! ! ACCTG!215! ! Autumn!2013!!1!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*Record*bond*issuance*Record*interest*payments*Par*Cash!!!!!! ! xx!!!!!!Bond!payable!!! !!!!!!!xx!Interest!expense!!!!! xx!!!!!!Cash!!! !!!!!!!!!!!!!!!!!!!!!!xx!Discount*Cash!!!!!! ! xx!Discount!on!bonds!!!!!xx!!!!!!Bond!payable!!! !!!!!!!xx!Interest!expense!!!!! xx!!!!!!Discount!on!bonds!!!!!!!!xx!!!!!!Cash!!! !!!!!!!!!!!!!!!!!!!!!!xx!Premium*Cash!!!!!! ! xx!!!!!!Premium!on!bonds!!!!!!xx!!!!!!Bond!payable!!! !!!!!!!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!**! ! ACCTG!215! ! Autumn!2013!!2!Interest*Amortization*Schedule*• StraightQline!amortization!• EffectiveQinterest!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!semiQannually!and!the!bond!matures!in!2Qyears.!!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!• DebtQtoQEquity!=!Total!Liabilities/Stockholder’s!Equity!!! !! ! ACCTG!215! ! Autumn!2013!!3!Problem*1*On!January!1,!2013,!White!Water!issues!$500,000!of!6%!bonds,!due!in!20!years,!with!interest!payable!semiQannually!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!semiQannual!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%!*!½!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!½)! ! ! 15,000!! (First(semi5annual(interest(payment)(!December!31,!2013!Interest!Expense! ! ! $15,000!! Cash!($500,000!x!6%!x!½)! ! ! 15,000!! (Second(semi5annual(interest(payment)(* *! ! ACCTG!215! ! Autumn!2013!!4!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!semiQannual!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%!*!½!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*Expense*Increase*in*Carrying*Value*Carrying*Value*!Face!Amount!x!Stated!Rate!Carrying!Value!x!Market!Rate!(3)!–!(2)!Prior!Carrying!Value!+!(4)!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!½)! ! ! 15,000!! ! ACCTG!215! ! Autumn!2013!!5!! (First(semi5annual(interest(payment)(!December!31,!2013!Interest!Expense! ! ! $15,654!! Discount!on!Bonds! ! ! ! 654!Cash!($500,000!x!6%!x!½)! ! ! 15,000!! (Second(semi5annual(interest(payment)(* *! ! ACCTG!215! ! Autumn!2013!!6!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!semiQannual!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%!*!½!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*Expense*Increase*in*Carrying*Value*Carrying*Value*!Face!Amount!x!Stated!Rate!Carrying!Value!x!Market!Rate!(3)!–!(2)!Prior!Carrying!Value!+!(4)!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!½)! ! ! 15,000!! ! ACCTG!215! ! Autumn!2013!!7!! (First(semi5annual(interest(payment)(!December!31,!2013!Interest!Expense! ! ! $14,046!Premium!on!Bonds! ! ! 954!Cash!($500,000!x!6%!x!½)! ! ! 15,000!!