Module 10 Bonds and Long Term Notes Payable. SAP 2007 / SAP University Alliances Introductory...
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Transcript of Module 10 Bonds and Long Term Notes Payable. SAP 2007 / SAP University Alliances Introductory...
Module 10
Bonds and Long Term Notes Payable
SAP 2007 / SAP University Alliances Introductory Accounting
Learning Objectives
SAP 2007 / SAP University Alliances Introductory Accounting
Bond
SAP 2007 / SAP University Alliances Introductory Accounting
Annual amount
of interest paid
Par value Stated of the x rate of bond interest
=
Bonds
SAP 2007 / SAP University Alliances Introductory Accounting
Bonds
SAP 2007 / SAP University Alliances Introductory Accounting
Bond Types
SAP 2007 / SAP University Alliances Introductory Accounting
Bond Types
SAP 2007 / SAP University Alliances Introductory Accounting
Bond Types
SAP 2007 / SAP University Alliances Introductory Accounting
Bond Types
SAP 2007 / SAP University Alliances Introductory Accounting
. . .an investment firm called an underwriter. The underwriter sells the bonds to. . .
A company sells the bonds to. . .
. . . investors.
Bond Issuing Procedures
A trustee monitors the bond issue.
SAP 2007 / SAP University Alliances Introductory Accounting
Bond Pricing
Contract rate is: Bond sells:
Above market rate At a premium
(> 100% of face value)
Equal to market rate At par value
(= 100% of face value)
Below market rate At a discount
(< 100% of face value)
Bond Pricing
SAP 2007 / SAP University Alliances Introductory Accounting
SAP 2007 / SAP University Alliances Introductory Accounting
Illustration: Issuing Bonds at Par
Barnes Corp. issues $800,000 of 9%, 20-year bonds. The bonds are dated January 1, 2005, and are due in 20 years on January 1, 2025. Interest is paid semi-annually each June 30 and December 31. All the bonds are sold at their par value.
On January 1, 2005, the date of issuance, the entry would be:
Cash 800,000
Bonds Payable 800,000
SAP 2007 / SAP University Alliances Introductory Accounting
Illustration: Issuing Bonds at Par
On June 30, 2005, the first interest payment date, the entry would be:
Bond Interest Expense 36,000
Cash 36,000
($800,000 x 9% x 6/12) = $36,000
On January 1, 2025, the maturity date, the entry would be:
Bonds Payable 800,000
Cash 800,000
SAP 2007 / SAP University Alliances Introductory Accounting
Issuing Bonds Between Interest Dates
SAP 2007 / SAP University Alliances Introductory Accounting
Illustration: Issuing Bonds Between Interest Dates
Canadian Tire has $100,000 of 9% bonds available for sale on January 1. Interest is payable on each June 30 and December 31. If the bonds are sold at par on March 1, two months after the original issue date of January 1, the issuer collects two months’ interest from the buyer at the time of sale.
Stated Issue Date
Jan. 1 Mar. 1 June 30
Date of Sale First Interest Date
Accrued interest
($100,000 x 9% x 2/12) = $1,500Purchaser pays face value
plus accrued interest.
SAP 2007 / SAP University Alliances Introductory Accounting
Jan. 1 Mar. 1 June 30
Stated Issue Date
Date of Sale First Interest Date
Accrued interest
On March 1, the date of issuance, the entry would be:
Cash 101,500 Bonds Payable 100,000 Interest Payable 1,500
($100,000 x 9% x 2/12) = $1,500
Purchaser pays face value plus accrued interest.
SAP 2007 / SAP University Alliances Introductory Accounting
Jan. 1 Mar. 1 June 30
Stated Issue Date
Date of Sale First Interest Date
Accrued interest
On June 30, the first interest payment, the entry would be:
Interest Payable 1,500 Bond Interest Expense 3,000 Cash 4,500
($100,000 x 9% x 2/12) = $1,500 ($100,000 x 9% x 4/12) = $3,000
Interest expense
SAP 2007 / SAP University Alliances Introductory Accounting
The issue price of the bond equals the present value of the future cash payments.
0 Per. 1 Per. 2 Per. 3 Per. 4 Per. 5 … .. .Maturity
Int.Pmt. Int.Pmt Int.Pmt. Int.Pmt. Int.Pmt. Int.Pmt.
Par Value
Bond Price = Present Value of Maturity Payment
+ Present Value of the Interest Payments
Bond Pricing
SAP 2007 / SAP University Alliances Introductory Accounting
Illustration: Present Value of a Discount Bond
Fila Corp. announces an offer to issue bonds with a $100,000 par value, an 8% annual contract rate with interest payable semi-annually, and with a three-year life.
The cash flows of the bond are:
0 6mo. 12mo. 18mo. 24mo. 30mo. 36mo.
$4,000* $4,000 $4,000 $4,000 $4,000 $4,000
$100,000
*Semi-annual interest payment = $100,000 x 8% x 6/12
SAP 2007 / SAP University Alliances Introductory Accounting
Illustration: Present Value of a Discount Bond
The issue price of the bond equals the present value of the future cash payments. The market rate for Fila’s bonds is 10%. Since the market rate is higher than the contract rate of 8%, the bonds will sell at a discount.
0 6mo. 12mo. 18mo. 24mo. 30mo. 36mo.
$4,000 $4,000 $4,000 $4,000 $4,000 $4,000
$100,000
The present value of these cash payments is $94,923.
SAP 2007 / SAP University Alliances Introductory Accounting
Illustration: Present Value of a Discount Bond
Assume the bonds were issued on December 31. The entry to record the issuance would be:
Cash 94,923Discount on Bonds Payable 5,077 Bonds Payable 100,000
SAP 2007 / SAP University Alliances Introductory Accounting
Illustration: Amortizing a Bond Discount
The discount of $5,077 is eventually paid to the bondholders and represents part of the cost of using the $94,923 for three years.
The discount is amortized over the life of the bonds using either the Straight-Line Method or the Effective Interest Method.
SAP 2007 / SAP University Alliances Introductory Accounting
An equal portion of the discount is allocated to each period. This yields a constant dollar amount of interest expense each period.
Discount to be amortized
each period=
Bond Discount
Number of periods
Straight Line Method
SAP 2007 / SAP University Alliances Introductory Accounting
Illustration: Straight-Line Method
Bond Interest Expense 4,846Discount on Bonds Payable 846 Cash 4,000($100,000 x 8% x 6/12) = $4,000
Periodic Amortization =
Bond Discount
Number of periods
=$5,077
6 periods
= $846/period
The entry to record each interest payment would be:
Fila Corp.’s bond discount of $5,077 is amortized over the life of the bonds.
SAP 2007 / SAP University Alliances Introductory Accounting
This method allocates bond interest expense over the life of the bonds that yields a constant rate of interest. The interest expense increases each period since the balance in the liability account increases each period.
=Periodic interest expense
Carrying Value of Bonds
xPeriodic Market Rate
Effective Interest Method
SAP 2007 / SAP University Alliances Introductory Accounting
Illustration: Effective Interest Method
Bond Interest Expense 4,746Discount on Bonds Payable 746 Cash 4,000
The entry to record the first interest payment would be:
First period interest expense
= ($100,000 - $5,077) x 5%*
= $4,746*Semi-annual market rate
=
Carrying Value of Bonds
xPeriodic Market Rate
SAP 2007 / SAP University Alliances Introductory Accounting
Issuing Bonds at a Premiume
SAP 2007 / SAP University Alliances Introductory Accounting
Bond Retirements
SAP 2007 / SAP University Alliances Introductory Accounting
Retirement of Bonds at Maturity
SAP 2007 / SAP University Alliances Introductory Accounting
Illustration: Retiring Bonds at Maturity
Assume Hydro Quebec had $100,000 of bonds that matured on December 31, 2009, and that the final interest payment has already been made.
The entry to record the retirement of the bonds would be:
Bonds Payable 100,000 Cash 100,000
SAP 2007 / SAP University Alliances Introductory Accounting
Retirement of Bonds before Maturity
SAP 2007 / SAP University Alliances Introductory Accounting
Illustration: Retiring Bonds before Maturity
Assume a company issued callable bonds with a par value of $100,000. The call option requires the issuer to pay a call premium of $3,000 to bondholders in addition to the par value.
Assume all interest has been paid and the bonds have a carrying value of $104,500.
The entry to record the retirement of the bonds would be:
Bonds Payable 100,000Premium on Bonds Payable 4,500 Gain on Retirement of Bonds 1,500* Cash 103,000($100,000 + $4,500) - $103,000 = $1500
SAP 2007 / SAP University Alliances Introductory Accounting
Retirement of Bonds by Conversion to Shares
SAP 2007 / SAP University Alliances Introductory Accounting
Illustration: Bond Retirement by Conversion to Shares
Assume a company has $100,000 par value bonds that have a $4,000 balance in the Discount on Bonds Payable account and these bonds are converted into 15,000 common shares.
The entry to record the conversion of the bonds would be:
Bonds Payable 100,000Discount on Bonds Payable 4,000 Common Shares 96,000
SAP 2007 / SAP University Alliances Introductory Accounting
Interest expense for the period =
Interest rate on the note x
Beginning-of-period balance
Long Term Notes Payable
SAP 2007 / SAP University Alliances Introductory Accounting
Long Term Notes Payable
SAP 2007 / SAP University Alliances Introductory Accounting
Mortgage Notes