1. Bonds and Long-term Notes
Chapter 14
Bonds and Long-term Notes

2. The Nature of Long-Term Debt
Liabilities signify creditors’ interest in a company’s assets.
A note payable and note receivable are two sides of the same coin.
A bond payable divides a large liability into many smaller liabilities.
Periodic interest is the effective interest rate times the amount of the debt outstanding during the period. Debt is reported at its present value
Corporations issuing bonds are obligated to repay a stated amount at a specified maturity date and period interest between the issue date.
Long-term debt:
Signifies creditors’ interest in a company’s assets.
Requires the future payment of cash in specified (or estimated) amounts, at specified (or projected) dates.
As time passes, interest accrues on debt.
Periodic interest is the effective interest rate times the amount of the debt outstanding during the interest period.
Debt is reported at the present value of its related cash flows (principal and/or interest payments), discounted at the effective rate of interest at issuance.

3. Face Value Payment at End of Bond Term
Bonds
At Bond Issuance Date
Company Issuing Bonds
Bond Selling Price
Investor Buying Bonds
Bond Certificate
Subsequent Periods
Investor Buying Bonds
Company Issuing Bonds
Part I On the date the bonds are issued, the company receives the selling price of the bond, and the investor receives the bond certificate.
Part II
In subsequent periods, the company pays the investors interest for the use of their money. At the maturity date of the bond the company must return the face amount of the bonds to the investors.
Interest Payments
Face Value Payment at End of Bond Term

4. The Bond Indenture
Debenture Bond secured by the “full faith and credit” of company.
Mortgage Bond secured by lien on specific real estate owned by the issuer.
The specific promises made to bondholders are described in a document called a bond indenture.
The specific promises made to bondholders are described in a document called a bond indenture. Because it would be impractical for the corporation to enter into a direct agreement with each of the many bondholders, the bond indenture is held by a trustee, usually a commercial bank or other financial institution, appointed by the issuing firm to represent the rights of the bondholders.
Most corporate bonds are debenture bonds. A debenture bond is secured only by the “full faith and credit” of the issuing corporation. No specific assets are pledged as security. Investors in debentures usually have the same standing as the firm’s other general creditors. So in case of bankruptcy, debenture holders and other general creditors would be treated equally.
A mortgage bond, on the other hand, is backed by a lien on specified real estate owned by the issuer. Because a mortgage bond is considered less risky than debentures, it typically will command a lower interest rate.
Years ago, it was typical for bonds to be structured as coupon bonds (sometimes called bearer bonds). The name of the owner of a coupon bond was not registered. Instead, to collect interest on a coupon bond the holder actually clipped an attached coupon and redeemed it in accordance with instructions in the indenture.
Most corporate bonds are callable (or redeemable). The call feature allows the issuing company to buy back, or call, outstanding bonds from bondholders before their scheduled maturity date.
Coupon Bond pays interest when investor submits attached coupon.
Callable Bond allows company to buy back outstanding bonds prior to maturity.

5. Recording Bonds at Issuance
On January 1, 2016, Masterwear Industries issued $700,000 of 12% bonds. Interest of $42,000 is payable semiannually on June 30 and December 31. The bonds mature in three years [an unrealistically short maturity to shorten the illustration]. The entire bond issue was sold in a private placement to United Intergroup, Inc. at face amount.
At Issuance (January 1)
Masterwear (Issuer)
Cash ,000
Bonds payable ,000
On January 1, 2011, Masterwear Industries issued $700,000 of 12% bonds. Interest of $42,000 is payable semiannually on June 30 and December 31. The bonds mature in three years [an unrealistically short maturity to shorten the illustration]. The entire bond issue was sold in a private placement to United Intergroup, Inc. at face amount.
On the date of issuance Masterwear, the issuer, will debit Cash and credit Bonds Payable for $700,000.
United, the investor, will debit Investment in Bonds and credit Cash for $700,000.
United (Investor)
Investment in bonds (face amount) 700,000
Cash ,000

6. Determining the Selling Price
To this point, we have assumed that bonds were sold at their face amount. This occurs only when the stated interest rate is equal to the market rate of interest. If the stated interest rate is below the market interest rate, the bonds will sell at a discount, meaning the cash received will be less than the face amount of the bonds. If the stated interest rate is above the market interest rate, the bonds will sell at a premium, meaning the cash received will be greater than the face amount of the bonds

7. Determining the Selling Price
On January 1, 2016, 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.
Present value of an ordinary annuity of $1: n=6, i=7%
A bond issue will be priced by the marketplace to yield the market rate of interest for securities of similar risk and maturity. To illustrate, 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.
To calculate the bond issue price, we multiply the semiannual interest annuity of $42,000 times , the present value of an ordinary annuity for $1 for 6 periods at 7% interest. Next we calculate the present value of the face amount of the bonds by multiplying the principal amount of $700,000 times , the present value factor of $1 for 6 periods at 7% interest. We add the two present value amounts to get the present value of the bonds of $666,633.
present value of $1: n=6, i=7%
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.

8. Bonds Issued at a Discount
Masterwear (Issuer)
Cash ,633
Discount on bonds payable 33,367
Bonds payable ,000
United (Investor)
Investment in bonds ,000
Discount on bond investment ,367
Cash ,633
Alternative “net method”
On the date is issuance, Masterwear, the issuer, will debit Cash for the present value amount of $666,633, debit Discount on Bonds Payable for $33,367, and credit Bonds Payable for the principal amount of $700,000.
On that same date, United, the investor, will debit Investment in Bonds for the principal amount of $700,000, credit Discount on Bond Investment for $33,367, and credit cash for $666,633, the present value amount we calculated.
As an alternative, the bonds payable and investment in bonds may be recorded at the net amount, that is the face amount less any discount and plus any premium. The net method actually is the preferred method for companies that prepare financial statements according to International Financial Reporting Standards.
Masterwear (Issuer)
Cash ,633
Bonds payable ,633
United (Investor)
Investment in bonds ,633
Cash ,633

9. Determining Interest – Effective Interest Method
Interest accrues on an outstanding debt at a constant percentage of the debt each period. Interest each period is recorded as the effective market rate of interest multiplied by the outstanding balance of the debt (during the interest period).
Interest is recorded as expense to the issuer and revenue to the investor. For the first six-month interest period the amount is calculated as follows:
$666,633 × (14% ÷ 2) = $46,664
Outstanding Balance Effective Rate Effective Interest
Interest accrues on an outstanding debt at a constant percentage of the debt each period. Interest each period is recorded as the effective market rate of interest multiplied by the outstanding balance of the debt (during the interest period).
Interest is recorded as expense to the issuer and revenue to the investor. For the first six-month interest period, the amount is $46,664, determined by multiplying the outstanding balance of $666,633 times the effective interest rate of 7%.
However, the bond indenture calls for semiannual interest payments of only $42,000 – the stated rate (6%) times the face value of $700,000. The difference ($4,664) increases the liability and is reflected as a reduction in the discount (a valuation account).
The bond indenture calls for semiannual interest payments of only $42,000 – the stated rate (6%) times the face value of $700,000. The difference ($4,664) increases the liability and is reflected as a reduction in the discount (a valuation account).

10. Recording Interest Expense
The effective interest is calculated each period as the market rate times the amount of the debt outstanding during the interest period.
At the First Interest Date (June 30)
Masterwear (Issuer)
Interest expense 46,664
Discount on bonds payable 4,664
Cash ,000
United (Investor)
Cash ,000
Discount on bond investment 4,664
Investment revenue ,664
At the first interest payment date, June 30th, Masterwear, the issuer, will debit Interest Expense for $46,664, credit Discount on Bonds Payable for $4,664, and credit Cash for $42,000. On the same date, United, the investor, will debit Cash for $42,000, debit Discount on Bond Investment for $4,664, and credit Interest Revenue for $46,664.
$700,000 × (12% ÷ 2) = $42,000
$666,633 × (14% ÷ 2) = $46,664
$46,664 - $42,000 = $4,664

11. Bond Amortization Schedule
Here is a bond amortization schedule showing the cash interest, effective interest, discount amortization, and the carrying value of the bonds.
The bond amortization schedule shows all the amounts that will enter into the journal entries in connection with this bond. Remember that effective interest is determined each period by multiplying the outstanding balance times the effective periodic interest rate. For example, for June 30, 2012, the effective interest is calculated by multiplying $676,288, the balance at the beginning of June 30, 2012, times the effective interest rate of 7 percent to get $47,340, rounded.
$666,633 + $4,664 = $671,297

12. 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.
Zero-coupon bonds do not pay interest; instead, they are sold at a very deep discount from face amount. As the bonds get closer to maturity, carrying value approaches face amount.

13. Bond Issued at Premium
On January 1, 2016, 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 10%. The entire bond issue was purchased by United Intergroup.
Present value of an ordinary annuity of $1: n=6, i=5%
A bond issue will be priced by the marketplace to yield the market rate of interest for securities of similar risk and maturity. To illustrate, 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 10%. The entire bond issue was purchased by United Intergroup at a cost of $735,533, or premium of $35,533 ($735,533 - $700,000).
To calculate the bond issue price, we multiply the semiannual interest annuity of $42,000 times , the present value of an ordinary annuity for $1 for 6 periods at 7% interest. Next we calculate the present value of the face amount of the bonds by multiplying the principal amount of $700,000 times , the present value factor of $1 for 6 periods at 7% interest. We add the two present value amounts to get the present value of the bonds of $666,633.
present value of $1: n=6, i=5%
Because interest is paid semiannually, the present value calculations use: (a) the semiannual stated rate (6%), (b) the semiannual market rate (5%), and (c) 6 (3 x 2) semi-annual periods.

14. Premium Amortization Schedule
Here is a bond amortization schedule showing the cash interest, effective interest, premium amortization, and the carrying value of the bonds.
The bond amortization schedule shows all the amounts that will enter into the journal entries in connection with this bond. Remember that effective interest is determined each period by multiplying the outstanding balance times the effective periodic interest rate. For example, for June 30, 2012, the effective interest is calculated by multiplying $724,875, the balance at the beginning of June 30, 2012, times the effective interest rate of 5 percent to get $47,341, rounded.
$735,533 × 5% = $36,777
$735,533 - $5,223 = $730,310

15. Bonds Sold at a Premium
Masterwear (Issuer)
Cash ,533
Premium on bonds payable ,533
Bonds payable ,000
United (Investor)
Investment in bonds ,000
Premium on bond investment 35,533
Cash ,533
On the date of acquisition, Masterwear, the bond issuer, will debit cash for $735,533, credit Premium on bonds payable for $35,533, and credit bonds payable for $700,000. At the same time, United (the investor in the bonds) will debit investment in bonds for $700,000, debit Premium on bond investment for $35,533, and credit cash for $735,533.
Interest expense and interest revenue will be recognized in a manner consistent with bonds issued at a discount.

16. Premium and Discount Amortization Compared
$735,533
Premium Amortization
$700,000
Discount Amortization
Bonds sold at a premium are sold at an amount above face amount, and bonds sold at a discount are sold at an amount less that face amount. The amortization process writes up (or down) to maturity over the life of the bond. At maturity, the liability for bonds payable is equal to the amount of cash necessary to extinguish the debt.
$666,633
1/1/13
12/31/15

17. When Financial Statements Are Prepared Between Interest Dates
On January 1, 2016, 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 at a cost of $666,633.
Masterwear and United both have October 31st year-ends.
We have accounted for these bonds on previous slides, so we are familiar with the values calculated. For example, on the date of issue the cash paid by United (investor) to Masterwear (issuer) will be $666,633. The total discount is $33,367. Let see the proper accounting when both companies have a October 31 year-end, and interest is paid on June 30, and December 31.
Semi-annual Stated Interest
June 30, 2016 Effective Interest
$700,000 × (12% ÷ 2) = $42,000
$666,633 × (14% ÷ 2) = $46,664

18. When Financial Statements Are Prepared Between Interest Dates
Year-end is on October 31, 2016, before the second interest date of December 31, so we must accrue interest for 4 months from June 30 to October 31.
Year-end accrual of interest expense and interest income.
Masterwear (Issuer)
Interest expense 31,327
Discount on bonds payable 3,327
Interest payable ,000
The year ended October 31, 2011, is four months from the interest payment date of June 30, The year-end entry is an accrual; no cash will change hands. Instead the issuer will record interest payable and the investor will record interest receivable.
We will recognize the interest for the four-month period of $31,327 (refer to the amortization schedule to calculate this amount). In addition, we will amortize the discount for the four-month period in the amount of $3,327.
The issuer will debit interest expense for $31,327 credit discount on bonds payable for $3,327 and credit interest payable for $28,000. The investor will debit interest receivable for $28,000, debit discount on bond investment for $3,327, and credit interest revenue for $31,327.
United (Investor)
Interest receivable 28,000
Discount on bond investment 3,327
Investment revenue ,327
$42,000 × 4/6 = $28,000
$671,297 × 7% × 4/6 = $31,327
$31,327 - $28,000 = $3,327

19. When Financial Statements Are Prepared Between Interest Dates
On December 31, the next interest payment date, the following entries would be recorded.
Masterwear (Issuer)
Interest expense 23,496
Interest payable 21,000
Discount on bonds payable 2,496
Cash ,000
On December 31, the next interest payment date, Masterwear, the issuer, will recognize an additional three months’ interest expense, an additional three months’ discount amortization, record the payment of cash, and remove the liability interest payable created by the accrual entry on September 30. Likewise, United, the investor, will recognize an additional three months’ interest revenue, an additional three months’ discount amortization, record the receipt of cash, and remove the asset interest receivable created by the accrual entry on September 30.
United (Investor)
Cash ,000
Discount on bond investment 2,496
Interest receivable 21,000
Investment revenue ,496

20. The Straight-Line Method – A Practical Expediency
Using the straight-line method of amortizing discounts and premiums, the discount in the earlier illustration would be allocated equally to the 6 semiannual periods (3 years):
$33,367 ÷ 6 periods = $5,561 per period
At Each of the Six Interest Dates
Masterwear (Issuer)
Interest expense 47,561
Discount on bonds payable 5,561
Cash ,000
Using the straight-line method, the discount in the earlier illustration would be allocated equally to the 6 semiannual periods (3 years) by dividing the total discount of $33,367 by 6 periods for a semiannual amortization of $5,561 per period.
On June 30, 2011, the first interest payment date, Masterwear, the issuer, will debt interest expense of $47,561, credit discount on bonds payable for $5,561 (the amount we just calculated), and credit Cash for $42,000. United, the investor, will debit cash for $42,000, debit Discount on bonds investment for $5,561, and credit interest revenue of $47,561. Both companies will make the same journal entry each interest period.
United (Investor)
Cash ,000
Discount on bond investment 5,561
Investment revenue ,561

21. Debt Issue Costs Legal Accounting Underwriting Commission Engraving
Printing
Registration
Promotion
Companies that issue bonds incur substantial debt issue costs. Here is a list of some of the costs that the company is likely to incur. Debt issue costs are recorded as a debit to a separate asset account and amortized to expense over the life of the bond using the straight-line method.

22. 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.
There are some difference in the treatment of debt issuance costs between U.S. GAAP and the rules of the IFRS. Some difference are:
From the viewpoint of the FASB,
Debt issuance costs are recorded separately as an asset and amortized over the term to maturity.
A lower (net) amount is borrowed at the same cost, increasing the effective interest rate.
The IFRS
Debt issuance costs reduce the recorded amount of the debt.
The cost of these services reduces the net cash the issuing company receives from the issuance.
A lower [net] amount is borrowed at the same cost, increasing the effective interest rate. However, unless the recorded amount of the debt is reduced by the transaction costs, the higher rate is not reflected in a higher recorded interest expense. The actual increase in the effective interest rate is reflected in the interest expense if the issue cost is allowed to reduce the carrying amount of the debt.
Unless the recorded amount of the debt is reduced by the transaction costs, the higher effective interest rate is not reflected in a higher recorded interest expense.

23. Early Extinguishment of Debt
Debt retired at maturity results in no gains or losses.
BUT
Debt retired before maturity may result in an gain or loss on extinguishment.
Cash Proceeds – Book Value = Gain or Loss
When debt of any type is retired prior to its scheduled maturity date, the transaction is referred to as early extinguishment of debt. When debt is retired at maturity, no gain or loss is recognized. If debt is retired early, that is before maturity, the company could recognize a gain or loss. A gain or loss is determined by comparing the cash proceeds to the book value of the debt.

24. Early Extinguishment of Debt
Illustration – On January 1, 2017, Masterwear Industries called its $700,000, 12% bonds when their carrying amount was $676,290. The indenture specified a call price of $685,000. The bonds were issued previously at a price to yield 14%.
Masterwear (Issuer)
Bonds payable ,000
Loss on early extinguishment ,710
Discount on bonds payable ,710
Cash ,000
$685,000 – 676,290
$700,000 – 676,290
Let’s look at the proper accounting for an early extinguishment of debt. Assume that on January 1, 2010, Masterwear Industries called its $700,000, 12% bonds when their carrying amount was $676,290. The indenture specified a call price of $685,000. The bonds were issued previously at a price to yield 14%. At the date of early extinguishment, we will eliminate the bonds payable by crediting that account for $700,000, and we will eliminate the unamortized discount on bonds payable with a credit of $23,710. You may wish to refer back to the amortization schedule developed earlier in this discussion. Next, we will credit cash for the call price of $685,000. Finally, we will recognize the loss on early extinguishment of $8,710, the difference between the call price of the bonds and the outstanding balance on the date of retirement.
For several years the FASB required companies to report gains and losses from early extinguishment of debt as
extraordinary items, but no longer. Now, these gains and losses are subject to the same criteria as other gains and
losses for such treatment; namely, that they be both (a) unusual and (b) infrequent.

25. Convertible Bonds
Some bonds may be converted into common stock at the option of the holder. When bonds are converted the issuer (1) updates interest expense and (2) amortization of discount or premium to the date of conversion. The bonds are reduced and shares of common stock are increased.
Some bonds have a provision permitting the holder to convert the bonds into common shares. When the bonds are converted they must be removed from the books along with any unamortized discount or premium at the date of conversion. Along with the reduction in the bonds, we have an increase in the number of common shares outstanding.
Bonds into Stock

26. Convertible Bonds
On January 1, 2016, HTL Manufacturers issued $100,000,000 of 8% convertible debentures due 2036 at 103 (103% of face value). The bonds are convertible at the option of the holder into $1 par common stock at a conversion ratio of 40 shares per $1,000 bond. HTL recently issued nonconvertible, 20 year, 8% debentures at 98.
At Issuance, January 1, 2016
HTL (Issuer)
Cash ,000,000
Convertible bonds payable ,000,000
Premium on bonds payable ,000,000
On January 1, 2011, HTL Manufacturers issued $100,000,000 of 8% convertible debentures due 2031 at 103 (103% of face value). The bonds are convertible at the option of the holder into $1 par common stock at a conversion ratio of 40 shares per $1,000 bond. HTL recently issued nonconvertible, 20 year, 8% debentures at 98.
$10,000,000 × 103%

27. Convertible Bonds
Assume the bondholder exercise one-half of their option to convert the bonds into shares of stock when there is an unamortized premium of $2,000,000 associated with these bonds. The bonds are removed from the accounting records and the new shares issued are recorded at the same amount (in other words, at the book value of the bonds).
At Date of Exercise of One-half of the Bonds
HTL (Issuer)
Convertible bonds payable 50,000,000
Premium on bonds payable 1,000,000
Common stock ,000,000
Paid-in capital – excess of par ,000,000
Assume the bondholder exercise one-half of their option to convert the bonds into shares of stock when there is an unamortized premium of $2,000,000 associated with these bonds. The bonds are removed from the accounting records and the new shares issued are recorded at the same amount (in other words, at the book value of the bonds).
On the date of exercise HTL will debit convertible bonds payable for $50,000,000, debit premium on bonds payable for $1.000,000, credit common stock for $2.000,000, and credit paid-in capital in excess of par for $49,000,000.
50,000 bonds × 40 shares × $1 par = $2,000,000 par value

28. Induced Conversion
Companies sometimes try to induce conversion. The motivation might be to reduce debt and become a better risk to potential lenders or achieve a lower debt-to-equity ratio.
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.
Investors often are reluctant to convert bonds to stock, even when share prices have risen significantly since the convertible bonds were purchased. This is because the market price of the convertible bonds will rise along with market prices of the stock. So companies sometimes try to induce conversion. The motivation might be to reduce debt and become a better risk to potential lenders or achieve a lower debt-to-equity ratio. One way is through the call provision. As we noted earlier, most corporate bonds are callable by the issuing corporation. 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.
Occasionally, corporations may try to encourage voluntary conversion by offering an added inducement in the form of cash, stock warrants, or a more attractive conversion ratio. When additional consideration is provided to induce conversion, the fair value of that consideration is considered an expense incurred to bring about the conversion.

29. U.S. GAAP vs. IFRS Convertible Bonds
Under IFRS, unlike U.S. GAAP, convertible debt is divided into its liability and equity elements.
  ($ in millions)
Cash (103%  $100 million) 103
 Convertible bonds payable (value of the debt only) 98*
 Equity–conversion option (difference) 5
  *The discount is combined with the face amount of the bonds. This is the “net method” – the preferred method under IFRS.
 Compound instruments such as this one are separated into their liability and equity components in accordance with IAS No. 32.
 If the bonds have a separate fair value of $98 M, we record that amount as the liability and the remaining $5 M as equity.
Under IFRS, unlike U.S. GAAP, convertible debt is divided into its liability and equity elements. For example, a journal entry to recognize the conversion of bonds would be to debit cash for $103 million, credit convertible bonds payable for the value of the debt, $98 million, and credit equity from conversion option for the difference of $5 million. The discount on the convertible bonds of $2 million is combined with the face amount of the debt of $100 million, to arrive at the net amount of the credit to convertible bonds payable of $98 million.
Compound instruments such as this one are separated into their liability and equity components in accordance with IAS No. 32.

30. 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.
A portion of the selling price of the bonds is allocated to the detachable stock warrants.
Another (less common) way to sweeten a bond issue is to include detachable stock purchase warrants as part of the security issue. A stock warrant gives the investor an option to purchase a stated number of shares of common stock at a specified option price, often within a given period of time. Like a conversion feature, warrants usually mean a lower interest rate and often enable a company to issue debt when borrowing would not be feasible otherwise.
However, unlike the conversion feature for convertible bonds, warrants can be separated from the bonds. This means they can be exercised independently or traded in the market separately from bonds, having their own market price. In essence, two different securities—the bonds and the warrants—are sold as a package for a single issue price. Accordingly, the issue price is allocated between the two different securities on the basis of their market values. If the independent market value of only one of the two securities is reliably determinable, that value establishes the allocation.

31. Bonds With Detachable Warrants
On January 1, 2016, HTL issued $100,000,000 of 8% bonds due in 2020 at 103 (103% of face value). Accompanying each $1,000 bond were 20 warrants. Each warrant permitted the holder to buy one share of $1 par common stock at $25 per share. Shortly after issuance, the warrants were listed on the stock exchange at $3 per warrant.
HTL (Issuer)
Cash ,000,000
Discount on bonds payable 3,000,000
Bonds payable ,000,000
Paid-in capital – stock warrants ,000,000
On January 1, 2011, HTL issued $100,000,000 0f 8% bonds due in 2018 at 130 (103% of face value). Accompanying each $1,000 bond were 20 warrants. Each warrant permitted the holder to buy one share of $1 par common stock at $25 per share. Shortly after issuance, the warrants were listed on the stock exchange at $3 per warrant.
At the date of issuance of the bonds, HTL will debit cash for $103,000,000 ($100,000,000 times 103 percent), debit discount on bonds payable for $3,000,000, credit bonds payable for $100,000,000 (face amount), and credit paid-in capital from stock warrants outstanding for $6,000,000. The paid-in capital will be reported as part of shareholders’ equity.
100,000 bonds × 20 warrants × $3

32. Bonds With Detachable Warrants
Assume one-half of the warrants (1,000,000) are exercised when the market value of HTL’s common stock is $30 per share. The exercise price is $25 per common share.
HTL (Issuer)
Cash ,000,000
Paid-in capital – stock warrants ,000,000
Common stock ,000,000
Paid-in capital – excess of par ,000,000
Assume one-half of the warrants (1,000,000) are exercised when the market value of HTL’s common stock is $30 per share. The exercise price is $25 per common share.
At the date of exercise, HTL will debit cash for $25,000,000, debit paid-in capital from stock warrants for $3,000,000, credit common stock for $1,000,000 (1,000,000 shares times $1 per share) and credit paid-in capital from stock warrants for $27,000,000.
1,000,000 warrants × $25
$6,000,000 ÷ 2

33. Option to Report Liabilities at Fair Value
Companies have the option to value some or all of their financial assets and liabilities at fair value.
The same market forces that influence the fair value of an investment in debt securities (interest rates, economic conditions, risk, etc.) influence the fair value of liabilities.
Companies are not required to, but have the option to, value some or all of their financial assets and liabilities at fair value. There are significant problems in determining fair value of some liabilities. How does a liability’s fair value change? Remember that there are two sides to every investment. For example, if a company has an investment in General Motors’ bonds, that investment is an asset to the investor, and the same bonds are a liability to General Motors. So, the same market forces that influence the fair value of an investment in debt securities (interest rates, economic conditions, risk, etc.) influence the fair value of liabilities. For bank loans or other debts that aren’t traded on a market exchange, the mix of factors will differ, but in any case, changes in the current market rate of interest will be a major contributor to changes in fair value.
When the fair value option is elected, we report changes in fair value in the income statement. Electing the fair value option means reporting unrealized holding gains and losses in earnings. A credit balance in the fair value adjustment increases the carrying value. A debit balance in the fair value adjustment reduces the carrying value.

34. U. S. GAAP vs. IFRS
International accounting standards are more restrictive than U.S. standards for determining when firms are allowed to elect the fair value option.
The fair value option may be elected by the firm.
Although U.S. GAAP guidance indicates that the intent of the fair value option under U.S. GAAP is to address these sorts of circumstances, it does not require that those circumstances exist.
Companies may only elect the fair value option
When a group of financial assets or liabilities is managed and its performance is evaluated on a fair value basis, or
If the fair value option reduces “accounting mismatch.”
Part I
International accounting standards are more restrictive than U.S. standards for determining when firms are allowed to elect the fair value option.
Part II
From the viewpoint of the IFRS,
Companies may only elect the fair value option
A group of financial assets or liabilities is managed and its performance is evaluated on a fair value basis, or
If the fair value option reduces “accounting mismatch.”
As far as the FASB is concerned,
The fair value option may be elected by the firm.
Although U.S. GAAP guidance indicates that the intent of the fair value option under U.S. GAAP is to address the sorts of circumstances required under IFRS, U.S. GAAP does not require that those circumstances exist.

35. Financial Statement Disclosure
Fair value
Sinking fund requirements (if any)
Aggregate amounts maturing for each of the next five years and the total amount thereafter
Statement of Cash Flow
Borrowing – financing activity
Lending – investing activity
Paying and receiving interest – operating activity