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Understanding Bond Issuance and Pricing

Learn about different bond types, issuing procedures, and pricing methods in corporate finance. Explore accounting entries for bond issuances at par and handling discounts. Understand the amortization of bond discounts using the Straight-Line Method and Effective Interest Method.

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Understanding Bond Issuance and Pricing

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  1. Module 10 Bonds and Long Term Notes Payable

  2. Learning Objectives

  3. Bond

  4. Bonds Annual amount of interest paid Par value Stated of the x rate of bond interest =

  5. Bonds

  6. Bond Types

  7. Bond Types

  8. Bond Types

  9. Bond Types

  10. Bond Issuing Procedures . . .an investment firm called an underwriter. The underwriter sells the bonds to. . . A company sells the bonds to. . . A trustee monitors the bond issue. . . . investors.

  11. Bond Pricing

  12. Bond Pricing Introductory Accounting SAP 2007 / SAP University Alliances

  13. Illustration: Issuing Bonds at Par Barnes Corp. issues $800,000 of 9%, 20-year bonds. The bonds are dated January 1, 2005, and are due in 20 years on January 1, 2025. Interest is paid semi-annually each June 30 and December 31. All the bonds are sold at their par value. On January 1, 2005, the date of issuance, the entry would be: Cash 800,000 Bonds Payable 800,000

  14. Illustration: Issuing Bonds at Par On June 30, 2005, the first interest payment date, the entry would be: Bond Interest Expense 36,000 Cash 36,000 ($800,000 x 9% x 6/12) = $36,000 On January 1, 2025, the maturity date, the entry would be: Bonds Payable 800,000 Cash 800,000

  15. Issuing Bonds Between Interest Dates

  16. Jan. 1 Mar. 1 June 30 Date of Sale First Interest Date Accrued interest Illustration: Issuing Bonds Between Interest Dates Canadian Tire has $100,000 of 9% bonds available for sale on January 1. Interest is payable on each June 30 and December 31. If the bonds are sold at par on March 1, two months after the original issue date of January 1, the issuer collects two months’ interest from the buyer at the time of sale. Stated Issue Date ($100,000 x 9% x 2/12) = $1,500 Purchaser pays face value plus accrued interest.

  17. On March 1, the date of issuance, the entry would be: Cash 101,500 Bonds Payable 100,000 Interest Payable 1,500 Jan. 1 Mar. 1 June 30 Date of Sale First Interest Date Stated Issue Date Accrued interest ($100,000 x 9% x 2/12) = $1,500 Purchaser pays face value plus accrued interest.

  18. On June 30, the first interest payment, the entry would be: Interest Payable 1,500 Bond Interest Expense 3,000 Cash 4,500 Jan. 1 Mar. 1 June 30 Stated Issue Date Date of Sale First Interest Date Interest expense Accrued interest ($100,000 x 9% x 4/12) = $3,000 ($100,000 x 9% x 2/12) = $1,500

  19. Par Value Int.Pmt. Int.Pmt Int.Pmt. Int.Pmt. Int.Pmt. Int.Pmt. 0 Per. 1 Per. 2 Per. 3 Per. 4 Per. 5 … .. .Maturity Present Value of Maturity Payment Present Value of the Interest Payments Bond Price = + Bond Pricing The issue price of the bond equals the present value of the future cash payments.

  20. $100,000 $4,000* $4,000 $4,000 $4,000 $4,000 $4,000 0 6mo. 12mo. 18mo. 24mo. 30mo. 36mo. Illustration: Present Value of a Discount Bond Fila Corp. announces an offer to issue bonds with a $100,000 par value, an 8% annual contract rate with interest payable semi-annually, and with a three-year life. The cash flows of the bond are: *Semi-annual interest payment = $100,000 x 8% x 6/12

  21. $100,000 $4,000 $4,000 $4,000 $4,000 $4,000 $4,000 0 6mo. 12mo. 18mo. 24mo. 30mo. 36mo. Illustration: Present Value of a Discount Bond The issue price of the bond equals the present value of the future cash payments. The market rate for Fila’s bonds is 10%. Since the market rate is higher than the contract rate of 8%, the bonds will sell at a discount. The present value of these cash payments is $94,923.

  22. Illustration: Present Value of a Discount Bond Assume the bonds were issued on December 31. The entry to record the issuance would be: Cash 94,923 Discount on Bonds Payable 5,077 Bonds Payable 100,000

  23. Illustration: Amortizing a Bond Discount The discount of $5,077 is eventually paid to the bondholders and represents part of the cost of using the $94,923 for three years. The discount is amortized over the life of the bonds using either the Straight-Line Method or the Effective Interest Method.

  24. Straight Line Method An equal portion of the discount is allocated to each period. This yields a constant dollar amount of interest expense each period. Discount to be amortized each period Bond Discount Number of periods =

  25. Illustration: Straight-Line Method Fila Corp.’s bond discount of $5,077 is amortized over the life of the bonds. Periodic Amortization Bond Discount Number of periods = $5,077 6 periods = = $846/period The entry to record each interest payment would be: Bond Interest Expense 4,846 Discount on Bonds Payable 846 Cash 4,000 ($100,000 x 8% x 6/12) = $4,000

  26. Effective Interest Method This method allocates bond interest expense over the life of the bonds that yields a constant rate of interest. The interest expense increases each period since the balance in the liability account increases each period. Periodic interest expense Carrying Value of Bonds Periodic Market Rate = x

  27. Illustration: Effective Interest Method First period interest expense Carrying Value of Bonds Periodic Market Rate x = = ($100,000 - $5,077) x 5%* = $4,746 *Semi-annual market rate The entry to record the first interest payment would be: Bond Interest Expense 4,746 Discount on Bonds Payable 746 Cash 4,000

  28. Issuing Bonds at a Premiume

  29. Bond Retirements

  30. Retirement of Bonds at Maturity

  31. Illustration: Retiring Bonds at Maturity Assume Hydro Quebec had $100,000 of bonds that matured on December 31, 2009, and that the final interest payment has already been made. The entry to record the retirement of the bonds would be: Bonds Payable 100,000 Cash 100,000

  32. Retirement of Bonds before Maturity

  33. Illustration: Retiring Bonds before Maturity Assume a company issued callable bonds with a par value of $100,000. The call option requires the issuer to pay a call premium of $3,000 to bondholders in addition to the par value. Assume all interest has been paid and the bonds have a carrying value of $104,500. The entry to record the retirement of the bonds would be: Bonds Payable 100,000 Premium on Bonds Payable 4,500 Gain on Retirement of Bonds 1,500* Cash 103,000 ($100,000 + $4,500) - $103,000 = $1500

  34. Retirement of Bonds by Conversion to Shares

  35. Illustration: Bond Retirement by Conversion to Shares Assume a company has $100,000 par value bonds that have a $4,000 balance in the Discount on Bonds Payable account and these bonds are converted into 15,000 common shares. The entry to record the conversion of the bonds would be: Bonds Payable 100,000 Discount on Bonds Payable 4,000 Common Shares 96,000

  36. Interest expense for the period Interest rate on the note Beginning-of-period balance = x Long Term Notes Payable

  37. Long Term Notes Payable

  38. Mortgage Notes

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