Slide 1 A Free sample background from © 2006 By Default! Welcome to ACCT 352! INTERMEDIATE FINANCIAL ACCOUNTING II

Slide 2 A Free sample background from © 2006 By Default! FINANCING PART I: OVERVIEW DEBT (Chapter 14) EQUITY (CHAPTER 18) Recording/ Retirement Conversion Warrants Reporting/Fair Value REPORTING BASIC/DILUTIVE EARNINGS PER SHARES (CHAPTER 19)

Slide 3 A Free sample background from © 2006 By Default! KEY POINTS:  FINANCIAL REPORTING Bigger picture Outside the box External impact Global impact Expand your knowledge: Read/listen/watch News KNOWLEDGE

Slide 4 A Free sample background from © 2006 By Default! CURRENT ECONOMIC CONDITIONS  DISCUSSION:  Current US economic conditions?  Is US the most important economy in the world? E.g. crisis?  Why is it important?  Impact on Corporations Globally CURRENT US MARKET

Slide 5 A Free sample background from © 2006 By Default! What is :CAPITAL MARKET? ‘Who are the key players? ‘ ‘ Which market is bigger? FINANCIAL REPORTING & ECONOMICS

Slide 6 A Free sample background from © 2006 By Default! New York Stock Exchange (NYSE) is the largest centralized bond market, representing mostly corporate bonds. New York Stock Exchange Why is it important for us to know the US/Global perspective of BOND/STOCK MARKET? Source: Securities Industry & Financial Markets Association (SIFMA) BOND MARKET!

Slide 7 A Free sample background from © 2006 By Default! OPTIONS: ISSUE: PRO/CON 1. BOND MARKET 1. STOCK MARKET LONG TERM FINANCING CORPORATION’S PERSPECTIVE

Slide 8 A Free sample background from © 2006 By Default! MAJOR DIFFERENCES: Debt Financing & Equity Financing

Slide 9 A Free sample background from © 2006 By Default! Bond Certificates- Bond borrowing agreement: Indenture or covenants NATURE OF BONDS Professor Vedd

Slide 10 A Free sample background from © 2006 By Default! 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

Slide 11 A Free sample background from © 2006 By Default! The Bond Indenture The specific promises made to bondholders are described in a document called a bond indenture. Mortgage Bond secured by lien on specific real estate owned by the issuer. Callable Bond allows company to buy back outstanding bonds prior to maturity. Coupon Bond pays interest when investor submits attached coupon. Debenture Bond secured by the “full faith and credit” of company.unsecured

Slide 12 A Free sample background from © 2006 By Default! Callable/Redeemable bonds: Convertible bonds: PROVISIONS: BONDS Professor Vedd

Slide 13 A Free sample background from © 2006 By Default! BONDS: Recording/Reporting/Issue of bonds Interest payment/accruals (during the term Presentation/disclosures Reporting Changes in Fair Value RETIREMENT: Prior to Maturity CONVERSION: Convert Bonds to Stock STOCK WARRANTS ACCOUNTING FOR BONDS

Slide 14 A Free sample background from © 2006 By Default! LONG TERM DEBT US GAAP: APB Opinion 21 (Issue costs) & APB Opinion 14 (convertible debt) SFAS No 159/157: The Fair Value Option FASB ASC Topic 470 / IAS 1 IFRS: IAS 32 & 39 US GAAP & IFRS

Slide 15 A Free sample background from © 2006 By Default! FACE VALUE: Nominal/principal Par value or maturity value. MATURITY DATE INTEREST RATE: Rate Printed on Bond: Stated/face/coupon/nominal rate Determines cash interest payments Market Interest Rate (effective rate) (Yield) Rate in effect when bonds are issued FEATURES OF BONDS

Slide 16 A Free sample background from © 2006 By Default! TWO WAYS: 1. NYSE/WSJ etc Quoted: percentage of face amount Bonds are quoted as a % of face value e.g. 98 DETERMINE PRICE OF BONDS

Slide 17 A Free sample background from © 2006 By Default! TWO WAYS: 2. PRESENT VALUE (PV) PV of the future cash flows:= A. PV: interest: annuity PAYMENT (Stated Interest Rate) plus B. PV of the Face/Par Value Discounted at the market (yield) rate of interest in effect at issue date. DETERMINE PRICE OF BONDS

Slide 18 A Free sample background from © 2006 By Default! Bond Interest Rates Bond Stated Rate = 9% Market Rate = 9% Bonds Sell At Par (Face) Market Rate = 8% Bonds Sell at a Premium Market Rate = 10% Bonds Sell at a Discount

Slide 19 A Free sample background from © 2006 By Default! Year 1 Year 2 Year 3 Year 4 Year 5 $9,000 market rate Discount at market rate, 11% $9,000 * $ 33,263 $100,000 market rate Discount at market rate, 11% $100,000 * $ 59,345 plus =$92,608 is the issue price Bond Valuation ILLUSTRATION

Slide 20 A Free sample background from © 2006 By Default! In Class Illustration: Example A On January 1, 2012, JJ Corporation issues $500,000 long- terms bonds with stated interest rate of 10%, due on January 1, Interest is paid semiannually on January 1 and July 1 each year. At the time of issuance, market interest rate is 12%. December 31 year-end Step 1: Calculate the price of the bond Step 2: Record the issue of bonds Jan 1, 2012 Step 3: Prepare schedule of interest expense Step 4: Record entries for interest expense/payments for 2012 Step 5: Presentation: statement December 31, 2012

Slide 21 A Free sample background from © 2006 By Default! PV of interest payments PV: ordinary annuity (6%, 10 periods) = ($500,000 x 5%) x $184,002 Present Value (PV of principal) = $500,000 (6%, 10 periods) = $500,000 x $279,200 BOND PRICE = $463,202 Cont. Example A: Calculating the Price of the Bond

Slide 22 A Free sample background from © 2006 By Default! Face Value:$500,000 Sold:$463,202 Issued $36,798 discount. Date: January 1, 2012 Dr. Cash 463,202 Dr. Discount on Bonds Payable 36,798 Cr. Bonds payable500,000 Record the issue of bonds

Slide 23 A Free sample background from © 2006 By Default! Effective interest method Amortize premium/discount

Slide 24 A Free sample background from © 2006 By Default! Discount on bonds Payable 36,798 – (2,792+2,960) = 31,046 Reporting: Statement Presentation JJ Corporation Partial Balance Sheet December 31, 2012 Current Liabilities: Interest Payable$25,000 LT Liabilities Bonds Payable$500,000 Less: Discount on Bonds Payable (31,046) $468,954

Slide 25 A Free sample background from © 2006 By Default! Determining the Price: On January 1, 2011, Masterwear Industries issued $700,000 of 12% bonds, dated January 1. Interest is payable semiannually on June 30 and December 31. The bonds mature in three years. The market yield for bonds of similar risk and maturity is 14%. The entire bond issue was purchased by United Intergroup.

Slide 26 A Free sample background from © 2006 By Default! Determining the Price: On January 1, 2011, Masterwear Industries issued $700,000 of 12% bonds, dated January 1. Interest is payable semiannually on June 30 and December 31. The bonds mature in three years. The market yield for bonds of similar risk and maturity is 14%. The entire bond issue was purchased by United Intergroup. Because interest is paid semiannually, the present value calculations use: (a) the semiannual stated rate (6%), (b) the semiannual market rate (7%), and (c) 6 (3 x 2) semi-annual periods. Present value of an ordinary annuity of $1: n=6, i=7% present value of $1: n=6, i=7%

Slide 27 A Free sample background from © 2006 By Default! Bond Amortization Schedule Here is a bond amortization schedule showing the cash interest, effective interest, discount amortization, and the carrying value of the bonds. $666,633 + $4,664 = $671,297

Slide 28 A Free sample background from © 2006 By Default! LESSON 1: CHAPTER 14 PART II BONDS ISSUE COST BONDS ISSUED INBETWEEN DATES RETIREMENT OF BONDS CONVERSION OF BONDS

Slide 29 A Free sample background from © 2006 By Default! What is Bond issue Costs? –According to FASB: (APB21) Debt issue costs are recorded separately as an asset. Amortized over the term to maturity using straight line method. Bond Issue Costs

Slide 30 A Free sample background from © 2006 By Default! U. S. GAAP vs. IFRS Debt issue costs (called transaction costs under IFRS) are accounted for differently by U.S. GAAP and IFRS. Debt issue costs are recorded separately as an asset. Amortized over the term to maturity. “Transaction costs” reduce the recorded amount of the debt. The cost of these services reduces the net cash the issuing company receives and the amount recorded for the debt.

Slide 31 A Free sample background from © 2006 By Default! Bonds issued between interest days Interest accrues from the date of the bonds Buyer is required to pay accrued interest Accrued interest is reported as interest payable (current liability) Year-end Between interest dates Bonds issued between interest days Interest accrues from the date of the bonds Buyer is required to pay accrued interest Accrued interest is reported as interest payable (current liability) Year-end Between interest dates BONDS ISSUED BETWEEN INTEREST DATES

Slide 32 A Free sample background from © 2006 By Default! Issued between interest date: April 30 th issued $100,000 6% bonds on May 31 April 30 Bond Date May 31 Issue Date Oct 31 Interest Payment Date Investor pays face value + Accrued interest $100,000 + $500 ($100,000 x 6% x 1/12) Corp. pays full 6 months’ of interest of $3,000

Slide 33 A Free sample background from © 2006 By Default!  Bonds retired at Maturity or Early  Bonds may be “Called” (Reacquisition)  or “Redeemed” retired prior to maturity  May be for all outstanding bonds, or a portion *Refinancing or refunding: issuing new bonds and applying the proceeds to the retirement of outstanding bonds/debts before maturity Retirement of Bonds: Extinguishment of Debt (Bonds Refinancing)*

Slide 34 A Free sample background from © 2006 By Default! Early Extinguishment of Debt (FASB 145) - Update the relevant accounts: (premium/discount and any issue costs) - Carrying Value (book value) 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 The FASB requires that the gain or loss be classified in the Income Statement as(OTHER gains/losses) unusual/infrequent Debt retired at maturity results in NO gain/losses

Slide 35 A Free sample background from © 2006 By Default! Sell the bonds at higher price (lower interest rate) In-Direct way of selling stock Medium of exchange in business combination …. Convertible Bonds

Slide 36 A Free sample background from © 2006 By Default! exchanging bond -> common stock Convertible Bonds (1)updates interest expense and (2) amortization of discount or premium to the date of conversion. (3)The bonds are reduced and shares of common stock are increased.

Slide 37 A Free sample background from © 2006 By Default! The conversion may be recorded under either Book value method (more common) or Market value method Convertible bonds: Option of converting the bonds into common stock. Professor Vedd

Slide 38 A Free sample background from © 2006 By Default! NO gain or loss is recognized STEPS: 1. Update the accrued interest up to the conversion date, 2. Amortize the bond discount or premium up to the conversion date, 3. Amortize the bond issue costs up to the conversion date, and 4. Record any difference as additional paid-in capital. (stocks are with par value) CONVERSION OF BONDS: BOOK VALUE METHOD

Slide 39 A Free sample background from © 2006 By Default! recognized gain or loss.: using Market Value Method At conversion: –The difference between the market value of the stock –& the book value of the bonds =gain or loss on CONVERSION. CONVERSION OF BONDS MARKET VALUE METHOD

Slide 40 A Free sample background from © 2006 By Default! Attraction for Investor Bonds are issued with an instrument -added value i.e. warrant Stock warrants: Stock warrants: –option to purchase: – a specified number of COMMON shares –specified option price per share –within a stated period. Bonds with Detachable Warrants

Slide 41 A Free sample background from © 2006 By Default! Bonds issued in conjunction with stock warrants. Bonds/warrants issued as elements of a single security Investors can trade the stock warrants separately Issuer is required to allocate the joint issuance price between the two instruments STOCK WARRANTS

Slide 42 A Free sample background from © 2006 By Default! Not Required: but option to value (some or all) liabilities at Fair Value If option is elected: –Increase/decrease in fair value is reported as a unrealized loss/gain in the income statement Reporting Debt at Fair Value SFAS No 159

Slide 43 A Free sample background from © 2006 By Default! To determine FV : present value of the remaining cash flows discounted at the current interest rate. At December 31, 18 of the original 20 payments remain. FAIR VALUE REPORTING (SFAS No 157 ) Professor Vedd

Slide 44 A Free sample background from © 2006 By Default! To determine FV : present value of the remaining cash flows discounted at the current interest rate. REMAINING 18 PERIODS If the current interest rate is 9% (4.5% semi-annually), Present Value s Interest$ 32,000¥ x *=$389,120 Principal $800,000 x † = 362,240 Present value of the bonds $751,360 ¥ (8% / 2) x $800,000 * Present value of an ordinary annuity of $1: n = 18, i = 4.5%. (Table 4) † Present value of $1: n = 18, i = 4.5%. Calculating FV

Slide 45 A Free sample background from © 2006 By Default! To increase the book value of $706,483 to Fair Value $751,360 entry: Unrealized holding loss44,877 Fair value adjustment ($751,360 – $706,483)44,877 Reporting FV

Slide 46 A Free sample background from © 2006 By Default! DECEMBER 31 LONG TERM LIABILITIES: BONDS PAYABLE$800,000 LESS DISCOUNTS ON BONDS(93,517) CARRYING VALUE AT DEC.$706,483 Fair value adjustment ($751,360 – $706,483)44,877 ADJUSTED CARRYING VALUE AT FV $751,360 BALANCE SHEET PRESENTATION

Slide 47 A Free sample background from © 2006 By Default!  Debt financing  Introduction  Various financing  Introduction: Bonds & various types of bonds  Accounting/recording: BONDS  Bonds payable issued at discount/premium…  Bonds Issued between interest dates  Retirement/Redemption of bonds  Convertible bonds  Bonds refinancing  Stock Warrants  Fair Value Reporting Debt Financing: Chapter 14:Summary Professor Vedd