspective Long-term debt impacts several key financial ratios. Times interest earned ratio Net income + interest + taxesInterest = Debt toequity ratio Total liabilitiesShareholders’ equity = Rate of return on assets Net incomeTotal assets =

  49. Learning Objectives Record the early extinguishment of debtand its conversion into equity securities. LO5

  50. Early Extinguishment of Debt Debt retired at maturity results in no gains or losses. BUT Debt retired before maturity may result in an gainor loss on extinguishment. Cash Proceeds – Book Value = Gain or Loss

More Related