2 BondsA bond is a debt security that is issued to obtain large amounts of cash on a long term basis.A bond indenture is the formal agreement which specifies the terms of the bonds.
3 Reasons for Issuance of Long-Term Liabilities Debt financing may be the only available source of funds.Debt financing may have a lower cost.Debt financing offers an income tax advantage.The voting privilege is not shared.Debt financing offers the opportunity for leverage.
5 Bond TerminologyThe principal, face, par or maturity value is the amount that the corporation will pay the bond holder at the maturity of a term bond.The stated rate, coupon rate, nominal rate, or contractual rate is the interest rate printed on the bond.The market rate, effective rate, or yield is the interest rate at which the bonds are actually sold.
6 Recording the Issuance of Bonds Company J sells bonds with a face value of $400,000 on the authorization date at 102.Cash ($400,000 x 1.02) 408,000Bonds Payable 400,000Premium on Bonds Payable 8,000Company M sells bonds with a face value of $400,000 on the authorization date at 97.Cash ($400,000 x .97) 388,000Discount on Bonds Payable 12,000Bonds Payable 400,000
7 Bonds Issued Between Interest Paying Dates On March 1, 2007, Grimes Corporation issues $800,000 of 10-year bonds dated January 1, 2007, at par. The bonds have a contract (stated) interest rate of 12% and pay interest semiannually.Cash 816,000Bonds Payable 800,000Interest Expense 16,000$800,000 x 0.12 x 2/12Continued
8 Bonds Issued Between Interest Paying Dates On July 1, 2007, Grimes Corporation records the semiannual interest payment.Interest Expense 48,000Cash 48,000$800,000 x 0.12 x 6/12Interest Expense48, ,000The balance of $32,000 represents the interest cost since the bonds were issued.32,000
9 Bonds Issued Between Interest Paying Dates Alternative MethodMarch 1 Cash 816,000Interest Payable($800,000 X 0.12 X 6/12) 16,000Bonds Payable 800,000July 1 Interest Expense($800,000 X 0.12 X 4/12) $ 32,000Interest Payable 16,000Cash $ 48,000
11 Issuing Bonds at a Discount Jet Company sells bonds for $92, on January 1, The bonds have a face value of $100,000 and a 12% stated annual interest rate and a 14% effective rate. Interest is paid semiannually and the bonds mature on December 31, 2011.Cash 92,976.39Discount on Bonds Payable 7,023.61Bonds Payable 100,000.00Continued
12 Bonds Issued at a Discount Straight-Line MethodJet Company records the first interest payment on June 30, 2007.$7, ÷ 10Interest Expense 6,702.36Discount on Bonds PayableCash 6,000.00$6,000 + $702.36$100,000 x 0.12 x 1/2
13 Bonds Issued at a Premium Straight-Line MethodJet Company sold the 5-year bonds on January 1, 2007, for $107, Interest is paid semiannually.Cash 107,721.71Bonds Payable 100,000.00Premium on Bonds Payable 7,721.71Continued
14 Bonds Issued at a Premium Straight-Line MethodThe first interest payment is made on June 30.Interest Expense 5,227.83Premium on Bonds PayableCash ($100,0000 x 0.12 x 1/2) 6,000.00$7, ÷ 10Continued
15 Determining the Selling Price Jet Company desires to sell $100,000 of 5-year bonds paying semiannual interest with a stated rate of 12%. The current effective interest rate is 14%.Present value of principal($100,000 x ) $ 50,834.90Present value of interest($6,000 x ) 42,141.49$ 92,976.39Less face value (100, )Discount $ 7,023.61
16 Determining the Selling Price Jet Company desires to sell $100,000 of 5-year bonds paying semiannual interest with a stated rate of 12%. The bonds are sold to yield 14% interest.Present value of principal($100,000 x ) $ 61,391.30Present value of interest($6,000 x ) ,330.41$107,721.71Less face value (100, )Premium $ 7,721.71
18 Effective Interest Method Using the straight-line method, Interest Expense is the same every year—which is not realistic when a premium or discount is involved. Instead, the effective-interest method allows for a stable interest rate per year.
19 Issuing Bonds at a Discount Effective InterestJet Company sells bonds for $92, on January 1, The bonds have a face value of $100,000 and a 12% stated annual interest rate and a 14% effective rate. Interest is paid semiannually and the bonds mature on December 31, 2011.Cash 92,976.39Discount on Bonds Payable 7,023.61Bonds Payable 100,000.00Continued
20 Issuing Bonds at a Discount Effective InterestJet Company records the first interest payment on June 30, 2007.$6, $6,000.00Interest Expense 6,508.35Discount on Bonds PayableCash 6,000.00$92, x 0.14 x 1/2$100,000 x 0.12 x 1/2
21 Issuing Bonds at a Discount Effective InterestJet Company records the second interest payment on December 31, 2007.$6, ,000.00Interest Expense 6,543.93Discount on Bonds PayableCash 6,000.00($92, $508.35) x 0.14 x 1/2$100,000 x 0.12 x 1/2
22 Issuing Bonds at a Premium Effective InterestJet Company sold bonds on January 1, 2007, for $107, Interest is paid semiannually.Cash 107,721.71Bonds Payable 100,000.00Premium on Bonds Payable 7,721.71Continued
23 Issuing Bonds at a Premium Effective InterestThe first interest payment is made on June 30.$6, –$5,386.09Premium on Bonds PayableInterest Expense 5,386.09Cash 6,000.00$107, x 0.10 x 1/2$100,000 x0.12 x 1/2Continued
24 Issuing Bonds at a Premium Effective InterestJet Company records the second interest payment on December 31, 2007.($107, $613.91) x 0.10 x 1/2Interest Expense 5,355.39Premium on Bonds PayableCash 6,000.00$6, $5,355.39$100,000 x 0.12 x 1/2
25 Bond Issue CostsOn January 1, 2007, Bergen Company issues 10-year bonds with a face value of $500,000 at Expenditures connected with the issue totaled $8,000.Cash ($520,000 - $8,000) 512,000Deferred Bond Issue Costs 8,000Bonds Payable 500,000 Premium on Bonds Payable 20,0000.04 x $500,000
26 Bond Issue CostsHowever, the FASB is planning to change GAAP, so that all debt issue costs are expensed as incurred.Each year for the ten years Deferred Bond Issue Costs is amortized on a straight-line basis by charging Bond Interest Expense for $800.
27 Accruing Bond Interest McAdams Company issues $200,000 of 10%, 5-year bonds on October 1, 2007, for $185, Interest on these bonds is payable each October 1 and April 1.Cash 185,279.87Discount on Bonds Payable 14,720.13Bonds Payable 200,000.00Continued
28 Accruing Bond Interest At the end of the fiscal year, December 31, 2007, an adjusting entry is required to record interest for three months (assume straight-line amortization).($14, ÷ 5) x 3/12Interest Expense (plug) 5,736.01Discount on Bonds PayableInterest Payable 5,000.00$200,000 x 0.10 x 3/12
29 Accruing Bond Interest At the end of the fiscal year, December 31, 2007, an adjusting entry is required to record interest for 3 months (assume the effective-interest amortization).$185,279 x 0.12 x 3/12Interest Expense 5,558.40Interest Payable 5,000.00Discount on Bonds Payable (plug)$5, $5,000.00
30 Extinguishment of Debt Under FASB Statement No. 140, a liability is considered extinguished for financial reporting purposes if either of the following occurs:The debtor pays the creditor and is relieved of its obligation for the liability.The debtor is released legally from being the primary obligor under the liability, either judicially or by the creditor.
31 Bonds Retired Prior to Maturity Conceptually, gains or losses from refundings could be recognized either--Over the remaining life of the old issue.Over the life of the new bond issue.In the current period.
32 Bonds Retired Prior to Maturity Whether bonds are recalled, retired, or refunded prior to maturity, any gain or loss is reported as a component of income from continuing operations in the current period.
33 Bonds Retired Prior to Maturity Channing Corporation originally issued $100,000 of 12% bonds at 97 on January 1, The bonds have a 10-year life, pay interest on January 1 and July 1, and are callable at 105 plus accrued interest. The company amortizes the discount by the straight-line method.On June 30, 2007, the company recalls the bonds.Continued
34 Bonds Retired Prior to Maturity First, Channing records the current interest expense and liability, including the amortization of the discount that expired since the last interest payment.($3,000 ÷ 10) x 1/2Interest Expense 6,150Discount on Bonds Payable 150Interest Payable 6,000$100,000 x 0.12 x 1/2
35 Bonds Retired Prior to Maturity Channing then records the reacquisition of the bonds at 105 plus accrued interest of $6,000.Bonds Payable 100,000Interest Payable 6,000Loss on Bond Redemption 6,350Discount on Bonds Payable 1,350Cash 111,000Original discount $ 3,000Less: Amortizationfor 5 1/2 years (1,650)Unamortized discount $1,350
36 Bonds with Equity Characteristics By acquiring bonds with detachable stock warrants or with a conversion feature, the bondholder has--the right to receive interest on the bonds, and…the right to acquire common stock and to participate in the potential appreciation of the market value of the company’s common stock.
37 Bonds with Equity Characteristics Some bonds are issued with rights, warrants, to acquire capital stock. If the warrants are detachable, a portion of the proceeds from selling the bonds must be allocated to the warrants.Proportional methodIncremental method
38 Bonds Issued with Detachable Stock Warrants Amount Assigned to Bonds=Market Value of Bonds Without Warrants+Market Value of WarrantsIssuance PricexAmount Assigned to Warrants=Market Value of WarrantsMarket Value of Bonds Without Warrants+Issuance Pricex
39 Bonds Issued with Detachable Stock Warrants Paul Company sold $800,000 of 12% bonds at 101 ($808,000). Each bond carried 10 warrants, and each warrant allows the holder to acquire one share of $5 par common stock for $25 per share. The bonds are quoted at 99 ex rights and the warrants at $3 each.
40 Bonds Issued with Detachable Stock Warrants Market Value of Bonds Without WarrantsAmount Assigned to BondsIssuance Pricex=Market Value of Bonds Without WarrantsMarket Value of Warrants+Amount Assigned to Bonds=$990 per bond x 800 bonds($990 x 800)+($3 x 800 x 10)$808,000xAmount Assigned to Bonds=$784,235.29
41 Bonds Issued with Detachable Warrants Amount Assigned to WarrantsMarket Value of WarrantsIssuance Pricex=Market Value of Bonds Without WarrantsMarket Value of Warrants+Amount Assigned to Warrants=$3 x 10 warrants x 800 bonds($990 x 800) + ($3 x 800 x 10)$808,000xAmount Assigned to Warrants=$23,764.71
42 Bonds Issued with Detachable Stock Warrants Cash 808,000.00Discount on Bonds Payable 15,764.71Bonds Payable 800,000.00Common Stock Warrants 23,764.71$800, $784,235.29From last slide
43 Bonds Issued with Detachable Warrants Later, 500 warrants are exercised at $25 each.Cash 12,500.00Common Stock Warrants 1,485.50Common Stock 2,500.00Additional Paid-in Capitalon Common Stock 11,485.50($23, ÷ 8,000) x 500The remaining warrants expire.$23, $1,485.50Common Stock Warrants 22,279.21Additional Paid-in Capitalfrom Expired Warrants 22,279.21
45 Convertible BondsAvoid the downward price pressures on its stock that placing a large new issue of common stock on the market would cause.Avoid the direct sale of common stock when it believes its stock currently is undervalued in the market.Penetrate that segment of the capital market that is unwilling or unable to participate in a direct common stock issue.Minimize the costs associated with selling securities.
46 Conversion MethodsBook value method. Record the stock at the book value of the convertible bonds and do not record a gain or loss. This method is the most widely used.Market value method. Record the stock at the market value of the stock or debt, whichever is more reliable, and recognize a gain or loss.
47 Conversion MethodsShannon Corporation has outstanding convertible bonds with a face value of $10,000 and a book value of $10,500. Each bond is convertible into 40 shares of $20 par common stock. The market price is $26.50 per share when the shares are converted.
48 Conversion MethodsBook Value Method- The market price is not considered.Bonds Payable 10,000Premium on Bonds PayableCommon Stock ,000Additional-Paid-in Capital-plug ,500Market Value Method-Equity accounts equal market price.Bonds Payable 10,000Premium on Bonds PayableLoss on ConversionCommon Stock ,000Additional-Paid-in Capital ,600
49 Induced ConversionsThe debtor recognizes an expense equal to the fair value of the “sweetener” and is measured on the date the offer is accepted by the bondholders.A company that has convertible bonds may desire bondholders to convert the bonds to common stock.To induce conversion, the company may add a “sweetener” to the convertible bond.
50 Induced ConversionsAssume that Harmon Company had $10,000 of outstanding convertible bonds, which had been issued at par. The original terms of issuance allowed each bond to be converted into 40 shares of no-par common stock. To induce conversion, the terms were changed to offer 50 shares per bond. All shares were converted when the market price was $30 per share.Bonds Payable 10,000Bond Conversion Expense 3,000Common Stock, no par 13,000
51 Notes Payable Issued for Cash On January 1 of the current year, Johnson Company issues a 3-year, non-interest-bearing note with a face value of $8,000 and receives $5, in exchange.Cash 5,694.24Discount on Notes Payable 2,305.76Notes Payable 8,000.00Contra account to Notes Payable
52 Notes Payable Issued for Cash Johnson Company records the interest expense on the note for the first year.Interest ExpenseDiscount on Notes PayableNotes payable $8,000.00Less: Unamortized discount (2,305.76)Carrying value at beginning of year $5,694.24x Effective interest rateEntry amount $
53 Notes Payable Exchanged for Property, Goods or Services APB Opinion No. 21 states that the stipulated rate of interest should be presumed fair. This presumption can be overcome only if--No interest is stated, orThe stated rate of interest is clearly unreasonable, orThe face value of the note is materially different from the cash sales price of the property, goods, or services, or the fair value of the note at the date of the transaction.
54 Long-Term Notes Receivable A note receivable is recorded at the fair value of the property, goods, or services or the fair value of the note, whichever is more reliable.
55 Long-Term Notes Payable On January 1, 2007, Marsden Company purchased used equipment from Joyce Company, issuing a 5 year, $10,000 non-interest-bearing note in exchange. Marsden’s incremental interest rate is 12%.Present valueEquipment 5,574.27Discount on Notes Payable 4,325.73Equipment 10,000.00
56 Long-Term Notes Payable Interest ExpenseDiscount on Notes PayableDecember 31, 2007($10,000 – $4,325.73) x 0.12Depreciation Expense Accumulated DepreciationInterest ExpenseDiscount on Notes PayableDecember 31, 2008$10,000 – ($4, – $680.91) x 0.12
57 Long-Term Notes Receivable A note receivable is recorded at the fair value of the property, goods, or services or the fair value of the note, whichever is more reliable.
58 Long-Term Notes Receivable On January 1, 2007, Joyce Company accepted a $10,000 non-interest-bearing, 5-year note in exchange for used equipment it sold to Marsden Company (12%).Notes Receivable 10,000.00Accumulated Depreciation 3,000.00Discount on Notes Receivable 4,325.73Equipment 8,000.00Gain on Sale of Equipment$10,000 – $5,674.27(present value of equipment)
59 Long-Term Notes Receivable Discount on Notes ReceivableInterest RevenueDecember 31, 2007($10,000 – $4,325.73) x 0.12Discount on Notes ReceivableInterest RevenueDecember 31, 2008$10,000 – ($4, – $680.91) x 0.12
60 Impairment of a LoanA loan is impaired if it is probable that the creditor will not be able to collect all amounts due according to the contract terms.
61 Impairment of a LoanSnook Company has a $100,000 note receivable from the Ullman Company that it is carrying at face value. The loan agreement called for Ullman to pay 8% interest each December 31 and the principal on December 31, Ullman paid the December 31, 2007, interest, but informed Snook that it probably would miss the next two year’s interest payments because of financial difficulties. In addition, the principal payment would be one year late.
62 Impairment of a LoanSnook Company computes the present value of the impaired loan.Value of the impaired loan is $85, ($63, $22,716.93)Present value of the principal = $100,000 x present value of a single sum for 6 years at 8%= $100,000 x= $63,017.00Present value of the interest = $8,000 x present value of an annuity for 4 years at 8% deferred 2 years= $8,000 x x= $22,716.93
63 Impairment of a Loan December 31, 2007, (Snook Company) Bad Debt Expense 14,266.07Allowance for Doubtful Accts. 14,266.07December 31, 2007, (Snook Company)$100,000 – $85,733.93Allowance for Doubtful Accounts 6,858.71Interest Revenue 6,858.71December 31, 2008, (Snook Company)8% x $85,733.93
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