1. Bonds Payable and Investments in Bonds15
Bonds Payable and Investments in Bonds

2. After studying this chapter, you should be able to:
Compute the potential impact of long-term borrowing on earnings per share.
Describe the characteristics, terminology, and pricing of bonds payable.
Journalize entries for bonds payable.

3. After studying this chapter, you should be able to:
Describe and illustrate the payment and redemption of bonds payable.
Journalize entries for the purchase, interest, discount and premium amortization, and sale of bond investments.
Prepare a corporation balance sheet.

4. 15-1
Objective 1
Compute the potential impact of long-term borrowing on the earnings per share of a corporation.

5. Two Methods of Long-Term Financing
Resources = Sources
Liabilities
Assets
Stockholders’
Equity

6. Two Methods of Long-Term Financing Equity Financing – Stockholders
Resources = Sources
Liabilities
Assets
Equity Financing – Stockholders
Stockholders’
Equity

7. Sources of Equity Financing
Issuance of Stocks
Retention of Earnings
Issuance of Stock Dividends

8. Two Methods of Long-Term Financing
Resources = Sources
Debt Financing – Bondholders
Liabilities
Bondholders
Assets
Equity Financing – Stockholders
Stockholders’
Equity

9. Financing Corporations
15-1
A bond is simply a form of an interest-bearing note. Like a note, a bond requires periodic interest payments, and the face amount must be repaid at the maturity date.

10. Two Methods of Financing
Bondholders
Stockholders
Why issue bonds rather than stock?
Bonds (debt) – Interest payments to bondholders are an expense that reduces taxable income.
Stock (equity) – Dividend payments are made from after tax net income and retained earnings.
Earnings per share on common stock can often be increased by issuing bonds rather than additional stock.

11. Issued 12% bonds $2 million
15-1
Plan Plan Plan 3
Issued 12% bonds $2 million
Issued 9% preferred stock, $50 par value $2 million $1 million
Issued common stock,
$10 par value $4 million $2 million $1 million
$4 million $4 million $4 million 6

12. 15-1
Effect of Alternative Financing Plans—$800,000 Earnings 7

13. 15-1
Effect of Alternative Financing Plans—$440,000 Earnings 8

14. Issue 10% Bonds (at face) $2,000,000
15-1
Example Exercise 15-1
Gonzales Co., is considering the following alternative plans for financing their company:
Plan I Plan II
Issue 10% Bonds (at face) $2,000,000
Issue $10 Common Stock $4,000,000 $2,000,000
Income tax is estimated at 40% of income.
Determine the earnings per share of common stock under the two alternative financing plans, assuming income before bond interest and income tax is $750,000. 9

15. For Practice: PE 15-1A, PE 15-1B
15-1
Follow My Example 15-1
$750,000
300,000
$450,000
/400,000
Plan I
$1.125
($750,000 x 40%)
$750,000
200,000
$550,000
220,000
$330,000
/200,000
Plan II
$1.65
(2,000,000 x 10%)
($550,000 x 40%)
Earnings before bond interest and income tax
Bond interest
Balance
Income tax
Net income
Dividend on preferred stock
Earnings available for common stock
Number of common shares
Earnings per share on common stock 10
For Practice: PE 15-1A, PE 15-1B

16. 15-2
Objective 2
Describe the characteristics, terminology, and pricing of bonds payable.

17. Characteristics of Bonds Payable
Long-term debt – repayable 10, 20, or 30 years after date of issuance.
Issued in face (principal) amounts of $1,000, or multiples of $1,000.
Contract interest rate is fixed for term (life) of the bond.
Face amount of bond repayable at maturity date.

18. Prices for bonds are quoted as a percentage of the face amount.
Bonds Payable
15-2
A corporation that issues bonds enters into a contract (called a bond indenture or trust indenture) with the bondholders.
Interest on bonds may be payable annually, semiannually, or quarterly. Most pay interest semiannually.
Prices for bonds are quoted as a percentage of the face amount.

19. Bond Variables and Constants
1. Constants – fixed by bond contract.
a. Principal (face) amount.
b. Contract rate of interest.
c. Term (life) of the bond.
2. Variables – determined in the bond market.
a. Market price of the bond.
b. Market (effective) interest rate.

20. Registered bonds may be transferred from one owner to another only by endorsement on the bond certificate, and the issuing corporation must maintain a record of the name and address of each bond holder.
Title to bearer bonds, which are also called coupon bonds, is transferred merely by delivery, and the issuing corporation does not know the identity of the bondholders.

21. 15-2
When all bonds of an issue mature at the same time, they are called term bonds.
If the maturity dates are spread over several dates, they are called serial bonds.
Bonds that may be exchanged for other securities are called convertible bonds.

22. 15-2
15-2
Bonds that a corporation reserves the right to redeem before their maturity are called callable bonds.
Bonds issued on the basis of the general credit of the corporation are debenture bonds.
Bonds that give the bondholder a claim on specific assets in case the issuing corporation fails to meet its obligation are called Secured Bonds.

23. 3. The market or effective rate of interest.
Pricing of Bonds Payable
15-2
When a corporation issues bonds, the price that buyers are willing to pay depends upon three factors:
1. The face amount of the bonds, which is the amount due at the maturity date.
2. The periodic interest to be paid on the bonds. This is called the contract rate or the coupon rate.
3. The market or effective rate of interest.

24. investors assessment of current economic conditions, and
15-2
The market or effective rate of interest is determined by transactions between buyers and sellers of similar bonds. The market rate of interest is affected by a variety of factors, including:
investors assessment of current economic conditions, and
future expectations.

25. $1,000 Selling price of bond = $1,000 MARKET RATE = CONTRACT RATE
15-2
MARKET RATE = CONTRACT RATE
Selling price of bond = $1,000
$1,000
10% payable
annually
If the contract rate equals the market rate of interest, the bonds will sell at their face amount. 17

26. – $1,000 Selling price of bond < $1,000
15-2
MARKET RATE > CONTRACT RATE
Selling price of bond < $1,000
$1,000
10% payable
annually
Discount –
If the market rate is higher than the contract rate, the bonds will sell at a discount. 18

27. + $1,000 Selling price of bond > $1,000 MARKET < CONTRACT RATE
15-2
MARKET < CONTRACT RATE
Selling price of bond > $1,000
$1,000
10% payable
annually
Premium +
If the market rate is lower than the contract rate, the bonds will sell at a premium. 19

28. Market and Contract Interest Rates
Differences in market and bond contract interest rates result in Discounts and Premiums.
When Bonds sell at
Market rate = Contract rate
Market rate > Contract rate
Market rate < Contract rate
Face value
Discount
Premium

29. How are Bond Prices Determined
The selling price of bonds are based on two amounts.
1. Present Value of Face Amount
The present value of the face amount (constant) of the bond at its maturity date, based on the current market interest rate (variable).
2. Present Value of Interest Payments
The present value of the periodic interest payments (constant) for the term of the bonds, based on the current market interest rate (variable).

30. Time Value of Money
15-2
The time value of money concept recognizes that an amount of cash to be received today is worth more than the same amount of cash to be received in the future.

31. Present Value of the Face Amount of Bonds
15-2
A $1,000, 10% bond is purchased. It pays interest annually and will mature in two years.
$1,000
10% payable
annually
Today
End of Year 1
End of Year 2
$1,000 x
$826.45 21

32. 15-2
Example Exercise 15-2
Using Exhibit 3 in your test, what is the present value of $4,000 to be received in 5 years, if the market rate of interest is 10% compounded annually?
Follow My Example 15-2
$4,000 x * = $2,483.68
*Present value of $1 for 5 periods at 10% 22
For Practice: PE 15-2A. PE 15-2B

33. $100 $173.55 Present Value of the Periodic Bond Interest Payments 15-2
Present Value of the Periodic Bond Interest Payments
15-2
Interest payment
$100
Interest payment
$100
Today
End of Year 1
End of Year 2
$90.91
$100 x
$82.64
$100 x
$173.55
Present value, at 10%, of $100 interest payments to be received each year for 2 years (rounded) 23

34. Present value of face value of $1,000 due in
Present Value of 2-Year, 10% Bond
15-2
Present value of face value of $1,000 due in
2 years at 10% compounded annually: $1,000 x (Exhibit 3: n = 2,
i = 10%)(Slide 21) $
Present value of 2 annual interest payments
of 10% compounded annually: $100 x (Exhibit 4: n = 2, i = 10%) (Slide 23)
Total present value of bond $1,000.00 24

35. 15-2
Example Exercise 15-3
Calculate the present value of a $20,000, 5%, 5-year bond that pays $1,000 ($20,000 x 5%) interest annually, if the market rate of interest is 5%. Use Exhibits 3 and 4 for computing present values. 25

36. For Practice: PE 15-3A, PE 15-3B
15-2
Follow My Example 15-3
Present value of face value of $20,000 due in 5 years at 5% compounded annually: $20,000 x (present value factor of $1 for 5 periods at 5%)
$15,671*
Present value of 5 annual interest payments of $1,000 at 5% interest compounded annually: $1,000 x (present value of annuity of $1 for 5 periods at 5%).
4,329*
$20,000
*Rounded to the nearest dollar 26
For Practice: PE 15-3A, PE 15-3B

37. Journalize entries for bonds payable.
15-3
Objective 3
Journalize entries for bonds payable.

38. Bonds Issued at Face Amount
15-3
On January 1, 2007, a corporation issues for cash $100,000 of 12%, five-year bonds; interest payable semiannually. The market rate of interest is 12%.

39. Total present value of bonds $100,000
15-3
Present value of face amount of $100,000 due in 5 years at 12% compounded annually: $100,000 x (Exhibit 3: n = 10, i = 6%)
$ 55,840
Present value of 10 interest payments of $6,000 at 12% compounded semiannually: $6,000 x (Exhibit 4: n = 10; i = 6%)
44,160*
Total present value of bonds $100,000
*Because the present value tables are rounded to five decimal places, minor rounding differences may appear in this illustration. 29

40. 15-3
On January 1, 2007, a corporation issues for cash $100,000 of 12%, five-year bonds; interest payable semiannual. The market rate of interest is 12%.
Jan. 1 Cash
2007
Bonds Payable
Issued $100,000 bonds payable at face amount. 30

41. 15-3
On June 30, an interest payment of $6,000 is made ($100,000 x .12 x 6/12).
June 30 Interest Expense
Cash
Paid six months’ interest on bonds. 31

42. 15-3
The bond matured on December 31, At this time, the corporation paid the face amount to the bondholder.
Dec. 31 Bonds Payable
2011
Cash
Paid bond principal at maturity date. 32

43. Bonds Issued at a Discount
15-3
Assume that the market rate of interest is 13% on the $100,000 bonds rather than 12%. What would be the present value of these bonds?

44. Total present value of bonds $96,406
15-3
Present value of face amount of $100,000 due in 5 years at 13% compounded semiannually: $100,000 x
$53,273
Present value of 10 interest payments of $6,000, at 13% compounded semiannually: $6,000 x (present value of annuity of $1 for 10 periods at 6%)
43,133
Total present value of bonds $96,406 34

45. 15-3
On January 1, 2007, the firm issued $100,000 bonds for $96,406 (a discount of $3,594).
Jan. 1 Cash
2007
Discount on Bonds Payable
Bonds Payable
Issued $100,000 bonds at discount. 35

46. Discount on Bonds Payable 154,438 Bonds Payable 1,000,000
15-3
Example Exercise 15-4
On the first day of the fiscal year, a company issues a $1,000,000, 6%, 5-year bond that pays semi-annual interest of $30,000 ($1,000,000 x 6% x ½), receiving cash of $845,562. Journalize the entry to record the issuance of the bonds.
Follow My Example 15-4
Cash 845,562
Discount on Bonds Payable 154,438
Bonds Payable 1,000,000 36
For Practice: PE 15-4A, PE 15-4B

47. There are two methods of amortizing a bond discount:
Amortizing a Bond Discount
15-3
There are two methods of amortizing a bond discount:
The straight-line method and
The effective interest rate method, often called the interest method.
Both methods amortize the same total amount of discount over the life of the bonds.

48. Amortizing a Bond Discount
15-3
On June 30, 2007, six-months’ interest is paid and the bond discount is amortized ($3,594 x 1/10) using the straight-line method.
June 30 Interest Expense
2007
Discount on Bonds Payable
Cash
Paid semiannual interest and amortized 1/10 of bond discount. 38

49. For Practice: PE 15-5A, PE 15-5B
15-3
Example Exercise 15-5
Using the bond from Example Exercise 15-4, journalize the first interest payment and the amortization of the related bond discount.
Click on this button to go to Example Exercise To return to this slide, type “39” and press “Enter.”
Follow My Example 15-5
Interest Expense 45,444
Discount on Bonds Payable 15,444
Cash 30,000
Paid interest and amortized the bond discount ($154,438 ÷ 10). 39
For Practice: PE 15-5A, PE 15-5B

50. Amortization of Discount by the Interest Method
Amortization of Discount by the Interest Method. In contrast to the straight-line method, which provides for a constant amount of interest expense, the interest method provides for a constant rate of interest on the carrying amount of the bonds at the beginning of each period. The interest rate used in the computation is the market rate as of the date the bonds were issued, and the carrying amount of the bonds is their face amount minus the unamortized discount.

51. The difference between the interest expense computed in this manner and the amount of the periodic interest payment is the amount of discount to be amortized for the period. Application of this method to the illustration yields the following data:

52. Amortization of Discount on Bonds Payable
Interest Payment A
Interest Paid (6% of Face Amount) B
Interest Expense (6½ % of Bond Carrying Amount) C
Discount Amortization (B-A) D
Unamortized Discount (D-C) E
Bond Carrying Amount ($100,000-D) 1 2 3 4 5 6 7 8 9 10
$6,000
6,000
$6,266(6½% of $96,403)
6,284(6½% of $96,669)
6,302(6½% of $96,953)
6,322(6½% of $97,255)
6,343(6½% of $97,577)
6,365 (6½% of $97,920)
6,389 (6½% of $98,285)
6,415 (6½% of $98,674)
6,441 (6½% of $99,089)
6,470 (6½% of $99,530)
$266
284
302
322
343
365
389
415
441
470
$3.597
3.391
3.047
2.745
2.423
2.080
1.715
1.326 99 --
$96,403
96.669
96.953
97.255
97.577
97.920
98.285
98.674
99.089
99.530

53. The unamortized discount (column D) decreases from the initial balance, $3,597, to a zero balance at the maturity date of the bonds.
The carrying amount (column E) increases from $96,403, the amount received for the bonds, to $100,000 at maturity.

54. The entry to record the first interest payment and the amortization of the related amount of discount is as follows:
June 30
Interest Expense…………………
Discount on Bonds Payable…..
Cash…………………………..
6,266
266
6,000
If the amortization is recorded only at the end of the year, the amount of the discount amortized on December 31 would be $550, which is the sum of the first two semiannual amortization amounts ($266 and $284) from the preceding table.

55. Bonds Issued at a Premium
15-3
If the market rate of interest is 11% and the contract rate is 12%, on the five year, $100,000 bonds, the bonds will sell for $103,769.

56. Total present value of bonds $103,769
15-3
Present value of face amount of $100,000 due in 5 years at 11% compounded semiannually: $100,000 x (Exhibit 3: n =10, i = 5½%)
$ 58,543
Total present value of bonds $103,769
Present value of 10 interest payments of $6,000, at 11% compounded semiannually: $6,000 x (Exhibit 4: n = 10, i = 5½%)
45,226 41

57. 15-3
Issued $100,000 of bonds for $103,769 (a premium of $3,769). The entry to record this information is as follows:
Jan. 1 Cash
2007
Bonds Payable
Premium on Bonds Payable
Issued $100,000 bonds at a premium. 42

58. Premium on Bonds Payable 154,438 Bonds Payable 2,000,000
15-3
Example Exercise 15-6
A company issues a $2,000,000, 12%, 5-year bond that pays semiannual interest of $120,000 ($2,000,000 x 12% x ½), receiving cash of $2,154,435. Journalize the bond issuance.
Follow My Example 15-6
Cash 2,154,435
Premium on Bonds Payable 154,438
Bonds Payable 2,000,000 43
For Practice: PE 15-6A, PE 15-6B

59. Amortizing a Bond Premium
15-3
On June 30, 2007, paid the semiannual interest and amortized the premium. The firm uses straight-line amortization.
June 30 Interest Expense
2007
Premium on Bonds Payable
$3,769 x 1/10
Cash
Paid semiannual interest and amortized 1/10 of bond prem. 44

60. Amortization of premium by the Interest Method
Amortization of Premium by the Interest Method. Application of the interest method of amortization yields the following data:

61. Interest Payment A
Interest Paid (6% of Face Amount) B
Interest Expense (5½ % of Bond Carrying Amount) C
Premium Amortization (A-B) D
Unamortized Premium(D-C) E
Bond Carrying Amount ($100,000+D) 1 2 3 4 5 6 7 8 9 10
$6,000
6,000
$5,707(5½%of $103,766)
$5,691(5½%of $103,473)
$5,674(5½%of $103,164)
$5,657(5½%of $102,838)
$5,638(5½%of $102,495)
$5,618(5½%of $102,133)
$5,597(5½%of $101,751)
$5,575(5½%of $101,348)
$5,551(5½%of $100,923)
$5,526(5½%of $100,474)
$293
309
326
343
362
382
403
425
449
474
$3,766
3,374
3,164
2,838
2,495
2,133
1,750
1,348
923
474 --
$103,768
103,473
103,164
102,838
102,495
102,133
101,751
101,348
100,923
100,474
100,000

62. The following important details should be observed:
The interest paid (column A) remains constant at 6% of $100,000, the face amount of the bonds.
The interest expense (column B) is computed at 5½ % of the bond carrying amount at the beginning of each period, yielding a gradually decreasing amount.
The excess of the periodic interest payment of $6,000 over the interest expense is the amount of premium to be amortized (column C)

63. The unamortized premium (column D) decreases from the initial balance, $3,766, to a zero balance at the maturity date of the bonds.
The carrying amount (column E) decreases from $103,766, the amount received for the bonds, to $100,000 at maturity.

64. Interest Expense………………… Premium on Bonds Payable….. Cash……………………..
The entry to record the first payment and the amortization of the related amount of premium is as follows:
June 30
Interest Expense…………………
Premium on Bonds Payable…..
Cash……………………..
5,707
293
6,000
If the amortization is recorded only at the end of the year, the amount of the premium amortized on December 31 would be $602, which is the sum of the first two semiannual amounts ($293 and $309) from the preceding table.

65. Premium on Bonds Payable 15,444 Bonds Payable 120,000
15-3
Example Exercise 15-7
Using the bond from Example Exercise 15-6 (Slide 43), journalize the first interest payment and the amortization of the related bond premium.
Follow My Example 15-7
Interest Expense 104,556
Premium on Bonds Payable 15, Bonds Payable 120,000
Paid interest and amortize the
bond premium ($154,435/10). 45
For Practice: PE 15-7A, PE 15-7B

66. Zero-Coupon Bonds
15-3
Zero-coupon bonds do not provide for interest payments. Only the face amount is paid at maturity. Assume that the market rate is 13% at date of issue.
Present value of $100,000 due in 5 years at 13% compounded semiannually: $100,000 x (PV of $1 for 10 periods at 6½%) = $53,273 46

67. 15-3
On January 1, 2007, issue 5-year, $100,000 zero-coupon bonds when the market rate of interest is 13%.
Jan. 1 Cash
2007
Discount on Bonds Payable
Bonds Payable
Issued $100,000 zero- coupon bonds. 47

68. Describe and illustrate the payment and redemption of bonds payable.
15-4
Objective 4
Describe and illustrate the payment and redemption of bonds payable.

69. 15-4
Since the payment of bonds normally involves a large amount of cash, a bond indenture may require that cash be periodically transferred into a special cash fund, called a sinking fund, over the life of the bond issue.

70. Accounting for Bond Sinking Fund
When cash is transferred to the sinking fund, an account called Sinking Fund Cash is debited and Cash is credited. The purchase of investments is recorded by a debit to Sinking Fund Investments and a credit to Sinking Fund Cash. As income (interest or dividends) is received, the cash is debited to Sinking Fund Cash and Sinking Fund Income is credited.

71. To illustrate the concept of the future value of an annuity for the periodic deposits in a bond sinking fund, assume that a corporation issues $100,000 of 10 year bonds, dated January 1. A bond sinking fund for the payment of the bonds at maturity is established, with deposits to be made at the end of each year. If the deposits are expected to earn 14% per year, the annual deposit would be $5,171, determined as follows:

72. Annual Deposit = $5.171 (rounded)

73. A few of the typical transactions and the related entries affecting the sinking fund during the 10-year period are illustrated in the following paragraphs:

74. Deposit of Cash in the hand
Sinking Fund Cash…………
Cash……………………
5,171
The first deposit in the sinking fund is recorded. A similar entry would be recorded as deposits are made at the end of each of the 9 remaining years.

75. Purchase of Investments
Sinking Fund Investments…………
Sinking Fund Cash………………
5,000
The purchases of securities after the first deposit was made are recorded in a summary entry. The time of purchase and the amount invested at any one time vary, depending upon market conditions and the unit price of securities purchased.

76. Receipt of Income from Investments
Sinking Fund Cash…………………
Sinking Fund Income……………
700
The receipt of income for the year on the securities purchased is recorded in a summary entry. Interest and dividends are received at different times during the year, and the amount earned per year normally increases as the fund increases.

77. Sale of Investments Sinking Fund Cash………………….
Sinking Fund Investments………..
Gain on Sale of Investments…….
85,100
82,480
2,620
The sale of all securities at the end of the tenth year is recorded. Investments may be sold from time to time and the proceeds reinvested. Prior to maturity, all investments are converted into cash.

78. Proceeds from sale of Investments……
$ 85,100
Income earned during tenth year………
11,520
Last annual deposit…………………….
5,171
Total………………………………..
$101,791

79. Payment of bonds Bonds Payable…………………… Cash………………………………
Sinking Fund Cash……………..
100,000
1,791
101,791
The payment of the bonds and the transfer of the remaining sinking fund cash to the cash account is recorded. The cash available in the fund at the end of the tenth year is assumed to be composed of the following:

80. In the illustration, the amount of the fund exceeded the amount of the liability by $1,791. This excess was transferred to the regular cash account. If the fund had been less than the amount of the liability, $99,500 for example, the regular cash account would have been drawn upon for the $500 deficiency.
Sinking fund income represents earnings of the corporation and is reported in the income statement as “Other income.” The cash and the securities making up the sinking fund are classified in the balance sheet as “Investments,” which usually appears immediately below the Current Asset section.

81. Bond Redemption
15-4
A corporation may call or redeem bonds before they mature. Callable bonds can be redeemed by the issuing corporation within the period of time and the price stated in the bond indenture. Normally, the call price is above the face value.

82. 15-4
On June 30, a corporation has a bond issue of $100,000 outstanding on which there is an unamortized premium of $4,000. The corporation purchases one-fourth of the bonds for $24,000.
June 30 Bonds Payable
2007
Premium on Bonds Payable
Cash
Gain on Redemption of Bonds
Retired bonds for $24,000. 51

83. 15-4
Instead, assume that on June 30 the corporation calls all of the bonds, paying $105,000.
June 30 Bonds Payable
2007
Premium on Bonds Payable
Loss on Redemption of Bonds
Cash
Redeemed $100,000 bonds for $105,000. 52

84. Loss on Redemption of Bonds 15,000 Discount on Bonds Payable 40,000
15-4
Example Exercise 15-8
A $500,000 bond issue on which there is an unamortized discount of $40,000 is redeemed for $475,000. Journalize the redemption of the bonds.
Follow My Example 15-8
Bonds Payable 500,000
Loss on Redemption of Bonds 15,000
Discount on Bonds Payable 40,000
Cash 475,000 53
For Practice: PE 15-8A, PE 15-8B

85. 15-5
Objective 5
Journalize entries for the purchase, interest, discount, and premium amortization, and sale of bond investments.

86. Accounting for Bond Investments
15-5
Bonds may be purchased either directly from the issuing corporation or through an organized bond exchange. Prices for bonds are quoted as a percentage of the face amount.

87. 15-5
On April 2, 2007, an investor purchases a $1,000 Lewis Company bond at 102 plus a brokerage fee of $5.30 and accrued interest of $10.20.
Apr. 2 Investment in Lewis Co. Bonds
2007
Interest Revenue
Cash
Invested in a Lewis Company bond. 56

88. 15-5
On April 2, 2007, an investor purchases a $1,000 Lewis Company bond at 102 plus a brokerage fee of $5.30 and accrued interest of $10.20.
Cash
Apr. 2 Investment in Lewis Co. Bonds
2007
Interest Revenue
Invested in a Lewis Company bond.
Note that the brokerage fee is added to the cost of the investment. 57

89. Extended Illustration for Crenshaw, Inc.
15-5
On July 1, 2007, Crenshaw Inc. purchases $50,000 of 8% bonds of Deitz Corporation due in 8 3/4 years. The effective interest rate is 11%. The purchase price is $41,706 plus interest of $1,000 accrued from April 1, 2007 ($50,000 x 8% x 3/12).

90. The entry to record the investment is as follows:
15-5
The entry to record the investment is as follows:
July 1 Investment in Deitz Corp. Bonds
2007
Interest Revenue
Cash
Purchased investment in bonds, plus accrued interest. 59

91. 15-5
Crenshaw, Inc. received semiannual interest for April 1 to October 1 ($50,000 x 8% x 6/12).
Oct. 1 Cash
Interest Revenue
Received semiannual interest for April 1 to October 1. 60

92. 15-5
Adjusting entry for interest accrued from October 1 to December 31 ($50,000 x 8% x 3/12).
Dec. 31 Interest Receivable
Interest Revenue
Adjusting entry for interest accrued from October 1 to December 31. 61

93. 15-5
Adjusting entry for amortization of discount for July 1 to December 31: ($50,000 –$41,706)/105 = $79 (rounded) x 6 months.
31 Investment in Deitz Corp. Bonds
Interest Revenue
Adjusting entry for amortization of discount for July 1 to December 31. 62

94. 15-5
Interest Revenue
Oct. 1 2,000
Dec. 31 Adj. 1,000
31 Adj
2,474
July 1 1,000
Adj. Bal.
The effect of these entries on Interest Revenue is as follows: 63

95. Accounting for Bond Investments—Sale
15-5
The Deitz bonds are sold for $47,350 plus accrued interest on June 30, The carrying amount of the bond as of January 1, 2014 is $47,868 [$41,706 + ($79 per month x 78 months)].

96. 15-5
It has been six months since the last amortization entry, so amortization for this period is recorded (6 months).
June 30 Investment in Deitz Corp. Bonds
2014
Interest Revenue
Amortized discount for current year. 65

97. 15-5
The next slide shows the Investment in Dietz Corp. Bonds account after all amortization entries have been made, including the June 30, 2014 adjusting entry.

98. Investment in Deitz Corp. Bonds
15-5
Investment in Deitz Corp. Bonds
2007
July 1 41,706
Dec
Dec
Dec
June ,342
2008
2009
2010
2011
2012
2013
2014 67

99. 15-5
This investment is sold on June 30, 2014 for $47,350 plus accrued interest of $1,000 ($50,000 x 8% x 3/12) .
30 Cash
Loss on Sale of Investments
Interest Revenue
Investment in Deitz Co. Bonds
Received interest and proceeds from sale of bonds. 68

100. Journalize the purchase of the bonds plus accrued interest.
15-5
Example Exercise 15-9
On October 1, 2008 Viewtec Corporation purchases $10,000 of 6% bonds of Watson Corporation due in 9¼ years. The bonds were purchased at a price of $8,341 plus interest of $150 ($10,000 x 6% x 3/12) accrued from July 1, 2008, the date of the last semiannual interest payment.
Journalize the purchase of the bonds plus accrued interest.
Journalize the entry to record the amortization of the discount on December 31. 69

101. Investment in Watson Corp. Bonds 8,341 Interest Revenue 150 Cash 8,491
15-5
Follow My Example 15-9
Investment in Watson Corp. Bonds 8,341
Interest Revenue 150
Cash 8,491
Oct. 1
2008 a.
Investment in Watson Corp. Bonds 42*
Interest Revenue 42
Dec. 1
2008 b.
*[($10,000 – $8,341)/111 months] x 3 months
For Practice: PE 15-9A, PE 15-9B 70

102. Prepare a corporation balance sheet.
15-6
Objective 6
Prepare a corporation balance sheet.

103. Balance Sheet of a Corporation
15-6 72
(Continued)

104. Balance Sheet of a Corporation
15-6 73
(Concluded)

105. Held-to-Maturity Securities
15-6
Investments in bonds or other debt securities that management intends to hold to their maturity are called held-to-maturity securities.

106. Balance Sheet Presentation of Bond Investments
15-6
Such securities are classified as long-term investments under the caption Investments.
These investments are reported at their cost less any amortized premium or plus any amortized discount.
The market (fair) value of the bond investment should be disclosed, either on the face of the balance sheet or in an accompanying note.

107. Financial Analysis and Interpretation
15-6
Some corporations have a high ratio of debt to stockholders’ equity. For such corporations, analysts often assess the relative risk of the debtholders in terms of the number of times the interest charges are earned during the year.

108. Income before income tax + Interest expense
Number of Times the Interest Charges Earned
15-6
To illustrate, assume the following data:
Interest expense $ 36,883,000
Income before income tax 174,315,000
Income before income tax + Interest expense
Interest expense
$174,315,000 + $36,883,000
$36,883,000 77
(Continued)

109. The number of times interest charges are earned is 5.73.
15-6
The number of times interest charges are earned is 5.73.
This ratio indicates that the debtholders have adequate protection against a potential drop in earnings jeopardizing their receipt of interest payments. A full analysis should involve a comparison with industry averages.