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Long-Term Bonds

Chapter. 22. Long-Term Bonds. Section 1: Financing Through Bonds. Section Objectives. Name and define the various types of bonds. Explain the advantages and disadvantages of using bonds as a method of financing. McGraw-Hill. © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

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Long-Term Bonds

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  1. Chapter 22 Long-Term Bonds Section 1: Financing Through Bonds Section Objectives • Name and define the various types of bonds. • Explain the advantages and disadvantages of using bonds as a method of financing. McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

  2. Name and define the various types of bonds Objective 1 Types of Bonds • Secured or unsecured • Registered or unregistered • Single-maturity or serial-maturity Secured and Unsecured • Secured: specific property pledged as collateral. • Unsecured: backed only by a company’s general credit. Unsecured bonds are known as debentures.

  3. Types of Bonds Registered and Unregistered • Registered: issued to a particular purchaser listed in the corporation’s records. • Unregistered (coupon): transferred by delivery; coupons attached for each interest payment. Single-Maturity and Serial-Maturity • Single-maturity: Bonds mature on the same day. • Serial-maturity: Bonds are payable over a period of years.

  4. Interest Rates • The market interest rate is the interest rate a corporation is willing to pay and investors are willing to accept at the current time. • The face interest rate refers to the contractual interest rate specified on the bond.

  5. Capital Stock Bonds Payable Explain advantages and disadvantages of using bonds Objective 2 Advantages and Disadvantages of Using Bonds as a Method of Financing • Permanent Capital • Debt • No debt to repay. • Must be repaid.

  6. Capital Stock Bonds Payable Advantages and Disadvantages of Using Bonds as a Method of Financing • Stockholders’ Equity • Long-term liabilities • Common stock has no legal requirement for dividends. Preferred stock requirements depend on contract. • Dividends are not deductible for income tax purposes. • Interest must be paid on the bonds. • Interest is a deductible expense.

  7. Capital Stock Bonds Payable Advantages and Disadvantages of Using Bonds as a Method of Financing • Preference dividends on preferred stock are usually slightly higher than interest rates on bonds because there is more risk associated with preferred stock. • Interest rates on bonds are usually slightly lower than dividends on preferred stock.

  8. Chapter 22 Long-Term Bonds Section 2: Bond Issue and Interest Section Objectives • Record the issuance of bonds. • 4. Record the payment of interest on bonds. • Record the accrual of interest on bonds. • Compute and record the periodic amortization of a bond premium. • Compute and record the periodic amortization of a bond discount. McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

  9. 2010 Apr. 1 Cash 50,000.00 10% Bonds Payable, 2018 50,000.00 Issued bonds at face value. Objective 3 Record the issuance of bonds Bonds Issued at Face Value On April 1, 2010, FLORAK Corporation sells $50,000 ($1,000 x 50) of its 8-year bonds at face value for cash.

  10. 2010 Oct. 1 Bond Interest Expense 2,500.00 Cash 2,500.00 Paid semiannual bond interest. Objective 4 Record the payment of interest on bonds Payment of Interest On October 1, 2010, the interest for six months at 10 percent becomes due on the $50,000 of bonds issued. ($50,000 X 10% X 6/12 = $2,500)

  11. 2010 Dec.31 Bond Interest Expense 1,250.00 Bond Interest Payable 1,250.00 Accrued interest for 3 months. Objective 5 Record the accrual of interest on bonds Accrual of Interest on Bonds Issued at Face Value On December 31, 2010, when the fiscal year ends for the FLORAK Corporation, bond interest of $1,250 has accrued for three months since the bond interest was last paid on October 1. ($50,000 X 10% X 3/12 = $1,250)

  12. Bond Premium If the facerate on the bonds exceeds the marketrate of interest at the time the bonds are issued, the bonds will be issued at a premium. The issuing corporation must write off, or amortize, the premium over the period from date of issue of the bonds until date of maturity. Amortizing the premium reduces the interest expense over the period the bonds are outstanding.

  13. 2010 Apr. 1 Cash 50,800.00 10% Bonds Payable, 2018 50,000.00 Premium on Bonds Payable 800.00 Issued Bonds at 101.6 Bonds Issued at a Premium Because the face rate of interest was greater than the market rate, the bonds sold at a premium (more than the face value). $800 extra was paid by the buyer!

  14. Compute and record the periodic amortization of a bond premium 2010 Oct. 1 Bond Interest Expense 2,500.00 Cash 2,500.00 Payment of semiannual interest on $50,000 of bonds. 1 Premium on Bonds Payable 50.00 Bond Interest Expense 50.00 Amortization of bonds sold at a premium. Objective 6 Premium is amortized over the life of the bond. When interest expense is recorded, premium amortization is also recorded. Bond Interest for 6 months ($50,000 x 10% x 6/12) = $2,500 Premium amortization reduces bond interest expense.

  15. 2010 Oct. 1 Bond Interest Expense 2,500.00 Cash 2,500.00 Payment of semiannual interest on $50,000 of bonds. 1 Premium on Bonds Payable 50.00 Bond Interest Expense 50.00 Amortization of bonds sold at a premium. Using the Straight-line Method to Amortize the Bond Premium Straight-line Amortization $800.00 / 8 years = $100.00 per year or $8.33 per month $8.33 x 6 months = $50.00

  16. 2010 Apr. 1 Cash 48,880.00 Discount on Bonds Payable 1,120.00 10% Bonds Payable, 2017 50,000.00 Issue bonds at 97.76 Objective 7 Compute and record the periodic amortization of a bond discount Bonds Issued at a Discount

  17. 2010 Oct. 1 Bond Interest Expense 5,030.00 Premium on Bonds Payable 50.00 Discount on Bonds Payable 80.00 Cash 5,000.00 Interest payment and amortization of premium and discount for six months. Recording Bond Interest Expense and Amortization of Bond Discount Straight-line method of amortizing was used to amortize both the premium and the discount.

  18. Bonds Payable + Premium on Bonds – Discount on Bonds Carrying Value Carrying Value of Bonds Formula Carrying value is also known as book value.

  19. Chapter 22 Long-Term Bonds Section 3: Bond Retirement Section Objectives • Record the transactions of a bond sinking fund investment. • Record an increase or decrease in retained earnings appropriated for bond retirement. • Record retirement of bonds payable. McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

  20. 2018 April 1 Bonds Payable 150,000.00 New Partner Given Credit for Amount Invested Cash 150,000.00 Bond retired at maturity. When a bond matures, it is Retired. • The bond is paid. • The liability is removed from company’s balance sheet.

  21. QUESTION: What is a bond sinking fund investment? ANSWER: A bond sinking fund investment is a fund established to accumulate assets to pay off bonds when they mature. Objective 8 Record the transactions of a bond sinking fund investment

  22. 2014 April 1 Bond Sinking Fund Investment 30,000.00 New Partner Given Credit for Amount Invested Cash 30,000.00 Bond Sinking Fund Investment • Journal entry to record first annual installment: first annual installment of bond sinking fund

  23. 2014 April 1 Bond Sinking Fund Investment 1,760.00 New Partner Given Credit for Amount Invested Income from Sinking FundInvestment 1,760.00 Bond Sinking Fund Investment • Journal entry to record net income earned by sinking fund for the year: Net income earned by Sinking Fund during the year.

  24. 2015 April 1 Bond Sinking Fund Investment 28,240.00 New Partner Given Credit for Amount Invested Cash 28,240.00 ($30,000 first year installment less $1,760 first year income equals $28,240) Bond Sinking Fund Investment • Journal entry to record second annual installment: This procedure is repeated each year, until the entire amount needed to retire funds is reached.

  25. 2018 April 1 10% Bonds Payable, 2017 150,000.00 New Partner Given Credit for Amount Invested Bond Sinking Fund Investment 150,000.00 Bond Sinking Fund Investment • Journal entry to record retirementof bonds: Bonds retired at maturity using balance in sinking fund.

  26. Record an increase or decrease in retained earnings appropriated for bond retirement Objective 9 Retained Earnings Appropriated for Bond Retirement The bond contract might require that retained earnings are appropriated while the bonds are outstanding.

  27. 2014 April 1 Retained Earnings 30,000.00 New Partner Given Credit for Amount Invested Retained Earnings Appropriatedfor Bond Retirement 30,000.00 Retained Earnings Appropriated for Bond Retirement • FLORAK’S Board of Directors decides to appropriate $30,000 of retained earnings during each of the last five years the bonds are outstanding. • Record annual appropriation in years 2014- 2018: Appears on the balance sheet under the heading “Appropriated Retained Earnings.”

  28. 2018 April 1 Retained Earnings Appropriatedfor Bond Retirement 150,000.00 New Partner Given Credit for Amount Invested Retained Earnings 150,000.00 Retained Earnings Appropriated for Bond Retirement • In year that bond matures, record close-out of appropriation account: $30,000 x 5 years= $150,000

  29. Objective 10 Record retirement of bonds payable Retirement of Bonds Recall that on April 1, 2010, FLORAK Corporation issued $50,000 face value, 10%, 8 year bonds at a discount. • Interest is paid on January 1 and July 1 of each year. • Bonds were issued at 97.76. • Discount of $1,120 is amortized on a straight-line basis over the remaining 8 years until the bonds due date. • They decide to retire the bonds one year after issuance (April, 1, 2011).

  30. Early Retirement of Bonds • Corporation could have surplus cash, so bonds are retired early. • Interest rate decreases could result in an early retirement of bonds.

  31. QUESTION: $1,120 discount ÷ 84 months (remaining life of bond) How much discount is amortized in eachsix-month interest period? $ 13.333 per month X 6 months ANSWER: $ 80

  32. Retirement of Bonds On April 1, 2011, FLORAK Corporation retired $50,000 face value of the bonds (originally issued at a discount). • Represents 50% of total bonds outstanding. • Retired at 101 plus accrued interest.

  33. QUESTION: What is the amount of unamortized discount that remains at time of retirement? ANSWER: Discount on Bonds Payable Beg. Bal 1,120 80 10/1/10 40 adj. entry 40 4/1/11 960 At time of retirement. . .

  34. QUESTION: $50,000 face value 960 discount book value What is the total book value to be removed? $49,040 REMINDER: Gain or loss is the difference between book value of bonds retired and what is paid for them. Face value – discount ANSWER:

  35. $50,000 face value X 10% interest rate QUESTION: What is the interest up to the date of retirement? 5,000 X 3/12 period to retirement ANSWER: $ 1,250 Record bond interest expense up to the date of retirement. . . Interest = principal X rate X time 2011 Apr 1 Bond Interest Expense 1,250 Bond Interest Payable 1,250 Cash 2,500

  36. $50,000 face value X1.01 purchase price QUESTION: What is the cash payment for repurchase price? $50,500 repurchase price ANSWER: $50,500 cash payment REMINDER: Gain or loss is the difference between book value of bonds retired and what is paid for them. Repurchase price = face value X 1.01

  37. QUESTION: $49,040 book value – 50,500 repurchase price What is the gain or loss on the transaction? $1,460loss on early retirement of bonds ANSWER: REMINDER: Gain or loss is the difference between book value of bonds retired and what is paid for them. Book value - repurchase price

  38. 2011 Apr. 1 Bonds Payable 50,000.00 Loss on Early Retirement of Bonds 1,460.00 Cash 50,500.00 Discount on Bonds Payable 960.00 Record Loss on Early Retirement

  39. Thank You for using College Accounting, 12th Edition Price • Haddock • Farina

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