1. CHAPTER TWENTY-FOUR CORPORATIONS: BONDS

2. BONDS 4Def. - a written promise to pay a specific sum of money at a specific future date. éIt is a debt of the corporation If not paid, creditors can force the company into bankruptcy. éUsually issued in denominations of $1,000 each Enabling corporation to obtain large amounts of money by selling bonds to many investors éBonds can be classified as to: Security Timing of payment of principal Identification of ownership

3. SECURITY Bonds are either secured or unsecured é SECURED BONDS one that is backed by specific corporate assets Example: Mortgage Bond é UNSECURED BONDS backed solely by the general credit of the corporation, rather than by specific assets Also called “Debenture Bonds”

4. TIMING OF PAYMENT OF PRINCIPAL Principal is to be paid at maturity é TERM BONDS -bonds that all have the same maturity date é SERIAL BONDS - bonds issued in a series so that a specified amount of the bond matures each year é CONVERTIBLE BONDS - bonds that give the holder the option of exchanging the bonds for capital stock of the corporation é CALLABLE BONDS - bonds that give the issuing corporation the option of calling the bonds for redemption before the maturity date

5. IDENTIFICATION OF OWNERSHIP Principal is to be paid at maturity é REGISTERED BONDS bonds whose ownership is recorded in the corporate records - name and address of each owner é COUPON BONDS (bearer bonds) bonds whose ownership generally is not recorded by the corporation - the holder of the bond presents the interest coupons for payment as they come due

6. DETERMINING SALES PRICE EXAMPLE: Watkin Corp. wants to sell $400,000 of 10%, 10-year bonds. Two factors affecting price: 1. Stated or Coupon rate of interest on the bond 2. Current Market rate of interest on similar investments What if the market rate is 11%?

7. DETERMINING SALES PRICE EXAMPLE: Watkin Corp. wants to sell $400,000 of 10%, 10-year bonds. Two factors affecting price: 1. Stated or Coupon rate of interest on the bond 2. Current Market rate of interest on similar investments If our bonds offer only 10% and other bonds are offering 11%, investors will not want our bonds.

8. DETERMINING SALES PRICE EXAMPLE: Watkin Corp. wants to sell $400,000 of 10%, 10-year bonds. Two factors affecting price: 1. Stated or Coupon rate of interest on the bond 2. Current Market rate of interest on similar investments Sell at a DISCOUNT

9. DETERMINING SALES PRICE EXAMPLE: Watkin Corp. wants to sell $400,000 of 10%, 10-year bonds. Two factors affecting price: 1. Stated or Coupon rate of interest on the bond 2. Current Market rate of interest on similar investments If the market rate is only 9%…. bonds will sell at a PREMIUM.

10. DETERMINING SALES PRICE EXAMPLE: Watkin Corp. wants to sell $400,000 of 10%, 10-year bonds. Stated Rate = Market Rate,=Face Value the Selling Price….When... Stated Rate> Market Rate, >Face Value (Premium) Stated Rate < Market Rate,<Face Value (Discount)

11. ISSUING BONDS AT FACE VALUE EXAMPLE: On April 1, 20-1 the stated rate of 10% is the same as the current market rate. Watkin Corp. will sell the $400,000, 10-year bonds at face value. Let’s look at the issuance journal entry.

12. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Cash 1 2 3 4 5 6 7 8 9 10 11 Bonds Payable is reported as a long-term liability on the balance sheet. 400,000 Bonds Payable 400,000 Issued bonds at face value Apr.1

13. ISSUING BONDS AT FACE VALUE EXAMPLE: On April 1, 20-1 the stated rate of 10% is the same as the current market rate. Watkin Corp. will sell the $400,000, 10-year bonds at face value. Interest Payment: Face ValuexStated Interest rate $400,000 x 10% $40,000/year Since interest payments are paid every 6 months, 1/2 of the yearly interest is paid in each payment.

14. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bond Interest Expense 1 2 3 4 5 6 7 8 9 10 11 Since the next interest payment will be after the year end, we must stop at year end and record the accrued interest. 20,000 Cash 20,000 Paid semiannual interest on bonds Oct.1

15. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bond Interest Expense 1 2 3 4 5 6 7 8 9 10 11 10,000Dec.31 October 1 - December 31 = 3 months $400,000 x 10% = $40,000/year $40,000 x 1/4 year(3 months) = $10,000

16. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bond Interest Expense 1 2 3 4 5 6 7 8 9 10 11 10,000Dec.31 Bond Interest Payable10,000

17. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bond Interest Expense 1 2 3 4 5 6 7 8 9 10 11 10,000Jan.1Bond Interest Payable 10,000 The adjustment is reversed on January 1.

18. ISSUING BONDS AT A PREMIUM EXAMPLE: On April 1, 20-1 the stated rate of 10% is GREATER than the current market rate, so Watkin Corp. will sell the $400,000, 10-year bonds at 106. $400,000 x 106% Bonds will sell for $424,000

19. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Cash 1 2 3 4 5 6 7 8 9 10 11 424,000 Bonds Payable 400,000 Apr.1 Bonds Payable is recorded at the FACE VALUE of the bonds.

20. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Cash 1 2 3 4 5 6 7 8 9 10 11 424,000 Bonds Payable 400,000 Apr.1 Premium on Bonds Payable is an adjunct-liability account. 24,000 Premium on Bonds Pay.

21. Balance Sheet (Partial) Long-term liabilities: Bonds Payable$400,000 Premium on Bonds Payable24,000$424,000 Bonds Payable + Premium = Carrying Value

22. ISSUING BONDS AT A PREMIUM EXAMPLE: On April 1, 20-1 the stated rate of 10% is GREATER than the current market rate, so Watkin Corp. will sell the $400,000, 10-year bonds at 106. $400,000 x 10% x 1/2 = $20,000 Interest payment Selling at a premium does not affect the amount of the interest payments.

23. ISSUING BONDS AT A PREMIUM EXAMPLE: On April 1, 20-1 the stated rate of 10% is GREATER than the current market rate, so Watkin Corp. will sell the $400,000, 10-year bonds at 106. $400,000 x 10% x 1/2 = $20,000 Interest payment But this is not the Interest Expense recognized every 6 months.

24. ISSUING BONDS AT A PREMIUM EXAMPLE: On April 1, 20-1 the stated rate of 10% is GREATER than the current market rate, so Watkin Corp. will sell the $400,000, 10-year bonds at 106. $400,000 x 10% x 1/2 = $20,000 Interest payment $24,000Premium received reduces the amount of interest expense Premium is amortized over the life of the bond.

25. AMORTIZING BOND PREMIUM 4 Two methods of amortizing premiums or discounts: éEFFECTIVE INTEREST recommended method covered in the appendix éSTRAIGHT-LINE simple to apply generally provides acceptable results

26. AMORTIZING BOND PREMIUM EXAMPLE: On April 1, 20-1 the stated rate of 10% is GREATER than the current market rate, so Watkin Corp. will sell the $400,000, 10-year bonds at 106. FORMULA: Premium Life of Bonds x1/2 Year $24,000 10 Years x 1/2 Year = $1,200

27. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bond Interest Expense 1 2 3 4 5 6 7 8 9 10 11 18,800 Oct.1 Interest Payment - Amortization of Premium $20,000 - $1,200

28. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bond Interest Expense 1 2 3 4 5 6 7 8 9 10 11 18,800 Premium on Bonds Pay. 1,200 Paid semiannual interest Oct.1 Cash 20,000 and amortized premium

29. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bond Interest Expense 1 2 3 4 5 6 7 8 9 10 11 9,400Dec.31 Bond Interest Payable10,000 At year end, 3 months of accrued Interest Expense and Premium Amortization are recognized. Premium on Bonds Pay.600

30. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bond Interest Expense 1 2 3 4 5 6 7 8 9 10 11 9,400Dec.31 Bond Interest Payable10,000 This entry will be reversed January 1. Premium on Bonds Pay.600

31. PREMIUM AMORTIZATION Date Interest Expense Debit Premium on Bonds Payable Cash Credit Bonds Payable Balance Premium on Bonds Payable Balance Carrying Value of Bonds 4/1/-1$400,000$24,000$424,000 When the bonds are issued the Carrying Value is $424,000. $400,000 face value + $24,000 premium

32. PREMIUM AMORTIZATION Date Interest Expense Debit Premium on Bonds Payable Cash Credit Bonds Payable Balance Premium on Bonds Payable Balance Carrying Value of Bonds 4/1/-1 $18,800$1,200 $400,000$24,000$424,000 10/1/-1 $1,200 of the Premium is amortized every six months.

33. PREMIUM AMORTIZATION Date Interest Expense Debit Premium on Bonds Payable Cash Credit Bonds Payable Balance Premium on Bonds Payable Balance Carrying Value of Bonds 4/1/-1 $18,800$1,200$20,000 $400,000$24,000$424,000 400,00010/1/-122,800422,800 The carrying value is reduced by $1,200 every six months.

34. PREMIUM AMORTIZATION Date Interest Expense Debit Premium on Bonds Payable Cash Credit Bonds Payable Balance Premium on Bonds Payable Balance Carrying Value of Bonds 4/1/-1 $18,800$1,200$20,000 $400,000$24,000$424,000 400,00010/1/-122,800422,800 4/1/-218,8001,20020,000400,00021,600421,600 10/1/-218,8001,20020,000400,00020,400420,400 4/1/1018,8001,20020,000400,0002,400402,400 10/1/1018,8001,20020,000400,0001,200401,200 4/1/1118,8001,20020,000400,0000 By the maturity date of the bond, the premium is gone and the carrying value has reached the face value of the bond.

35. ISSUING BONDS AT A DISCOUNT EXAMPLE: On April 1, 20-1 the stated rate of 10% is LESS than the current market rate, so Watkin Corp. will sell the $400,000, 10-year bonds at 96. $400,000 x 96% Bonds will sell for $384,000

36. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Cash 1 2 3 4 5 6 7 8 9 10 11 384,000 Bonds Payable 400,000 Apr.1 Discount on Bonds Payable is a contra-liability account. Discount on Bonds Pay. 16,000

37. Balance Sheet (Partial) Long-term liabilities: Bonds Payable$400,000 Discount on Bonds Payable16,000$384,000 Bonds Payable - Discount = Carrying Value

38. ISSUING BONDS AT A DISCOUNT EXAMPLE: On April 1, 20-1 the stated rate of 10% is LESS than the current market rate, so Watkin Corp. will sell the $400,000, 10-year bonds at 96. $400,000 x 10% Interest Payments $20,000 every 6 months x 1/2 Selling bonds at a discount, does not affect the amount of interest paid.

39. ISSUING BONDS AT A DISCOUNT EXAMPLE: On April 1, 20-1 the stated rate of 10% is LESS than the current market rate, so Watkin Corp. will sell the $400,000, 10-year bonds at 96. $16,000 Discount will be amortized over the life of the bond. $16,000 10 years x 1/2 $800 =

40. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bond Interest Expense 1 2 3 4 5 6 7 8 9 10 11 20,800 Discount on Bonds Pay. 800 Paid semiannual interest Oct.1 Cash 20,000 and amortized discount Discount amortization increases the interest expense.

41. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bond Interest Expense 1 2 3 4 5 6 7 8 9 10 11 10,400Dec.31 Bond Interest Payable10,000 At year end, 3 months of accrued Interest Expense and Discount Amortization are recognized. 400 Discount on Bond Pay.

42. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bond Interest Expense 1 2 3 4 5 6 7 8 9 10 11 10,400Dec.31 Bond Interest Payable10,000 This entry will be reversed January 1. 400 Discount on Bond Pay.

43. DISCOUNT AMORTIZATION Date Interest Expense Debit Discount on Bonds Payable Cash Credit Bonds Payable Balance Discount on Bonds Payable Balance Carrying Value of Bonds 4/1/-1 $20,800$800$20,000 $400,000$16,000$384,000 400,00010/1/-115,200384,800 Every 6 months, the discount is reduced by $800, causing the Carrying Value to rise by $800.

44. DISCOUNT AMORTIZATION Date Interest Expense Debit Discount on Bonds Payable Cash Credit Bonds Payable Balance Discount on Bonds Payable Balance Carrying Value of Bonds 4/1/-1 $20,800$800$20,000 $400,000$16,000$384,000 400,00010/1/-115,200384,800 4/1/-220,80080020,000400,00014,400385,600 10/1/-220,80080020,000400,00013,600386,400 4/1/1020,80080020,000400,0001,600398,400 10/1/1020,80080020,000400,000800399,200 4/1/1120,80080020,000400,0000 At the maturity date of the bond, the discount is gone and the carrying value is now equal to the face value.

45. BOND REDEMPTION 4Corporations may redeem bonds: éAt maturity date By paying the face value of the note éBefore maturity By paying the call price if “callable” –Or market price if not callable Usually results in a gain or a loss –Difference between the amount paid to redeem the bonds and the carrying value of the bonds

46. BOND REDEMPTION EXAMPLE: Watkin Corp. redeems $40,000 of the $400,000 of bonds that were sold at face value. The $40,000 of bonds were redeemed at 103. $40,000x=103 $41,200 Watkin will pay $41,200 to redeem $40,000 of bonds…. $1,200 LOSS

47. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bonds Payable 1 2 3 4 5 6 7 8 9 10 11 40,000 Loss on Bonds Redeemed1,200 What if these bonds had originally been sold at a 106 (Premium)? 41,200 Cash

48. BOND REDEMPTION To determine if there is a gain or loss, we must compare the Carrying Value at the time of redemption with the amount paid to redeem the bonds. Face Value + Unamortized Premium Carrying Value = $40,000 + We must determine how much of the premium remains unamortized at the date of redemption (8 years later).

49. UNAMORTIZED PREMIUM $42,400 Bonds were originally sold at $40,000 x 106

50. UNAMORTIZED PREMIUM $42,400 Bonds were originally sold at Face Value 40,000 Premium $ 2,400 Amortized over10years $ 240 per year 8 ÷ x years $ 1,920 Amortized so far $2,400 premium - $1,920 amortized so far = $480 remaining unamortized

51. BOND REDEMPTION To determine if there is a gain or loss, we must compare the Carrying Value at the time of redemption with the amount paid to redeem the bonds. Face Value + Unamortized Premium Carrying Value = $40,000 + Carrying Value of $40,480; but cash paid to redeem the bonds is $41,200 ($40,000 x 103)…. $720 LOSS $480

52. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bonds Payable 1 2 3 4 5 6 7 8 9 10 11 40,000 Loss on Bonds Redeemed 480 41,200 Cash Premium on Bonds Pay. 720

53. BOND REDEMPTION EXAMPLE: Watkin Corp. redeems $40,000 of the $400,000 of bonds that were sold at face value. The $40,000 of bonds were redeemed at 97. $40,000x=97 $38,800 Watkin will pay $38,800 to redeem $40,000 of bonds…. $1,200 GAIN

54. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bonds Payable 1 2 3 4 5 6 7 8 9 10 11 40,000 Gain on Bonds Redeem.1,200 What if these bonds had originally been sold at 96 (Discount)? 38,800 Cash

55. BOND REDEMPTION To determine if there is a gain or loss, we must compare the Carrying Value at the time of redemption with the amount paid to redeem the bonds. Face Value - Unamortized Discount Carrying Value = $40,000 - We need to determine how much of the discount remains unamortized at the time of redemption.

56. UNAMORTIZED DISCOUNT $38,400 Bonds were originally sold at $40,000 x 96

57. UNAMORTIZED DISCOUNT $38,400 Bonds were originally sold at Face Value 40,000 Discount $ 1,600 Amortized over10years $ 160 per year 6 ÷ x years $ 960 Amortized so far $1,600 discount - $960 amortized so far = $640 remaining unamortized

58. BOND REDEMPTION To determine if there is a gain or loss, we must compare the Carrying Value at the time of redemption with the amount paid to redeem the bonds. Face Value - Unamortized Discount Carrying Value = $40,000 - Carrying Value is $39,360; but cash paid to redeem the bonds is $38,800 ($40,000 x 97)…. $560 GAIN $640

59. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bonds Payable 1 2 3 4 5 6 7 8 9 10 11 40,000 Gain on Bonds Redeem. 640 38,800 Cash Discount on Bonds Pay. 560

60. BOND SINKING FUNDS 4Required by the Bond Indenture éwritten agreement for issuing bonds 4Issuer must accumulate and invest funds over a period of years 4To provide the amount at maturity

61. BOND SINKING FUNDS EXAMPLE: Watkin Corp. is required to make deposits of $30,000 to a trustee each year. Let’s look that the journal entry.

62. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bonds Sinking Fund 1 2 3 4 5 6 7 8 9 10 11 30,000 Cash30,000 Watkin’s trustee reports earnings of $2,800 for the year.

63. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bonds Sinking Fund 1 2 3 4 5 6 7 8 9 10 11 30,000 Cash30,000 Bonds Sinking Fund 2,800 Sinking Fund Earnings2,800 Watkin bonds are redeemed at maturity by the trustee….

64. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bonds Sinking Fund 1 2 3 4 5 6 7 8 9 10 11 30,000 Cash30,000 Bonds Sinking Fund 2,800 Sinking Fund Earnings2,800 Bonds Payable 400,000 Bond Sinking Fund400,000 $960 is remaining in the sinking fund after the bonds are redeemed.

65. GENERAL JOURNAL DATEDESCRIPTIONPRDEBITCREDIT Bonds Sinking Fund 1 2 3 4 5 6 7 8 9 10 11 30,000 Cash30,000 Bonds Sinking Fund 2,800 Sinking Fund Earnings2,800 Bonds Payable 400,000 Bond Sinking Fund400,000 Bond Sinking Fund Cash960