22-1. Long-Term Bonds Section 1: Financing Through Bonds Chapter 22 Section Objectives 1.Name and...

Long-Term Bonds

Long-Term Bonds

Section 1: Financing

Through Bonds

Chapter

22

Section Objectives

1. Name and define the various types of bonds.

2. Explain the advantages and disadvantages of using bonds as a method of financing.

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Secured or unsecured

Registered or unregistered

Single-maturity or serial-maturity

Types of Bonds

Name and define the various types of bonds

Secured and Unsecured Secured: specific property pledged as

collateral.

Unsecured: backed only by a company’s general credit.

Unsecured bonds are known as debentures.

Objective 1

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Registered and Unregistered

Registered: issued to a particular purchaser listed in the corporation’s records.

Unregistered (coupon): transferred by delivery; coupons attached for each interest payment.

Single-Maturity and Serial-Maturity Single-maturity: Bonds mature on the same day.

Serial-maturity: Bonds are payable over a period of years.

Types of Bonds

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The market interest rate is the interest rate a corporation is willing to pay and investors are willing to accept at the current time.

The face interest rate refers to the contractual interest rate specified on the bond.

Interest Rates

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Capital Stock Bonds PayablePermanent Capital

No debt to repay.

Debt Must be repaid.

Advantages and Disadvantages of Using Bonds as a Method of Financing

Explain advantages and disadvantages of using bonds

Objective 2

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Capital Stock Bonds Payable

Stockholders’ EquityCommon stock has no legal

requirement for dividends. Preferred stock requirements depend on contract.

Dividends are not deductible for income tax purposes.

Long-term liabilities Interest must be paid on the bonds. Interest is a deductible expense.


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Capital Stock Bonds Payable

Preference dividends on preferred stock are usually slightly higher than interest rates on bonds because there is more risk associated with preferred stock.

Interest rates on bonds are usually slightly lower than

dividends on preferred stock.


Long-Term Bonds

Long-Term Bonds

Section 2: Bond Issue

and Interest

Chapter

22

Section Objectives3. Record the issuance of bonds.4. Record the payment of interest on bonds.5. Record the accrual of interest on bonds.6. Compute and record the periodic amortization of a

bond premium.7. Compute and record the periodic amortization of a

bond discount.


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On April 1, 2010, FLORAK Corporation sells $50,000 ($1,000 x 50) of its 8-year bonds at face value for cash.

Bonds Issued at Face Value

2010

Apr. 1 Cash 50,000.00 10% Bonds Payable, 2018 50,000.00

Issued bonds at face value.

Record the issuance of bondsObjective 3

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Payment of Interest

On October 1, 2010, the interest for six months at 10 percent becomes due on the $50,000 of bonds issued.

($50,000 X 10% X 6/12 = $2,500)2010

Oct. 1 Bond Interest Expense 2,500.00 Cash 2,500.00 Paid semiannual bond

interest.

Record the payment of interest on bonds

Objective 4

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Accrual of Interest on Bonds Issued at Face Value

On December 31, 2010, when the fiscal year ends for the FLORAK Corporation, bond interest of $1,250 has accrued for three months since the bond interest was last paid on October 1.

($50,000 X 10% X 3/12 = $1,250)

2010

Dec. 31 Bond Interest Expense 1,250.00 Bond Interest Payable 1,250.00

Accrued interest for 3 months.

Record the accrual of interest on bonds

Objective 5

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The issuing corporation must write off, or amortize, the premium over the period from date of issue of the bonds until date of maturity.

If the face rate on the bonds exceeds the market rate of interest at the time the bonds are issued, the bonds will be issued at a premium.

Amortizing the premium reduces the interest expense over the period the bonds are outstanding.

Bond Premium

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Bonds Issued at a Premium

2010

Apr. 1 Cash 50,800.00 10% Bonds Payable, 2018 50,000.00

Premium on Bonds Payable 800.00

Issued Bonds at 101.6

Because the face rate of interest was greater than the market rate, the bonds sold at a premium (more than the face value).

$800 extra was paid by the buyer!

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Premium is amortized over the life of the bond. When interest expense is recorded, premium amortization is also recorded.

Bond Interest for 6 months ($50,000 x 10% x 6/12) = $2,500

2010

Oct. 1 Bond Interest Expense 2,500.00 Cash 2,500.00 Payment of semiannual interest on $50,000 of bonds.

1 Premium on Bonds Payable 50.00 Bond Interest Expense 50.00 Amortization of bonds sold at a premium.

Premium amortization reduces bond interest expense.

Compute and record the periodic amortization of a bond premium

Objective 6

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2010

Oct. 1 Bond Interest Expense 2,500.00 Cash 2,500.00 Payment of semiannual interest on $50,000 of bonds.

1 Premium on Bonds Payable 50.00 Bond Interest Expense 50.00 Amortization of bonds sold at a premium.

Using the Straight-line Method to Amortize the Bond Premium

Straight-line Amortization

$800.00 / 8 years = $100.00 per year or $8.33 per month

$8.33 x 6 months = $50.00

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Bonds Issued at a Discount

2010

Apr. 1 Cash 48,880.00Discount on Bonds Payable 1,120.00 10% Bonds Payable, 2017 50,000.00 Issue bonds at 97.76

Compute and record the periodic amortization of a bond discount

Objective 7

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Recording Bond Interest Expense and Amortization of Bond Discount

2010

Oct. 1 Bond Interest Expense 5,030.00Premium on Bonds Payable 50.00 Discount on Bonds Payable 80.00 Cash 5,000.00

Interest payment and amortization of premium and discount for six months.

Straight-line method of amortizing was used to amortize both the premium and the discount.

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Carrying Value of Bonds

Formula

Bonds Payable

+ Premium on Bonds

– Discount on Bonds

Carrying Value

Carrying value is also known as book value.

Long-Term Bonds

Long-Term Bonds

Section 3: Bond Retirement

Chapter

22

Section Objectives

8. Record the transactions of a bond sinking fund investment.

9. Record an increase or decrease in retained earnings appropriated for bond retirement.

10. Record retirement of bonds payable.


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The bond is paid.

The liability is removed from company’s balance sheet.

When a bond matures, it is Retired.

New Partner Given Credit for Amount Invested

2018

April 1 Bonds Payable 150,000.00Cash 150,000.00

Bond retired at maturity.

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A bond sinking fund investment is a fund established to accumulate assets to pay off bonds when they mature.

ANSWER:

QUESTION:

What is a bond sinking fund investment?

Record the transactions of a bond sinking fund investment

Objective 8

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Journal entry to record first annual installment:

Bond Sinking Fund Investment


2014

April 1 Bond Sinking Fund Investment 30,000.00Cash 30,000.00

first annual installment of bond sinking fund

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Journal entry to record net income earned by sinking fund for the year:


2014

April 1 Bond Sinking Fund Investment 1,760.00Income from Sinking FundInvestment 1,760.00


Net income earned by Sinking Fund during the year.

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Journal entry to record second annual installment:


2015

April 1 Bond Sinking Fund Investment 28,240.00Cash 28,240.00

($30,000 first year installment less $1,760 first year income equals $28,240)

This procedure is repeated each year, until the entire amount needed to retire funds is reached.


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Journal entry to record retirement of bonds:


2018

April 1 10% Bonds Payable, 2017 150,000.00Bond Sinking Fund Investment 150,000.00


Bonds retired at maturityusing balance in sinkingfund.

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The bond contract might require that retained earnings are appropriated while the bonds are outstanding.

Retained Earnings Appropriated for Bond Retirement

Record an increase or decrease in retained earnings appropriated for bond retirement

Objective 9

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FLORAK’S Board of Directors decides to appropriate $30,000 of retained earnings during each of the last five years the bonds are outstanding.

Record annual appropriation in years 2014- 2018:


2014

April 1 Retained Earnings 30,000.00Retained Earnings Appropriatedfor Bond Retirement 30,000.00


Appears on the balance sheet under the heading “Appropriated Retained Earnings.”

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In year that bond matures, record close-out of appropriation account:


2018

April 1 Retained Earnings Appropriatedfor Bond Retirement 150,000.00

Retained Earnings 150,000.00


$30,000 x 5 years= $150,000

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Recall that on April 1, 2010, FLORAK Corporation issued $50,000 face value, 10%, 8 year bonds at a discount.

Interest is paid on January 1 and July 1 of each year.

Bonds were issued at 97.76.

Discount of $1,120 is amortized on a straight-line basis over the remaining 8 years until the bonds due date. They decide to retire the bonds one year after issuance (April, 1, 2011).

Retirement of Bonds

Record retirement of bonds payableObjective 10

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Corporation could have surplus cash, so bonds are retired early.

Interest rate decreases could result in an early retirement of bonds.

Early Retirement of Bonds

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QUESTION:

How much discount is amortized in eachsix-month interest period?

ANSWER:$ 80

$1,120 discount

÷ 84 months (remaining life of bond)

$ 13.333 per month X 6 months

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On April 1, 2011, FLORAK Corporation retired $50,000 face value of the bonds (originally issued at a discount).

Retirement of Bonds

Represents 50% of total bonds outstanding.

Retired at 101 plus accrued interest.

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Discount on Bonds Payable

Beg. Bal 1,12080 10/1/10

40 adj. entry

960

40 4/1/11

At time of retirement. . .

ANSWER:

What is the amount of unamortized discount that remains at time of retirement?

QUESTION:

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QUESTION:

What is the total book value to be removed?

$49,040

$50,000 face value

960 discount book valueFace value – discount

REMINDER: Gain or loss is the difference between book value of bonds retired and what is paid for them.

ANSWER:

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ANSWER:

$ 1,250

Interest = principal X rate X time

QUESTION:

What is the interest up to the date of retirement?

$50,000 face value

X 10% interest rate

5,000

X 3/12 period to retirement

Record bond interest expense up to the date of retirement. . .

2011Apr 1 Bond Interest Expense 1,250 Bond Interest Payable 1,250 Cash 2,500

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QUESTION:

What is the cash payment for repurchase price?

ANSWER:$50,500 cash payment

$50,000 face value

X 1.01 purchase price

$50,500 repurchase price

Repurchase price = face value X 1.01


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ANSWER:

$ 1,460 loss on early retirement of bonds

Book value - repurchase price

$49,040 book value

– 50,500 repurchase price

QUESTION:

What is the gain or loss on the transaction?


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Record Loss on Early Retirement

2011

Apr. 1 Bonds Payable 50,000.00 Loss on Early Retirement of Bonds 1,460.00 Cash 50,500.00

Discount on Bonds Payable 960.00

22-40

Thank Youfor using

College Accounting, 12th Edition

Price • Haddock • Farina

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