Presentation is loading. Please wait.

Presentation is loading. Please wait.

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Bonds and Long-Term Notes 14.

Similar presentations


Presentation on theme: "Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Bonds and Long-Term Notes 14."— Presentation transcript:

1 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Bonds and Long-Term Notes 14

2 14-2 Nature of Long-Term Debt Obligations that extend beyond one year or the operating cycle, whichever is longer Mirror image of an asset Accrue interest expense Reported at present value Loan agreement restrictions

3 14-3 Bonds Bond Selling Price Bond Certificate Interest Payments Face Value Payment at End of Bond Term At Bond Issuance Date Company Issuing Bonds Subsequent Periods Investor Buying Bonds Company Issuing Bonds Investor Buying Bonds

4 14-4 The Bond Indenture Debenture Bond Mortgage Bond Subordinated Debenture Coupon Bonds CallableCallable Sinking Fund Serial Bonds Convertible Bonds The indenture is the written specific promises made by the company to the bondholders. Types of Bonds

5 14-5 Bonds BOND PAYABLE Face Value $1,000 Interest 10% 6/30 & 12/31 Maturity Date 12/31/15 Bond Date 1/1/06 1. Face value (maturity or par value) 2. Maturity Date 3. Stated Interest Rate 4. Interest Payment Dates 5. Bond Date Other Factors: 6. Market Interest Rate 7. Issue Date

6 14-6 Recording Bonds at Issuance On 1/1/06, Matrix, Inc. issues 1,000 bonds at face value to Apex, Inc. The market interest rate is 10%. The bonds have the following terms: Face Value = $1,000 Maturity Date = 12/31/10 (5 years) Stated Interest Rate = 10% Interest Dates = 6/30 & 12/31 Bond Date = 1/1/06 On 1/1/06, Matrix, Inc. issues 1,000 bonds at face value to Apex, Inc. The market interest rate is 10%. The bonds have the following terms: Face Value = $1,000 Maturity Date = 12/31/10 (5 years) Stated Interest Rate = 10% Interest Dates = 6/30 & 12/31 Bond Date = 1/1/06 Record the issuance of the bonds on 1/1/06.

7 14-7 Recording Bonds at Issuance Matrix, Inc. - Issuer Apex, Inc. - Investor

8 14-8 Bonds Issued Between Interest Dates Interest begins to accrue on the date the bonds are dated. If the bonds are issued after the day they are dated, the investor would be asked to pay the company accrued interest. On the interest payment date, the investor will receive a check for the full period’s interest. 1/1/06 Bonds Dated 1/12/06 Bonds Sold 6/30/06 First Interest Payment Date

9 14-9 Bonds Issued Between Interest Dates On 1/12/06, Matrix, Inc. issues 1,000 bonds at face value plus accrued interest to Apex, Inc. The market interest rate is 10%. The bonds have the following terms: Face Value = $1,000 Maturity Date = 12/31/10 (5 years) Stated Interest Rate = 10% Interest Dates = 6/30 & 12/31 Bond Date = 1/1/06 On 1/12/06, Matrix, Inc. issues 1,000 bonds at face value plus accrued interest to Apex, Inc. The market interest rate is 10%. The bonds have the following terms: Face Value = $1,000 Maturity Date = 12/31/10 (5 years) Stated Interest Rate = 10% Interest Dates = 6/30 & 12/31 Bond Date = 1/1/06

10 14-10 Bonds Issued Between Interest Dates Accrued Interest $1,000,000 × 10% = $100,000 ÷ 360 days = $ interest per day 11 days × $ = $3, Matrix - Issuer Apex - Investor

11 14-11 Bonds Issued Between Interest Dates At the first interest date $1,000,000 × 10% × ½ = $50,000 cash Matrix - Issuer Apex - Investor

12 14-12 Determining the Selling Price

13 14-13 Determining the Selling Price On 1/1/06, Matrix, Inc. issues 1,000 bonds at face value to Apex, Inc. The market interest rate is 12%. The bonds have the following terms: Face Value = $1,000 Maturity Date = 12/31/10 (5 years) Stated Interest Rate = 10% Interest Dates = 6/30 & 12/31 Bond Date = 1/1/06 On 1/1/06, Matrix, Inc. issues 1,000 bonds at face value to Apex, Inc. The market interest rate is 12%. The bonds have the following terms: Face Value = $1,000 Maturity Date = 12/31/10 (5 years) Stated Interest Rate = 10% Interest Dates = 6/30 & 12/31 Bond Date = 1/1/06 What is the selling price of these bonds?

14 14-14 Determining the Selling Price n = 5 years × 2 payments per year = 10 i = 12% ÷ 2 payments per year = 6% Interest annuity = $1,000,000 × 10% ÷ 2 = $50,000 Bonds issued at a discount.

15 14-15 Determining the Selling Price Matrix, Inc. - Issuer Apex, Inc. - Investor

16 14-16 Determining Interest Effective Interest Method (Effective rate multiplied by the outstanding balance of the debt) $926,395 × 6% $55,584 - $50,000 $926,395 + $5,584

17 14-17 Determining Interest Effective Interest Method (Effective rate multiplied by the outstanding balance of the debt)

18 14-18 Determining Interest Matrix, Inc. - Issuer Apex, Inc. - Investor

19 14-19 Zero-Coupon Bonds These bonds do not pay interest. Instead, they offer a return in the form of a “deep discount” from the face amount. Those who invest in zero-coupon bonds usually have tax-deferred or tax-exempt status. These bonds do not pay interest. Instead, they offer a return in the form of a “deep discount” from the face amount. Those who invest in zero-coupon bonds usually have tax-deferred or tax-exempt status.

20 14-20 Bonds Sold at a Premium On 1/1/06, Matrix, Inc. issues 1,000 bonds at face value to Apex, Inc. The market interest rate is 8%. The bonds have the following terms: Face Value = $1,000 Maturity Date = 12/31/10 (5 years) Stated Interest Rate = 10% Interest Dates = 6/30 & 12/31 Bond Date = 1/1/06 On 1/1/06, Matrix, Inc. issues 1,000 bonds at face value to Apex, Inc. The market interest rate is 8%. The bonds have the following terms: Face Value = $1,000 Maturity Date = 12/31/10 (5 years) Stated Interest Rate = 10% Interest Dates = 6/30 & 12/31 Bond Date = 1/1/06 What is the selling price of these bonds?

21 14-21 Bonds Sold at a Premium n = 5 years × 2 payments per year = 10 i = 8% ÷ 2 payments per year = 4% Interest annuity = $1,000,000 × 10% ÷ 2 = $50,000 Bonds issued at a premium.

22 14-22 Bonds Sold at a Premium Matrix, Inc. - Issuer Apex, Inc. - Investor

23 14-23 Bonds Sold at a Premium

24 14-24 Financial Statements Prepared Between Interest Dates Assume that in our previous example, Matrix, Inc. and Apex, Inc. both have fiscal years that end on September 30. Let’s look at the June 30 entry: Matrix, Inc. - Issuer Apex, Inc. - Investor

25 14-25 Year-end is on September 30, 2006, before the second interest date of December 31. $42,974 × ½ = $21,487 (3 months interest) $ 7,026 × ½ = $ 3,513 (3 months amortization) Matrix, Inc. - Issuer Financial Statements Prepared Between Interest Dates Apex, Inc. - Investor

26 14-26 Financial Statements Prepared Between Interest Dates The entries at December 31, Matrix, Inc. - Issuer Apex, Inc. - Investor

27 14-27 Straight-Line Method The discount or premium is allocated equally to each period over the outstanding life of the bond. The discount or premium is allocated equally to each period over the outstanding life of the bond. Considered practical and expedient. expedient.

28 14-28 Straight-Line Method In our last example, straight-line premium amortization would be: $81,105 ÷ 10 = $8,111 every six months. In our last example, straight-line premium amortization would be: $81,105 ÷ 10 = $8,111 every six months.

29 14-29 Straight-Line Method

30 14-30 Debt Issue Costs  Legal  Accounting  Underwriting  Commission  Engraving  Printing  Registration  Promotion

31 14-31 Debt Issue Costs  These costs should be recorded separately and amortized over the term of the related debt.  Straight-line amortization is often used.  These costs should be recorded separately and amortized over the term of the related debt.  Straight-line amortization is often used.

32 14-32 Long-Term Notes Present value techniques are used for valuation and interest recognition. The procedures are similar to those we encountered with bonds.

33 14-33 Notes Exchanged for Assets or Services On 1/1/06, Matrix, Inc. issued a $100,000, 3-year, 6% note in exchange for equipment owned by Apex, Inc. Interest is paid every 12/31. The equipment does not have a ready market value. The appropriate rate of interest for notes of this type is 9%. Let’s determine the present value of the note. On 1/1/06, Matrix, Inc. issued a $100,000, 3-year, 6% note in exchange for equipment owned by Apex, Inc. Interest is paid every 12/31. The equipment does not have a ready market value. The appropriate rate of interest for notes of this type is 9%. Let’s determine the present value of the note.

34 14-34 Notes Exchanged for Assets or Services

35 14-35 Notes Exchanged for Assets or Services Let’s prepare the entries on January 1. Amortization Schedule

36 14-36 Notes Exchanged for Assets or Services Matrix, Inc. - Purchaser Apex, Inc. - Seller

37 14-37 Notes Exchanged for Assets or Services Entries for the first interest period. Matrix, Inc. - Purchaser Apex, Inc. - Seller

38 14-38 Installment Notes oTo compute cash payment use present value tables. oInterest expense or revenue: Effective interest rate Effective interest rate × Outstanding balance of debt Interest expense or revenue Interest expense or revenue oPrincipal reduction: Cash amount Cash amount – Interest component Principal reduction per period Principal reduction per period oTo compute cash payment use present value tables. oInterest expense or revenue: Effective interest rate Effective interest rate × Outstanding balance of debt Interest expense or revenue Interest expense or revenue oPrincipal reduction: Cash amount Cash amount – Interest component Principal reduction per period Principal reduction per period

39 14-39 Installment Notes On January 1, 2006, Matrix, Inc. purchased a truck by issuing a 4-year note payable to Apex Motors. The truck cost $50,000 and is financed at a 9% interest rate. Payments are made at the end of each of the next four years. Let’s calculate the annual payment. $50,000 ÷ = $15,433 (rounded) PV of annuity of $1, n = 4, i = 9%

40 14-40 Installment Notes Here is our loan amortization table.

41 14-41 Installment Notes The entries on date of purchase are: Matrix, Inc. - Purchaser Apex Motors - Seller

42 14-42 Installment Notes Date of first payment. Matrix, Inc. - Purchaser Apex Motors - Seller

43 14-43 Financial Statement Disclosures Long-Term Debt For all long-term borrowing, disclosures should include the aggregate amounts maturing and sinking fund requirement, if any, for each of the next five years.

44 14-44 Early Extinguishment of Debt Debt retired at maturity results in no gains or losses. Debt retired before maturity may result in an gain or loss on extinguishment. Cash Proceeds – Book Value = Gain or Loss Debt retired before maturity may result in an gain or loss on extinguishment. Cash Proceeds – Book Value = Gain or Loss BUT

45 14-45 Convertible Bonds Some bonds may be converted into common stock at the options of the holder. When bonds are converted the issuer updates interest expense and amortization of discount or premium to the date of conversion. The bonds are reduced and shares of common stock are increased. Bonds into Stock

46 14-46 Convertible Bonds The Book Value Method Record new stock at the book value of the convertible bonds. No gain or loss is recognized. Record new stock at the book value of the convertible bonds. No gain or loss is recognized. On December 31, 2006, all of the bondholders of Matrix, Inc. convert their bonds into common stock. There are 10,000 bonds outstanding with a face value of $1,000 each. Each bond is convertible into 50 shares of the company’s $1 par value common stock. There is $1,500,000 on unamortized discount associated with the bonds that are converted. Interest and discount amortization have been brought up to December 31. Let’s look at the entry to record the conversion. On December 31, 2006, all of the bondholders of Matrix, Inc. convert their bonds into common stock. There are 10,000 bonds outstanding with a face value of $1,000 each. Each bond is convertible into 50 shares of the company’s $1 par value common stock. There is $1,500,000 on unamortized discount associated with the bonds that are converted. Interest and discount amortization have been brought up to December 31. Let’s look at the entry to record the conversion.

47 14-47 Convertible Bonds 10,000 × 50 shares × $1 par value The carrying value of the bonds is assigned to the stock.

48 14-48 Induced Conversion Companies sometimes try to induce conversion of their bonds into stock. One way to induce conversion is through a “call” provision. When the specified call price is less than the conversion value of the bonds (the market value of the shares), calling the convertible bonds provides bondholders with incentive to convert. Bondholders will choose the shares rather than the lower call price.

49 14-49 Bonds With Detachable Warrants Stock warrants provide the option to purchase a specified number of shares of common stock at a specified option price per share within a stated period. Stock warrants provide the option to purchase a specified number of shares of common stock at a specified option price per share within a stated period. A portion of the selling price of the bonds is allocated to the detachable stock warrants. A portion of the selling price of the bonds is allocated to the detachable stock warrants. Stock warrants provide the option to purchase a specified number of shares of common stock at a specified option price per share within a stated period. Stock warrants provide the option to purchase a specified number of shares of common stock at a specified option price per share within a stated period. A portion of the selling price of the bonds is allocated to the detachable stock warrants. A portion of the selling price of the bonds is allocated to the detachable stock warrants.


Download ppt "Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Bonds and Long-Term Notes 14."

Similar presentations


Ads by Google