CHAPTER TWENTY-FOUR

1
CHAPTER TWENTY-FOUR

• CORPORATIONS BONDS

2
BONDS

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

3
SECURITY
Bonds are either secured or unsecured

• SECURED BONDS
• one that is backed by specific corporate assets
• Example Mortgage Bond

• 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

• TERM BONDS -bonds that all have the same
  maturity date
• SERIAL BONDS - bonds issued in a series so that
  a specified amount of the bond matures each year
• CONVERTIBLE BONDS - bonds that give the holder
  the option of exchanging the bonds for capital
  stock of the corporation
• 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

• REGISTERED BONDS
• bonds whose ownership is recorded in the
  corporate records
• name and address of each owner
• 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
Sell at a DISCOUNT
2. Current Market rate of interest on similar
investments
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.
the Selling Price.
When...
Stated Rate
Market Rate,

Face Value

Stated Rate
gt
gt
Face Value
Market Rate,
(Premium)
Stated Rate
Market Rate,
lt
Face Value
lt
(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.
Lets look at the issuance journal entry.
12
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
Apr.
1
Cash
400,000
1
2
Bonds Payable
400,000
3
Issued bonds at face value
4
5
Bonds Payable is reported as a long-term
liability on the balance sheet.
6
7
8
9
10
11
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 Value
x
Stated Interest rate
Since interest payments are paid every 6
months, 1/2 of the yearly interest is paid in
each payment.
400,000
10
x
40,000/year
14
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
Bond Interest Expense
Oct.
1
20,000
1
Cash
2
20,000
3
Paid semiannual interest
4
on bonds
5
Since the next interest payment will be after the
year end, we must stop at year end and record the
accrued interest.
6
7
8
9
10
11
15
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
10,000
Dec.
31
Bond Interest Expense
1
2
3
4
5
October 1 - December 31 3 months 400,000 x 10
40,000/year 40,000 x 1/4 year(3 months)
10,000
6
7
8
9
10
11
16
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
10,000
Dec.
31
Bond Interest Expense
1
2
Bond Interest Payable
10,000
3
4
5
6
7
8
9
10
11
17
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
10,000
Jan.
1
Bond Interest Payable
1
Bond Interest Expense
2
10,000
3
4
The adjustment is reversed on January 1.
5
6
7
8
9
10
11
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.
x
400,000
106
424,000
Bonds will sell for
19
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
Apr.
1
Cash
424,000
1
2
Bonds Payable
400,000
3
4
Bonds Payable is recorded at the FACE VALUE of
the bonds.
5
6
7
8
9
10
11
20
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
Apr.
1
Cash
424,000
1
2
Bonds Payable
400,000
3
Premium on Bonds Pay.
24,000
4
5
Premium on Bonds Payable is an adjunct-liability
account.
6
7
8
9
10
11
21
Balance Sheet (Partial)
Long-term liabilities
Bonds Payable
400,000
Premium on Bonds Payable
24,000
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
24,000
Premium received reduces the amount of
interest expense
Premium is amortized over the life of the bond.
25
AMORTIZING BOND PREMIUM

• Two methods of amortizing premiums or discounts
• EFFECTIVE INTEREST
• recommended method
• covered in the appendix
• STRAIGHT-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
x
1/2 Year
Life of Bonds
24,000
1,200
x
1/2 Year

10 Years
27
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
Bond Interest Expense
Oct.
1
18,800
1
2
Interest Payment - Amortization of
Premium 20,000 - 1,200
3
4
5
6
7
8
9
10
11
28
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
Bond Interest Expense
Oct.
1
18,800
1
Premium on Bonds Pay.
2
1,200
3
Cash
20,000
4
Paid semiannual interest
5
and amortized premium
6
7
8
9
10
11
29
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
9,400
Dec.
31
Bond Interest Expense
1
2
Premium on Bonds Pay.
600
3
Bond Interest Payable
10,000
4
5
At year end, 3 months of accrued Interest
Expense and Premium Amortization are recognized.
6
7
8
9
10
11
30
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
9,400
Dec.
31
Bond Interest Expense
1
2
Premium on Bonds Pay.
600
3
Bond Interest Payable
10,000
4
5
This entry will be reversed January 1.
6
7
8
9
10
11
31
PREMIUM AMORTIZATION
Interest Expense Debit
Premium on Bonds Payable
Bonds Payable Balance
Premium on Bonds Payable Balance
Carrying Value of Bonds
Cash Credit
Date
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
Interest Expense Debit
Premium on Bonds Payable
Bonds Payable Balance
Premium on Bonds Payable Balance
Carrying Value of Bonds
Cash Credit
Date
4/1/-1
400,000
24,000
424,000
18,800
1,200
10/1/-1
1,200 of the Premium is amortized every six
months.
33
PREMIUM AMORTIZATION
Interest Expense Debit
Premium on Bonds Payable
Bonds Payable Balance
Premium on Bonds Payable Balance
Carrying Value of Bonds
Cash Credit
Date
4/1/-1
400,000
24,000
424,000
18,800
1,200
20,000
400,000
10/1/-1
22,800
422,800
The carrying value is reduced by 1,200 every six
months.
34
PREMIUM AMORTIZATION
Interest Expense Debit
Premium on Bonds Payable
Bonds Payable Balance
Premium on Bonds Payable Balance
Carrying Value of Bonds
Cash Credit
Date
By the maturity date of the bond, the premium is
gone and the carrying value has reached the face
value of the bond.
4/1/-1
400,000
24,000
424,000
18,800
1,200
20,000
400,000
10/1/-1
22,800
422,800
4/1/-2
18,800
1,200
20,000
400,000
21,600
421,600
10/1/-2
18,800
1,200
20,000
400,000
20,400
420,400
4/1/10
18,800
1,200
20,000
400,000
2,400
402,400
10/1/10
18,800
1,200
20,000
400,000
1,200
401,200
400,000
4/1/11
18,800
1,200
20,000
400,000
0
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.
x
400,000
96
384,000
Bonds will sell for
36
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
Apr.
1
Cash
384,000
1
2
Discount on Bonds Pay.
16,000
3
Bonds Payable
400,000
4
5
Discount on Bonds Payable is a contra-liability
account.
6
7
8
9
10
11
37
Balance Sheet (Partial)
Long-term liabilities
Bonds Payable
400,000
Discount on Bonds Payable
16,000
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.
x
x
400,000
10
1/2
20,000 every 6 months
Interest Payments
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
800
x

1/2
10 years
40
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
Bond Interest Expense
Oct.
1
20,800
1
Discount on Bonds Pay.
2
800
3
Cash
20,000
4
Paid semiannual interest
5
and amortized discount
6
Discount amortization increases the interest
expense.
7
8
9
10
11
41
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
10,400
Dec.
31
Bond Interest Expense
1
Bond Interest Payable
10,000
2
3
400
Discount on Bond Pay.
4
5
At year end, 3 months of accrued Interest
Expense and Discount Amortization are recognized.
6
7
8
9
10
11
42
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
10,400
Dec.
31
Bond Interest Expense
1
Bond Interest Payable
10,000
2
3
400
Discount on Bond Pay.
4
5
This entry will be reversed January 1.
6
7
8
9
10
11
43
DISCOUNT AMORTIZATION
Interest Expense Debit
Discount on Bonds Payable
Bonds Payable Balance
Discount on Bonds Payable Balance
Carrying Value of Bonds
Cash Credit
Date
4/1/-1
400,000
16,000
384,000
20,800
800
20,000
400,000
10/1/-1
15,200
384,800
Every 6 months, the discount is reduced by 800,
causing the Carrying Value to rise by 800.
44
DISCOUNT AMORTIZATION
Interest Expense Debit
Discount on Bonds Payable
Bonds Payable Balance
Discount on Bonds Payable Balance
Carrying Value of Bonds
Cash Credit
Date
4/1/-1
400,000
16,000
384,000
At the maturity date of the bond, the discount
is gone and the carrying value is now equal to
the face value.
20,800
800
20,000
400,000
10/1/-1
15,200
384,800
4/1/-2
20,800
800
20,000
400,000
14,400
385,600
10/1/-2
20,800
800
20,000
400,000
13,600
386,400
4/1/10
20,800
800
20,000
400,000
1,600
398,400
10/1/10
20,800
800
20,000
400,000
800
399,200
400,000
4/1/11
20,800
800
20,000
400,000
0
45
BOND REDEMPTION

• Corporations may redeem bonds
• At maturity date
• By paying the face value of the note
• Before 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.
41,200
40,000
x

103
Watkin will pay 41,200 to redeem 40,000 of
bonds. 1,200 LOSS
47
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
40,000
Bonds Payable
1
Loss on Bonds Redeemed
1,200
2
3
41,200
Cash
4
5
What if these bonds had originally been sold at
a 106 (Premium)?
6
7
8
9
10
11
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.
Carrying Value
Unamortized Premium
Face Value
40,000

We must determine how much of the premium
remains unamortized at the date of redemption (8
years later).
49
UNAMORTIZED PREMIUM
Bonds were originally sold at
42,400
40,000 x 106
50
UNAMORTIZED PREMIUM
Bonds were originally sold at
42,400
- 40,000
Face Value
2,400
Premium
Amortized over
10
years

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.
Carrying Value
Unamortized Premium
Face Value
40,000
480

Carrying Value of 40,480 but cash paid to
redeem the bonds is 41,200 (40,000 x
103). 720 LOSS
52
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
40,000
Bonds Payable
1
480
2
Premium on Bonds Pay.
3
Loss on Bonds Redeemed
720
4
Cash
41,200
5
6
7
8
9
10
11
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.
38,800
40,000
x

97
Watkin will pay 38,800 to redeem 40,000 of
bonds. 1,200 GAIN
54
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
40,000
Bonds Payable
1
Gain on Bonds Redeem.
1,200
2
3
38,800
Cash
4
5
What if these bonds had originally been sold at
96 (Discount)?
6
7
8
9
10
11
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.
Carrying Value
- Unamortized Discount
Face Value
40,000
-
We need to determine how much of the discount
remains unamortized at the time of redemption.
56
UNAMORTIZED DISCOUNT
Bonds were originally sold at
38,400
40,000 x 96
57
UNAMORTIZED DISCOUNT
Bonds were originally sold at
38,400
40,000
Face Value
1,600
Discount
Amortized over
10
years

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.
Carrying Value
- Unamortized Discount
Face Value
40,000
640
-
Carrying Value is 39,360 but cash paid to
redeem the bonds is 38,800 (40,000 x 97). 560
GAIN
59
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
40,000
Bonds Payable
1
640
2
Discount on Bonds Pay.
3
Gain on Bonds Redeem.
560
4
Cash
38,800
5
6
7
8
9
10
11
60
BOND SINKING FUNDS

• Required by the Bond Indenture
• written agreement for issuing bonds
• Issuer must accumulate and invest funds over a
  period of years
• To 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.
Lets look that the journal entry.
62
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
30,000
Bonds Sinking Fund
1
Cash
30,000
2
3
4
5
Watkins trustee reports earnings of 2,800 for
the year.
6
7
8
9
10
11
63
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
30,000
Bonds Sinking Fund
1
Cash
30,000
2
3
4
Bonds Sinking Fund
2,800
Sinking Fund Earnings
2,800
5
6
Watkin bonds are redeemed at maturity by the
trustee.
7
8
9
10
11
64
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
30,000
Bonds Sinking Fund
1
Cash
30,000
2
3
4
Bonds Sinking Fund
2,800
Sinking Fund Earnings
2,800
5
6
7
Bonds Payable
400,000
8
Bond Sinking Fund
400,000
9
960 is remaining in the sinking fund after the
bonds are redeemed.
10
11
65
GENERAL JOURNAL
DATE
DESCRIPTION
PR
DEBIT
CREDIT
30,000
Bonds Sinking Fund
1
Cash
30,000
2
3
4
Bonds Sinking Fund
2,800
Sinking Fund Earnings
2,800
5
6
7
Bonds Payable
400,000
8
Bond Sinking Fund
400,000
9
Cash
960
10
Bond Sinking Fund
960
11