2. Section 1: Financing Through Bonds
Chapter 22
Long-Term Bonds
Section 1: Financing
Through Bonds
Section Objectives
Chapter 21 discussed corporate capital transactions including earnings and income taxes. Chapter 22 completes the corporate accounting section, and discusses the use of long-term bonds as a method of financing. Companies can raise capital by selling company stock. This was discussed in the last two chapters. However, another popular way for a company to raise needed funds is to borrow money. (Notes payable, mortgage loan and by issuing bonds.) This first section discusses financing through bonds. Bonds payable are long-term debt instruments that are written promises to repay the principal at a future date. A bond payable is similar to a loan.
Name and define the various types of bonds.
Explain the advantages and disadvantages of using bonds as a method of financing.
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3. Types of Bonds Secured and Unsecured
Name and define the various types of bonds
Objective 1
Types of Bonds
Secured or unsecured
Registered or unregistered
Single-maturity or serial-maturity
Secured and Unsecured
Secured: specific property pledged as collateral.
Unsecured: backed only by a company’s general credit.
There are several different kinds of bonds that a corporation can issue. The factors most commonly considered when classifying and describing bonds are:
Are the bonds secured by collateral?
Are the bonds registered?
Do all the bonds mature on the same date, or over a period of several years?
When a company issues Collateral trust bonds it pledges specific property as collateral.
In contrast, Debentures are bonds backed only by the general credit of the corporation.
A bond indenture is a bond contract prepared to protect the interests of bondholders.
Unsecured bonds are known as debentures.

4. Registered and Unregistered Single-Maturity and Serial-Maturity
Types of Bonds
Registered and Unregistered
Registered: issued to a particular purchaser listed in the corporation’s records.
Unregistered (coupon): transferred by delivery; coupons attached for each interest payment.
Single-Maturity and Serial-Maturity
Registered bonds are issued to a particular individual whose name is listed in the corporation’s records. On the other hand, with Coupon bonds the corporation keeps no record of the owner’s identity.
Single-maturity bonds are bonds that are due on the same date.
Serial bonds on the other hand, are payable over a period of years, with bonds maturing at different times.
Other characteristics of bonds is that they can be convertible or they can be callable.
Single-maturity: Bonds mature on the same day.
Serial-maturity: Bonds are payable over a period of years.

5. Interest Rates
The market interest rate is the interest rate a corporation is willing to pay and investors are willing to accept at the current time.
The face interest rate refers to the contractual interest rate specified on the bond.
A corporation will pay a bondholder interest during the life of the bond. The face interest rate refers to the contractual interest rate specified on the bond which the corporation agrees to pay. However, the market interest rate is important at the time of bond issuance because it is the interest rate a corporation is willing to pay and investors are willing to accept. If the market rate and the face rate are different then the bonds will be sold at more or less than the face amount of the bond.

6. Advantages and Disadvantages of Using Bonds as a Method of Financing
Explain advantages and disadvantages of using bonds
Objective 2
Advantages and Disadvantages of Using Bonds as a Method of Financing
Capital Stock
Bonds Payable
Permanent Capital
Debt
There are advantages and disadvantages of using bonds.
Remember that corporations obtain funds by :
Equity financing (selling stock)
Debt financing (borrowing the money—bonds payable)
The equity source (stock financing) was discussed in Ch The debt source (bond financing) is discussed in this chapter.
If we compare the two methods of raising funds we notice that:
Cash received through stock issuance does not have to be repaid however cash received via bonds, does have to be repaid.
No debt to repay.
Must be repaid.

7. Advantages and Disadvantages of Using Bonds as a Method of Financing
Capital Stock
Bonds Payable
Stockholders’ Equity
Long-term liabilities
Common stock has no legal requirement for dividends. Preferred stock requirements depend on contract.
Dividends are not deductible for income tax purposes.
Interest must be paid on the bonds.
Interest is a deductible expense.
In addition:
Dividends don’t have to be paid but interest does. Interest is deductible, dividends are not.

8. Advantages and Disadvantages of Using Bonds as a Method of Financing
Capital Stock
Bonds Payable
Preference dividends on preferred stock are usually slightly higher than interest rates on bonds because there is more risk associated with preferred stock.
Interest rates on bonds are usually slightly lower than dividends on preferred stock.
The cost to the company of issuing preferred stock dividends is greater than the required interest rate paid on bonds.

9. Section 2: Bond Issue and Interest
Chapter 22
Long-Term Bonds
Section 2: Bond Issue
and Interest
Section Objectives
In section 2 we will see how to record the bond issuance and the required interest payments. This section also explains how to calculate any amortization of a premium or discount.
Record the issuance of bonds.
4. Record the payment of interest on bonds.
Record the accrual of interest on bonds.
Compute and record the periodic amortization of a bond premium.
Compute and record the periodic amortization of a bond discount.
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10. Bonds Issued at Face Value
Objective 3
Record the issuance of bonds
Bonds Issued at Face Value
On April 1, 2010, FLORAK Corporation sells $50,000 ($1,000 x 50) of its 8-year bonds at face value for cash.
2010
Apr. 1 Cash ,000.00
10% Bonds Payable, , Issued bonds at face value.
Let’s record the issuance of bonds. In this journal entry, the bonds were sold for the FACE VALUE amount of the bonds. The corporation credits 10% Bonds Payable, 2018 for $50,000. This new account would be reported on the Balance Sheet in the long term liability section.

11. Payment of Interest Record the payment of interest on bonds
Objective 4
Record the payment of interest on bonds
Payment of Interest
On October 1, 2010, the interest for six months at 10 percent becomes due on the $50,000 of bonds issued.
($50,000 X 10% X 6/12 = $2,500)
2010
Oct. 1 Bond Interest Expense ,500.00
Cash ,500.00
Paid semiannual bond interest.
A company must pay periodic interest payments to the bondholder. Since interest is paid twice a year on the bonds, the corporation debits Bond Interest Expense for $2,500 six months after the issue date and issues a check to the bondholder. The formula for simple interest on the bond is: Face value x interest rate x time

12. Accrual of Interest on Bonds Issued at Face Value
Objective 5
Record the accrual of interest on bonds
Accrual of Interest on Bonds Issued at Face Value
On December 31, 2010, when the fiscal year ends for the FLORAK Corporation, bond interest of $1,250 has accrued for three months since the bond interest was last paid on October 1.
($50,000 X 10% X 3/12 = $1,250)
2010
Dec. 31 Bond Interest Expense ,250.00
Bond Interest Payable ,250.00
Accrued interest for 3
months.
If the fiscal year ends and it is not time to make an interest payment, the corporation needs to accrue interest owed through the end of the current accounting period. This is the required adjusting journal entry to accrue 3 months of interest expense. (Dr. Bond Interest Expense; Cr. Bond Interest Payable)

13. Bond Premium
If the face rate on the bonds exceeds the market rate of interest at the time the bonds are issued, the bonds will be issued at a premium.
The issuing corporation must write off, or amortize, the premium over the period from date of issue of the bonds until date of maturity.
If the face rate on the bonds exceeds the market rate of interest at the time the bonds are issued, the bonds will be issued at a premium. The premium on the bond will, over the life of the bond, decrease the total cost of borrowing funds. The extra amount paid by a bondholder, called a premium, is written off (or amortized), thus reducing the total interest expense incurred by selling the bond.
Amortizing the premium reduces the interest expense over the period the bonds are outstanding.

14. Bonds Issued at a Premium
2010
Apr. 1 Cash ,800.00
10% Bonds Payable, , Premium on Bonds Payable
Issued Bonds at 101.6
In this journal entry, the bonds were sold for $800 more than the face value. 10% Bonds Payable, 2018 will only be credited for the FACE amount of the bonds. “Premium on Bonds Payable” is an additional liability account.
Because the face rate of interest was greater than the market rate, the bonds sold at a premium (more than the face value).
$800 extra was paid by the buyer!

15. Compute and record the periodic amortization of a bond premium
Objective 6
Premium is amortized over the life of the bond. When interest expense is recorded, premium amortization is also recorded.
2010
Oct. 1 Bond Interest Expense ,500.00
Cash ,500.00
Payment of semiannual
interest on $50,000 of bonds.
1 Premium on Bonds Payable
Bond Interest Expense
Amortization of bonds sold at a premium.
Over the life of the bonds, any premium paid will be written off or amortized by the corporation. There are two ways to amortize a premium, the straight-line method and the effective interest method. We will be using the straight-line method which amortizes an equal amount of the premium each month.
When interest expense is recorded the premium amortization is also recorded. When we amortize the premium we debit the Premium on Bonds Payable account and credit Bond Interest Expense. The premium amortization actually causes a reduction in the bond interest expense for the period.
Bond Interest for 6 months ($50,000 x 10% x 6/12) = $2,500
Premium amortization reduces bond interest expense.

16. Using the Straight-line Method to Amortize the Bond Premium
2010
Oct. 1 Bond Interest Expense ,500.00
Cash ,500.00
Payment of semiannual
interest on $50,000 of bonds.
1 Premium on Bonds Payable
Bond Interest Expense
Amortization of bonds sold at a premium.
Using the straight-line method to write-off (amortize) the premium we can calculate the amount of the amortization-- The formula is:
Amount of premium paid/ # of interest payments over life of bond.
In this example, $800/8 years = $100 per year. For six months, the amortization is $50.
Straight-line Amortization
$ / 8 years = $ per year or $8.33 per month
$8.33 x 6 months = $50.00

17. Bonds Issued at a Discount
Objective 7
Compute and record the periodic
amortization of a bond discount
Bonds Issued at a Discount
2010
Apr. 1 Cash ,880.00
Discount on Bonds Payable 1,120.00
10% Bonds Payable, ,000.00
Issue bonds at 97.76
If a bond is sold for less than the face value then it is sold at a discount. The account Discount on Bonds Payable will be used to keep track of the unamortized discount amount.
In this example, bonds were sold for $1,120 less than the face amount. Only $48,880 was received by the corporation. The bonds were sold at a discount because the market interest rate at the time of issuance was greater than the face interest rate. “Discount on Bonds Payable” is a contra-liability account and has a debit balance.

18. Recording Bond Interest Expense and Amortization of Bond Discount
2010
Oct. 1 Bond Interest Expense 5,030.00
Premium on Bonds Payable
Discount on Bonds Payable
Cash ,000.00
Interest payment and amortization
of premium and discount for six
months.
In this journal entry, the corporation is paying interest on two different bonds. One was sold at a discount and the other was sold at a premium.
We have already discussed the amortization of the premium using the straight-line method. The discount can also be amortized using the straight-line method. The discount amortization is $1,120/ 7 years = $160 per year or $80 per interest payment. To write-off part of the discount, the Discount on Bonds Payable account needs to be credited in order to reduce it. The discount amortization increases the total interest expense of the period.
Straight-line method of amortizing was used to amortize both the premium and the discount.

19. Carrying Value of Bonds Carrying value is also known as book value.
Formula
Bonds Payable
+ Premium on Bonds
– Discount on Bonds
Carrying Value
Bonds Payable is shown as a long-term liability on the balance sheet. The Premium on Bonds Payable account has a credit balance and will be shown on the balance sheet as an addition to the value of Bonds Payable. Since both Bonds Payable and the Premium account have credit balances they are added together on the Balance Sheet to determine the “carrying value” of the bonds. In contrast, the Discount on Bonds Payable account has a debit balance so it is shown as a subtraction from the balance of Bonds Payable on the Balance Sheet.
Carrying value is also known as book value.

20. Section 3: Bond Retirement
Chapter 22
Long-Term Bonds
Section 3: Bond Retirement
Section Objectives
This final section of chapter 22 explains how to record the transactions of a bond sinking fund investment and the eventual retirement of a bond.
Record the transactions of a bond sinking fund investment.
Record an increase or decrease in retained earnings appropriated for bond retirement.
Record retirement of bonds payable.
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21. When a bond matures, it is Retired.
The bond is paid.
The liability is removed from company’s balance sheet.
New Partner Given Credit for Amount Invested
2018
April 1
Bonds Payable ,000.00
Cash ,000.00
Bond retired at maturity.
When a bond is paid off, the bond is retired and removed from the books of the company.

22. What is a bond sinking fund investment?
Objective 8
Record the transactions of a bond sinking fund investment
QUESTION:
What is a bond sinking fund investment?
A bond sinking fund investment is a fund established to accumulate assets to pay off bonds when they mature.
ANSWER:
One way to financially prepare for the retirement of bonds is to set up a fund and periodically contribute to it. A bond sinking fund investment is a fund established to accumulate assets to pay off bonds when they mature. A corporation uses the bond sinking fund to save a constant amount every month or year to pay off its bonds at the maturity date. The net earnings of the fund will reduce the amount that the corporation will have to add each year after the first year.

23. Bond Sinking Fund Investment
Journal entry to record first annual installment:
New Partner Given Credit for Amount Invested
2014
April 1
Bond Sinking Fund Investment ,000.00
Cash ,000.00
first annual installment
of bond sinking fund
Let’s look at a sinking fund created by FLORAK corporation. FLORAK decides to accumulate $30,000 per year in a bond sinking fund for each of the last five years the bonds are outstanding.
To record the first annual installment, the Bond Sinking Fund Investment account is debited for $30,000.

24. Bond Sinking Fund Investment
Journal entry to record net income earned by sinking fund for the year:
New Partner Given Credit for Amount Invested
2014
April 1
Bond Sinking Fund Investment ,760.00
Income from Sinking Fund Investment ,760.00
Net income earned by
Sinking Fund during the year.
Each year the sinking fund earns income. To record the earnings of the fund the corporation credits Income from Sinking Fund Investment and debits the Bond Sinking Fund Investment account.

25. Bond Sinking Fund Investment
Journal entry to record second annual installment:
New Partner Given Credit for Amount Invested
2015
April 1
Bond Sinking Fund Investment ,240.00
Cash ,240.00
($30,000 first year installment less $1,760 first year income equals $28,240)
Since the fund had earnings of $1,760 in its first year, the amount that the company must invest in the fund this second year is reduced to $28,240.
This procedure is repeated each year, until the entire amount needed to retire funds is reached.

26. Bond Sinking Fund Investment
Journal entry to record retirement of bonds:
New Partner Given Credit for Amount Invested
2018
April 1
10% Bonds Payable, ,000.00
Bond Sinking Fund Investment ,000.00
Bonds retired at maturity
using balance in sinking
fund.
When the bonds payable mature and must be paid off, the money comes from the Bond Sinking Fund Investment account.

27. Retained Earnings Appropriated for Bond Retirement
Record an increase or decrease in retained earnings appropriated for bond retirement
Objective 9
Retained Earnings Appropriated for Bond Retirement
The bond contract might require that retained earnings are appropriated while the bonds are outstanding.
As covered in Chapter 21, when retained earnings are appropriated, they are restricted from dividend payments.

28. Retained Earnings Appropriated for Bond Retirement
FLORAK’S Board of Directors decides to appropriate $30,000 of retained earnings during each of the last five years the bonds are outstanding.
Record annual appropriation in years :
New Partner Given Credit for Amount Invested
2014
April 1
Retained Earnings ,000.00
Retained Earnings Appropriated for Bond Retirement ,000.00
When retained earnings are appropriated for future bond retirements:
Dr Retained Earnings
Cr Retained Earnings Appropriated for Bond Retirement.
Remember, since appropriations may affect dividend payments, any restrictions should be disclosed in the corporation’s financial statements.
Appears on the balance sheet under the heading “Appropriated Retained Earnings.”

29. Retained Earnings Appropriated for Bond Retirement
In year that bond matures, record close-out of appropriation account:
New Partner Given Credit for Amount Invested
2018
April 1
Retained Earnings Appropriated for Bond Retirement ,000.00
Retained Earnings ,000.00
At the end of five years, $150,000 has been accumulated in the account for the bond retirement.
In this year of bond maturity, the corporation will record a close-out of the appropriation account.
$30,000 x 5 years= $150,000

30. Retirement of Bonds Record retirement of bonds payable
Objective 10
Record retirement of bonds payable
Retirement of Bonds
Recall that on April 1, 2010, FLORAK Corporation issued $50,000 face value, 10%, 8 year bonds at a discount.
Interest is paid on January 1 and July 1 of each year.
Bonds were issued at
Discount of $1,120 is amortized on a straight-line basis over the remaining 8 years until the bonds due date.
They decide to retire the bonds one year after issuance (April, 1, 2011).
When bonds are retired, the corporation stops paying interest on them and those bonds are “out of circulation.”
In the FLORAK Corporation example, the company decides to retire the discounted bonds one year after issuance.

31. Early Retirement of Bonds
Corporation could have surplus cash, so bonds are retired early.
Interest rate decreases could result in an early retirement of bonds.
Sometimes it is advantageous to retire bonds early. (interest rate on bonds is too high).
A gain or loss may be incurred on the early retirement of a bond if its book value is different than the proceeds required to pay it off early.

32. How much discount is amortized in each six-month interest period?
QUESTION:
How much discount is amortized in each six-month interest period?
$1,120 discount
÷ months (remaining life of bond)
$ per month X months
ANSWER:
For the discounted bonds which the company wants to retire early, we need to calculate the carrying value of the bonds. First, we need to calculate how much of the discount has been amortized. We know that $80 of the discount was amortized every six months. . . $

33. Retirement of Bonds
On April 1, 2011, FLORAK Corporation retired $50,000 face value of the bonds (originally issued at a discount).
Represents 50% of total bonds outstanding.
Retired at 101 plus accrued interest.
The company is retiring 50% of the bonds or a face amount of $50,000. They are paying 101% of this face amount plus any accrued interest to the bondholders.

34. Discount on Bonds Payable
QUESTION:
What is the amount of unamortized discount that remains at time of retirement?
ANSWER:
Discount on Bonds Payable
Beg. Bal 1,120
/1/10
adj. entry
/1/11
The amount of unamortized Discount that remains at time of retirement is $960 as shown above.
960
At time of retirement. . .

35. What is the total book value to be removed?
REMINDER: Gain or loss is the difference between book value of bonds retired and what is paid for them.
QUESTION:
What is the total book value to be removed?
$50,000 face value
960 discount book value
Face value – discount
$49,040
In order to figure if there was a gain or loss on the early retirement, we still need to know what the carrying value of the bonds were. If we examine the balances in the Bonds Payable account and its contra account, the Discount on Bonds Payable account, we see that the carrying value of the bonds is $49,040. The gain or loss incurred on early retirement is the difference between (carrying value) book value of bonds retired and what is paid for them. The carrying value of the bonds is $49,040
ANSWER:

36. What is the interest up to
Record bond interest expense up to the date of retirement. . .
QUESTION:
What is the interest up to
the date of retirement?
$50,000 face value
X % interest rate
Interest = principal X rate X time
5,000
X /12 period to retirement
ANSWER:
Before retiring the bonds and taking them off of the books, we need to record any interest expense up to the date of retirement.
$ 1,250
2011
Apr Bond Interest Expense ,250
Bond Interest Payable ,250
Cash ,500

37. What is the cash payment for
REMINDER: Gain or loss is the difference between book value of bonds retired and what is paid for them.
QUESTION:
What is the cash payment for
repurchase price?
$50,000 face value
X purchase price
$50,500 repurchase price
Repurchase price = face value X 1.01
ANSWER:
The corporation agreed to pay 101% of the face amount of the bonds which would be equal to $50,500.
$50,500 cash payment

38. What is the gain or loss on the transaction?
REMINDER: Gain or loss is the difference between book value of bonds retired and what is paid for them.
QUESTION:
What is the gain or loss on the transaction?
$49,040 book value
– ,500 repurchase price
Book value - repurchase price
$ 1,460 loss on early retirement of bonds
ANSWER:
The difference between the book value of $49,040 and the repurchase price of $50,500 is $1,460. This is recorded as a loss on early retirement of bonds.

39. Record Loss on Early Retirement
2011
Apr Bonds Payable ,000.00
Loss on Early Retirement of Bonds ,460.00
Cash ,500.00
Discount on Bonds Payable
The journal entry on April 1 to record the early retirement is shown here. In the journal entry the Bonds Payable face amount of $50,000 is removed along with the unamortized balance of the discount. The loss of $1,460 is also recorded in the Loss on Early Retirement of Bonds account.

40. College Accounting, 12th Edition
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College Accounting, 12th Edition
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