1. Chapter 10

2. Describe bonds payable

3.  Large company issue bonds to public to raise money ◦ Multiple lenders = bondholders  Each bondholder receives bond certificate that shows  Amount borrowed (principal)  Maturity date  Interest rate  Company pays interest (usually semi-annually) to bondholders ◦ Bondholders receive interest 3Copyright (c) 2009 Prentice Hall. All rights reserved.

4. 4 Principal or Maturity value Amount borrower must pay back on maturity date Maturity date Date on which borrower must pay principal to the bondholders Stated interest rate Annual rate of interest borrower pays to bondholders Copyright (c) 2009 Prentice Hall. All rights reserved.

5.  Term bonds ◦ All mature at same date  Serial bonds ◦ Mature in installments at regular intervals  Secured bonds ◦ Bondholder has right to assets if company fails to pay principal or interest  Debenture ◦ Unsecured; not backed by company’s assets 5Copyright (c) 2009 Prentice Hall. All rights reserved.

6. Maturity(par) value $1,000 bond issued for $1,000 No discount or premium Discount $1,000 bond issued for $980 Issued below maturity value Premium $1,000 bond issued for $1,015 Issued above maturity value 6Copyright (c) 2009 Prentice Hall. All rights reserved.

7.  Quoted as a percent of maturity value  Issue price determines cash company receives  Company must pay maturity value at maturity date 7 A $1,000 bond quoted a price of 101.5 would sell for $1,015 A $1,000 bond quoted a price of 89.75 would sell for $897.50 Copyright (c) 2009 Prentice Hall. All rights reserved.

8.  Money earns income over time  Investors will pay less than $1,000 now to receive $1,000 in the future 8 2009 2012 Present value: Today’s price $750 Future value: Maturity value $1,000 Present value is always less than future value Copyright (c) 2009 Prentice Hall. All rights reserved.

9. Stated interest rateMarket interest rate  Determines amount of cash interest borrower pays each year  Remains constant  Rate investors demand for loaning money  Varies daily 9 Stated interest rate Market interest rate Issue price of bonds payable 9%= Maturity value 9%<10% Discount (below maturity value) 9%>8% Premium (above maturity value) Copyright (c) 2009 Prentice Hall. All rights reserved.

10. Measure interest expense on bonds using the straight-line amortization method

11. 11 GENERAL JOURNAL DATEDESCRIPTIONDEBITCREDIT Cash100,000 Bonds payable100,000 To record issuance of 8% bonds at maturity value Interest expense4,000 Cash4,000 To record semi-annual interest payment Issue date $100,000 x 8% x 1/2 Int. pmt dates Copyright (c) 2009 Prentice Hall. All rights reserved.

12. 12 GENERAL JOURNAL DATEDESCRIPTIONDEBITCREDIT Bond payable100,000 Cash100,000 To record payment of bonds at maturity Maturity date Copyright (c) 2009 Prentice Hall. All rights reserved.

13. 13 GENERAL JOURNAL DATEDESCRIPTIONDEBITCREDIT Cash98,000 Discount on bonds payable2,000 Bonds payable100,000 To record issuance of $100,000, 10-year, 8% bonds at 98 Issue date Contra account to Bonds payable Copyright (c) 2009 Prentice Hall. All rights reserved.

14. Long-term liabilities Bonds payable $100,000 Less: Discount on bonds payable ( $2,000)$98,000 14 Carrying value Copyright (c) 2009 Prentice Hall. All rights reserved.

15. 15 GENERAL JOURNAL DATEDESCRIPTIONDEBITCREDIT Interest expense4,100 Discount on bonds payable100 Cash4,000 Int. pmt date $100,000 x 8% x 6/12 $2000/10 x 6/12 Copyright (c) 2009 Prentice Hall. All rights reserved.

16. 16 GENERAL JOURNAL DATEDESCRIPTIONDEBITCREDIT Cash104,000 Premium on bonds payable4,000 Bonds payable100,000 To record issuance of $100,000, 10-year, 8% bonds at 98 Issue date Companion account to Bonds payable Copyright (c) 2009 Prentice Hall. All rights reserved.

17. Long-term liabilities Bonds payable $100,000 Plus: Premium on bonds payable $4,000$104,000 17 Carrying value Copyright (c) 2009 Prentice Hall. All rights reserved.

18. 18 GENERAL JOURNAL DATEDESCRIPTIONDEBITCREDIT Interest expense3,800 Premium on bonds payable200 Cash4,000 Int. pmt date $100,000 x 8% x 6/12 $4,000/10 x 6/12 Copyright (c) 2009 Prentice Hall. All rights reserved.

19. 19 Bonds payablePremium $100,000$4,000$200 $3,800 Carrying value after first interest payment = $103,800 Carrying value after first interest payment = $103,800 Copyright (c) 2009 Prentice Hall. All rights reserved.

20.  Interest payments seldom occur at year-end ◦ Interest must be accrued 20 GENERAL JOURNAL DATEDESCRIPTIONDEBITCREDIT 1231Interest expense2,050 Discount on bonds payable50 Interest payable2000 (100,000 x 8% x 3/12) $2,000/10 x 3/12 Copyright (c) 2009 Prentice Hall. All rights reserved.

21.  The following interest payment entry will take into account the adjusting entry previously made 21 GENERAL JOURNAL DATEDESCRIPTIONDEBITCREDIT 331Interest payable2,000 Interest expense2,050 Discount on bonds payable50 Cash4,000 (100,000 x 8% x 1/12) $2,000/10 x 3/12 Copyright (c) 2009 Prentice Hall. All rights reserved.

22. 22 January 1: bond date April 1: issue date June 20: 1 st interest payment $ 100,000 x 8% x 6/12 = $4,000 $2,000 (100,000 x 8% x 3/12) $2,000 (100,000 x 8% x 3/12) Cash interest payment Accrued interest Interest expense Copyright (c) 2009 Prentice Hall. All rights reserved.

23. 23 GENERAL JOURNAL DATEDESCRIPTIONDEBITCREDIT 41Cash102,000 Bonds payable100,000 Interest payable2,000 630Interest expense2,000 Interest payable2,000 Cash4,000 Copyright (c) 2009 Prentice Hall. All rights reserved.

24. Report liabilities on the balance sheet

25. 25Copyright (c) 2009 Prentice Hall. All rights reserved.

26. Compare issuing bonds to issuing stock

27. Issuing bondsIssuing stock  Must pay interest and principal to bondholders  Reduces net income ◦ Interest expense  Can increase earnings per share ◦ Leverage  Does not have to be “paid off”  Does not affect net income  Increases number of shares outstanding 27Copyright (c) 2009 Prentice Hall. All rights reserved.