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Chapter 17 Bonds Payable

Chapter 17 Bonds Payable. Main Points: 1. Interest Rate & Market Interest Rate 2. Bonds Issued at Face Value 3. Bonds Issued at a Discount 4. Bonds Issued at Premium Time Allocated: 4 Periods. Learning Objectives. In this chapter the students will learn:

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Chapter 17 Bonds Payable

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  1. Chapter 17 Bonds Payable • Main Points: • 1. Interest Rate & Market Interest Rate • 2. Bonds Issued at Face Value • 3. Bonds Issued at a Discount • 4. Bonds Issued at Premium Time Allocated: 4 Periods

  2. Learning Objectives In this chapterthe students will learn: • Get the general idea of a bond indenture • Know the difference between face interest rate & market interest rate • Grasp how to report the entries of bonds issued at face value, at a discount & at premium.

  3. Revision 1.What is a plant asset? --- A plant asset is one type of tangible assets such as plant, buildings and equipment. 2. Why do we say that plant assets have a limited useful life? --- Due to deterioration and obsolescence, plant assets have limited useful life. They benefit many periods to earn revenues.

  4. What? Warm-up • 1. What is a bond? • 2. What is a bond issue? • 3. What is a bond indenture? • 4. What is face value? • 5. What is discount? • 6. What is premium? • 7. What is amortization?

  5. Warm-up (1) 1. A bond: is a security, usually long-term, representing money borrowed by a corporation from the investing public. 2. A bond issue : the total number of bonds that are issued at one time.

  6. Warm-up (2) 3. A bond indenture: is a written document defining the rights, privileges, and limitations of bondholders, describes the maturity date of the bonds, interest payment dates, interest rates, repayment plans and restrictions. 4. Face value: the total amount of a loan that must be repaid, specified on the face of a bond.

  7. Warm-up (3) 5. Discount: If the market rate is greater than the face rate, the issued price will be less than the face value and the bonds are to be issued at a discount. 6. Premium: If the market rate is less than the face rate, the issued price will be more than the face value and the bonds are to be issued at a premium. 7. Amortization: The process of writing off the cost of intangible assets. Sometimes used as a name for expensing the cost of all assets.

  8. Presentation • A bond is a security, usually long-term, representing money borrowed by a corporation from the investing public. Some bonds are issued by the government, foreign countries to raise money. Investors buy these bonds and effectively make a loan to the issuing company. • In most cases, the holder of a bond receives a bond certificate as evidence of the company’s debt to the bondholder.

  9. 1. Interest Rate & Market Interest Rate (1) Questions: 1. What is the face interest rate? 2. What is the market interest rate? 3. Does the issue price of the bond always equal the face value of the bond?

  10. 1. Interest Rate & Market Interest Rate (2) Answers: 1. The face interest rate is the rate of interest paid to the bondholders based on the face value or principal of the bonds. 2. The market interest rate is the rate of interest paid in the market by bond investors for bonds of similar risk. 3. No, it doesn’t.

  11. > < < > 1. Interest Rate & Market Interest Rate (3) Face Rate Market Rate Market Rate Face Rate Face Value Issue Price Issue Price Face Value Bonds are issued at a discount. Bonds are issued at a premium.

  12. 2. Bonds Issued at Face Value (1) Suppose Corp. A issues 100 of its 5-year, 8% bonds at face value on April 1, 20X0. interest is paid on Oct. 1 and April 1 of each year. How to record the entries: April 1, 20X0 Dr. Cash $100,000 Cr. Bonds Payable $100,000

  13. 2. Bonds Issued at Face Value (2) Oct.1 of each year Dr. Interest Expense 4,000 Cr. Cash 4,000 Dec. 31 from 20X0 to 20X4 Dr. Interest Expense 2,000 Cr. Interest Payable 2,000

  14. 2. Bonds Issued at Face Value (3) April 1 from 20X1 to 20X5 Dr. Interest Expense 2,000 Interest Payable 2,000 Cr. Cash 4,000 April 1, 20X5 Dr. Bonds Payable 100,000 Cr. Cash 100,000

  15. 3. Bonds Issued at a Discount (1) • Suppose A issues 100 of its 5-year, 8% bonds at $92,278 on Jan. 1, 20X0 when the market interest rate is 10%. The interest will be paid on July 1 and Jan. 1 of each other. A will have to repay a total of $140,000, which consist of the $4,000 every 6 months for 5 years and $100,000 at maturity. Thus, A will repay $47,722 more than was borrowed. This $47,722 must be spread over 10 six-month periods. We can consider the problem from another aspect. The total cost is increased by the $7,722 discount, since more is to be repaid at maturity than was borrowed. Thus, the $4,000 periodic interest payment is increased by $772.20 of discount amortization each period.

  16. 3. Bonds Issued at a Discount (2) Jan. 1, 20X0 Dr. Cash $92,278 Discount on Bonds Payable 7,722 Cr. Bonds Payable $100,000 July 1 & Jan. 1 of each other Dr. Interest Expense 4,772 Cr. Discount on Bonds Payable 772 Cash 4,000 Dec. 31, 20X5 Dr. Bonds Payable 100,000 Cr. Cash 100,000

  17. 4. Bonds Issued at Premium (1) • Suppose A issues 100 of its 5-year, 8% bonds at $108,530 on Feb. 1, 20X1 when the market interest rate is 6%. The interest will be paid on July 1 and Jan. 1 of each other. A will have to repay $140,000, which consists of $4,000 every half year for 5 years, plus $100,000. Thus, A will repay $31,470 more than was borrowed. This $31,470 must be expensed over 10 six-month periods. Another way to consider this problem is that the total borrowing cost is reduced by the $8,530 premium, since less is to be repaid at maturity date than was borrowed. Thus, the $4,000 periodic interest payment is reduced by $853 of premium amortization each period.

  18. 4. Bonds Issued at Premium (2) Jan 1, 20X1 Dr. Cash $108,530 Cr. Premium on Bonds Payable $8,530 Bonds Payable 100,000 July 1 & Jan. 1 of each other Dr. Interest Expense 3,147 Premium on Bonds Payable 853 Cr. Cash 4,000 Dec. 31, 20X6 Dr. Bonds Payable 100,000 Cr. Cash100,000

  19. Further Practice 1. Exercise One at Page 120. Corp. W issued $100,000 0f 9%, 5-year bonds on Jan. 1, 20X1 at face value. Interest is to be paid on Jan. 1 and July 1 of each other. 2. Prepare the journal entries to record the issue of the bonds on Jan.1, 20X1 and the interest payment on July 1, 20X2. 3. Exercise Four at Page 121 Discuss the following questions with your partners. 1) What are the differences between the bond certificate and the bond indenture? 2) What are some examples of items found in a bond indenture? 3) What incurs the bond to be issued at a premium or discount?

  20. Further Practice 1. Answers for Exercise One: Jan. 1, 20X1 Dr. Cash $100,000 Cr. Bonds Payable $100,000 July 1, 20X1 Dr. Interest Expense 4,500 Cr. Cash 4,500 Jan. 1, 20X2 Dr. Interest Expense 4,500 Cr. Cash 4,500

  21. Homework 1. Revise Chapter 17 to get further understanding. 2. Finish the exercises two, three and four on your homework book. 3. Preview Chapter 18.

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