Corporations and Bonds Payable

1. Corporations and Bonds Payable Chapter 21

2. Journalizing the recording of bondsas well as interest payments. Learning Objective 1

3. Learning Unit 21-1 • Each bond certificate is usually issued in denominations of $1,000. • The face value is the amount to be repaid at maturity date. • The contract rate is the stated interest rate. • A bond indenture is a written agreement. • A trustee usually monitors bond activities.

4. Learning Unit 21-1 • Bonds are stated at a percentage of face value. • Bonds are 100% if the bond rate and market interest rate are equal. • A bond discount occurs when the bond rate is lower than market rate. • Bonds are sold at a premium when the bond rate is higher than market rate.

5. Learning Unit 21-1 • What are some types of bonds? • secured bonds • debenture bonds • registered bonds • callable bonds • convertible bonds

6. Learning Unit 21-1 • Bond issuance requires interest to be paid. • Interest expense reduces net income, thereby reducing income tax. • Issuing bonds is borrowing while issuing shares of stock means less ownership for existing shareholders (unless they buy the new shares).

7. Learning Unit 21-1 • Interest on bonds must be paid each year. • Dividend payments are optional. • Bonds are a long-term liability. • Interest is computed on a semi-annual basis.

8. Learning Unit 21-1 Face value × Stated rate × 6/12 = Amount of interest to be paid in cash each 6 months. Face value × Market rate at issuance date × 6/12 = Amount to be debited to interest expense every 6 months (effective method)

9. Learning Unit 21-1 • The above are equal if bonds were sold at 100%. • If bonds were not sold at 100%, a bond discount or bond premium exists. • A discount or premium is amortized at the interest payment date.

10. Amortizing bond discounts and bond premiums by the straight-line method and by the interest method. Journalizing year-end adjusting entries for bonds. Learning Objectives 2 and 3

11. Learning Unit 21-2 Straight-Line Method The discount (or premium) is divided by the number of interest periods for the bond issue and provides the amount for amortization.

12. Learning Unit 21-2 • Amortization of a discount increases interest expense. • Amortization of a premium decreases interest expense.

13. Learning Unit 21-2 Bondswith a face value of $200,000 are sold at 97%. The contract rate of interest is 12% (20 periods). The market rate is 12.4%. Cash 194,000 Discount on Bonds Payable 6,000 Bonds Payable 200,000

14. Learning Unit 21-2 • Discount amortization = $6,000 ÷ 20 = $300 • How much is the interest payable at the end of period one? • $200,000 × 12% × 6/12 = $12,000 • How much is the interest expense? • $300 (bond amortization) + $12,000 (interest payable) = $12,300

15. Learning Unit 21-2 Bondswith a face value of $200,000 are sold at 102%. The contract rate of interest is 12%. The market rate is 11.8%. Cash 204,000 Bonds Payable 200,000 Premium on Bonds Payable 4,000

16. Learning Unit 21-2 • Cash payment is $12,000. • 4,000/20 = 200 • Premium amortization is $200. • Interest expense is 12,000 – 200 = $11,800 • What is the journal entry at the end of period one?

17. Learning Unit 21-2 Interest Expense 11,800 Premium Bonds Payable (amortization) 200 Cash 12,000

18. Learning Unit 21-3 Interest Method The interest method makes interest expense a constant percentage of the bond carrying value.

19. Learning Unit 21-3 • Face value × Stated rate × 6/12 = Amount of interest to be paid in cash each 6 months • Carrying value × Market rate at issuance date × 6/12 = Amount to be debited to Interest Expense every 6 months • The above are equal if bonds were sold at 100%.

20. Learning Unit 21-3 • Assume that Yang Corporation is issuing $200,000 of 12%, ten-year bonds on April 1. Interest is to be paid on October 1 and April 1. • The selling price of the bonds is $178,808. • The market rate is 14 %.

21. Learning Unit 21-3 • What is the interest paid to bondholders at the end of period one? • $200,000 × 12% × 6/12 = $12,000 • What is the interest expense? • $178,808 × 14% × 6/12 = $12,517 • What is the discount amortization? • $517

22. Learning Unit 21-3 Interest Expense 12,517 Cash 12,000 Discount on Bonds Payable (amortization) 517

23. Learning Unit 21-3 • Assume that on December 31, three months interest of $6,000 for the second period has accrued. What is the adjusting entry? Interest Expense 6,276.50 Discount on Bonds Payable 276.50 Bond interest payable 6,000.00

24. Journalizing entries related to retirement of bonds and to sinking funds. Learning Objective 4

25. Learning Unit 21-4 • Bonds are a long-term liability. • Liabilities are paid at maturity (or early). • Amortization must be brought up to date and interest paid to bondholders. • Maturity value (face value of bonds) is paid. • Some issues require a sinking fund in which cash is set aside to repay the bonds at maturity date.

26. Learning Unit 21-4 • Assume that on June 30, a corporation retired a $500,000, 10 % bond issue that had an unamortized premium of $19,000. • The bonds were called at 105. • What is the journal entry?

27. Learning Unit 21-4 Bonds Payable 500,000 Premium on Bonds Payable 19,000 Loss on Bond Retirement 6,000 Cash 525,000 Retirement of bond

28. End of Chapter 21