Bonds

1. Bonds Chapter 13 from Financial Accounting

2. Bonds • A form of interest bearing note • Requires periodic interest payments • The face amount must be repaid at the maturity date • Bondholders are creditors of the issuing corporation

3. Bond Indenture Contract with bondholders Principal Face value of each bond Terminology

4. Types of Bonds • Term Bonds • Serial Bonds • Convertible bonds • Callable bonds • Debenture bonds

5. Present Value & Bonds • Price that buyers are willing to pay for the bonds dependent upon • The face amount of the bonds • Periodic interest to be paid • Market rate of interest

6. Interest • Coupon rate – • Rate of interest stated on the bonds • Market or effective rate • Interest determined by market conditions

7. Interest rates • If the Market rate = coupon rate • BONDS sells at FACE • If the market rate > Coupon rate • BONDS sells BELOW Face • DISCOUNT • If the market rate < coupon rate • BONDS sells ABOVE face • PREMIUM

8. Accounting for Bonds • Bonds issued at face value • Cash DR • Bonds payable CR • Interest exp DR • Cash CR

9. Bonds at Discount • Steps: • Compute the PV of the face amount • Computer the PV of the interest payments • Add the amounts in the first two steps • Face amount – selling price = discount

10. Bonds at Discount • Entry: • Cash DR • Discount DR • Bonds payable CR • Example: Corp sells $100,000 of 5 years bonds with a coupon rate of interest of 12% and market rate of interest of 13%. Interest is $6,000 is paid semiannually.

11. Example 3: Selling Price of Bonds PV of FACE ( 100,000, r = 13%/2, p = 5 X 2) $100,000 X .53273 = $53,273 PV of Interest pay ($6,000, r = 6.5%, p =10) $6,000 X 7.1883 = 43,130 Selling price of bonds 96,403

12. Example 3 Face value $100,000 Selling price 96,403 Discount 3,597 ENTRY: Cash 96,403 Discount 3,597 Bonds payable 100,000

13. Example 4: PV( $200,000, r 11%/2, p = 10) $200,000 X .58543 = $117,086 PV ( $10,000, r 11%/2, p=10) $10,000 X 7.53763 = 75,376 Selling price 192,462 Face 200,000 Discount 7,538

14. Example 4 Entry: Cash 192,462 Discount 7,538 Bonds payable 200,000

15. Amortization of Bond Discount • Two methods • Straight line method • Discount amortized = Discount/# of interest payments • Effective interest method

16. Example 5 • Discount amortized = 3594/10 = $359.4 • Interest expense 6,360 Discount 360 Cash 6,000

17. Example 6 • Interest exp 3780 • discount 780 • cash 3000 • Discount amortized = 7800/10 = $780

18. Bonds issued at Premium • Same as discount • Face amount – selling price = premium • Entry: Cash DR Bonds payable CR Premium CR

19. Example 3 • Corporation sells $100,000 of 5 year bond with a coupon rate of interest of 12% and market rate of interest of 11%. Interest of $6,000 is paid semiannually.

20. Example 3 PV ( $100,000, r=11%/2, p =10) $100,000 X .58543 = $58,543 PV($6,000, r=11%/2, p=10) $6,000 X 7.53763 = 45,226 Selling price 103,769 Face 100,000 Premium 3,769

21. Example 3 • Cash 103,769 • Premium 3,769 • Bonds payable 100,000

22. Example 4 • PV( $200,000, p=10, r =5%) • $200,000 * .61391 = $122,782 • PV($11,000, p =10, r=%) • $11,000 * 7.72174 = 89,939 • Selling price 207,721 • Face 200,000 • Premium 7,721

23. Entry • Cash 207,721 • Premium 7,721 • Bonds payable 200,000

24. Premium Amortization • Straight line method • Amortized = Premium/# of interest payment • Example 5: • Amortized = 3594/10 = $360 • Interest exp 5640 • Premium 360 • Cash 6,000

25. Example 6 • Amortized = 7800/10 = $780 • Interest exp 7020 • Premium 780 • Cash 7800

26. EX 13-8 EX 13-9 Ex 13-11 EX 13-12 EX 13-13 Homework

27. Wed 12/3: Review Test Three Differential analysis Capital investment analysis Cash flows Bonds Multiple choice/ short problems Monday 12/8 Homework due Test three Wednesday 12/10 Review for final examination Monday 12/15 Final Examination Update