ACCTG 215 Autumn 2013 Reporting and Interpreting Bonds Chapter 10 Types of bonds Unsecured bond debenture no assets are pledged as a guarantee of repayment at maturity Secured bond specific assets are pledged as a guarantee of repayment at maturity Callable bond issuer has the option to pay off the bond early Convertible bond bond owner has option to convert bonds into shares of common stock Bond indenture a contract that specifies the legal provisions of a bond issue Valuing and recording bonds Par value bond principal face amount Coupon rate stated rate of interest Market interest rate yield effective interest rate Life of the bond maturity date Issuing bonds at a premium or discount Bond issued at Par Discount Premium Record bond issuance Cash xx Bond payable xx Cash xx Discount on bonds xx Bond payable xx Cash xx Premium on bonds xx Bond payable xx Record interest payments Interest expense xx Cash xx Interest expense xx Discount on bonds xx Cash xx Interest expense xx Premium on bonds xx Cash xx Calculating the issue amount interest expense Issue amount the present value of the cash flows principal AND interest payments associated with the bond using the market rate as the discount rate Cash paid Par value Coupon rate Interest expense Beginning book value Market interest rate 1 ACCTG 215 Autumn 2013 Interest Amortization Schedule Straight line amortization Effective interest amortization E g Bonds issued at a discount A firm sells bonds with a par value of 100 000 and a coupon rate of 10 The market interest rate is 12 The firm pays interest semi annually and the bond matures in 2 years Note If the bond is issued at a premium d Beginning book value c Key ratios from Chapter 10 Times Interest Earned Net Income Interest Expense Income Tax Expense Interest Expense Debt to Equity Total Liabilities Stockholder s Equity 2 ACCTG 215 Autumn 2013 Problem 1 On January 1 2013 White Water issues 500 000 of 6 bonds due in 20 years with interest payable semi annually on June 30 and December 31 of each year Required 1 Assuming the market interest rate on the issue date is 6 how much will the bonds issue for 2 Record the bond issue on January 1 2013 and the first two semi annual interest payments on June 30 2013 and December 31 2013 Solution 1 The bonds issue for 500 000 To prove this Each interest payment 500 000 6 year 15 000 PV of interest payments 15 000 PV Annuity Factor n 40 r 3 23 11467 346 720 PV of repayment 500 000 PV Factor n 40 r 3 0 30656 153 280 Total PV 500 000 2 Record the entries January 1 2013 Cash 500 000 Bonds Payable 500 000 To record the bond issue June 30 2013 Interest Expense 15 000 Cash 500 000 x 6 x 15 000 First semi annual interest payment December 31 2013 Interest Expense 15 000 Cash 500 000 x 6 x 15 000 Second semi annual interest payment 3 ACCTG 215 Autumn 2013 Problem 2 Same as problem 1 but now assume that the market interest rate is 7 upon issuance Required 1 How much will the bonds issue for 2 Complete the first three rows of the amortization table 3 Record the bond issue on January 1 2013 and the first two semi annual interest payments on June 30 2013 and December 31 2013 Solution 1 The bonds issue for 446 612 To prove this Each interest payment 500 000 6 year 15 000 PV of interest payments 15 000 PV Annuity Factor n 40 r 3 5 21 35507 320 327 PV of repayment 500 000 PV Factor n 40 r 3 5 0 25257 126 285 Total PV 446 612 2 Amortization Table 1 2 3 4 5 Date Cash Paid Interest Increase in Carrying Expense Carrying Value Value Face Amount Carrying 3 2 Prior Carrying x Stated Rate Value x Value 4 Market Rate 1 1 13 446 612 6 30 13 15 000 15 631 631 447 243 12 31 13 15 000 15 654 654 447 897 3 Entries January 1 2013 Cash 446 612 Discount on Bonds 53 388 Bonds Payable 500 000 To record the bond issue June 30 2013 Interest Expense 15 631 Discount on Bonds 631 Cash 500 000 x 6 x 15 000 4 First semi annual interest payment December 31 2013 Interest Expense 15 654 Discount on Bonds Cash 500 000 x 6 x Second semi annual interest payment ACCTG 215 Autumn 2013 5 654 15 000 ACCTG 215 Autumn 2013 Problem 3 Same as problem 1 but now assume that the market interest rate is 5 upon issuance Required 1 How much will the bonds issue for 2 Complete the first three rows of the amortization table 3 Record the bond issue on January 1 2013 and the first two semi annual interest payments on June 30 2013 and December 31 2013 Solution 1 The bonds issue for 562 757 To prove this Each interest payment 500 000 6 year 15 000 PV of interest payments 15 000 PV Annuity Factor n 40 r 2 5 25 10278 376 542 PV of repayment 500 000 PV Factor n 40 r 2 5 0 37243 186 215 Total PV 562 757 2 Amortization Table 1 2 3 4 5 Date Cash Paid Interest Increase in Carrying Expense Carrying Value Value Face Amount Carrying 3 2 Prior Carrying x Stated Rate Value x Value 4 Market Rate 1 1 13 562 757 6 30 13 15 000 14 069 931 561 826 12 31 13 15 000 14 046 954 560 872 3 Entries January 1 2013 Cash 562 757 Premium on Bonds 62 757 Bonds Payable 500 000 To record the bond issue June 30 2013 Interest Expense 14 069 Premium on Bonds 931 Cash 500 000 x 6 x 15 000 6 First semi annual interest payment December 31 2013 Interest Expense 14 046 Premium on Bonds 954 Cash 500 000 x 6 x Second semi annual interest payment ACCTG 215 Autumn 2013 7 15 000