Bonds

1
Bonds

• Chapter 13 from Financial Accounting

2
Bonds

• A form of interest bearing note
• Requires periodic interest payments
• The face amount must be repaid at the maturity
  date
• Bondholders are creditors of the issuing
  corporation

3
Terminology

• Bond Indenture
• Contract with bondholders
• Principal
• Face value of each bond

4
Types of Bonds

• Term Bonds
• Serial Bonds
• Convertible bonds
• Callable bonds
• Debenture bonds

5
Present Value Bonds

• Price that buyers are willing to pay for the
  bonds dependent upon
• The face amount of the bonds
• Periodic interest to be paid
• Market rate of interest

6
Interest

• Coupon rate
• Rate of interest stated on the bonds
• Market or effective rate
• Interest determined by market conditions

7
Interest rates

• If the Market rate coupon rate
• BONDS sells at FACE
• If the market rate gt Coupon rate
• BONDS sells BELOW Face
• DISCOUNT
• If the market rate lt coupon rate
• BONDS sells ABOVE face
• PREMIUM

8
Accounting for Bonds

• Bonds issued at face value
• Cash DR
• Bonds payable CR
• Interest exp DR
• Cash CR

9
Bonds at Discount

• Steps
• Compute the PV of the face amount
• Computer the PV of the interest payments
• Add the amounts in the first two steps
• Face amount selling price discount

10
Bonds at Discount

• Entry
• Cash DR
• Discount DR
• Bonds payable CR
• Example Corp sells 100,000 of 5 years bonds
  with a coupon rate of interest of 12 and market
  rate of interest of 13. Interest is 6,000 is
  paid semiannually.

11
Example 3
Selling Price of Bonds PV of FACE ( 100,000, r
13/2, p 5 X 2) 100,000 X .53273
53,273 PV of
Interest pay (6,000, r 6.5, p 10) 6,000 X
7.1883
43,130 Selling price of bonds
96,403
12
Example 3
Face value 100,000 Selling price
96,403 Discount 3,597 ENTRY
Cash 96,403 Discount 3,597
Bonds payable 100,000
13
Example 4
PV( 200,000, r 11/2, p 10) 200,000 X
.58543 117,086 PV (
10,000, r 11/2, p10) 10,000 X 7.53763
75,376 Selling price
192,462 Face 200,000 Discount
7,538
14
Example 4
Entry Cash 192,462 Discount
7,538 Bonds payable 200,000
15
Amortization of Bond Discount

• Two methods
• Straight line method
• Discount amortized Discount/ of interest
  payments
• Effective interest method

16
Example 5

• Discount amortized 3594/10 359.4
• Interest expense 6,360
• Discount 360
• Cash 6,000

17

• Example 6
• Interest exp 3780
• discount 780
• cash 3000

• Discount amortized 7800/10 780

18
Bonds issued at Premium

• Same as discount
• Face amount selling price premium
• Entry
• Cash DR
• Bonds payable CR
• Premium CR

19
Example 3

• Corporation sells 100,000 of 5 year bond with a
  coupon rate of interest of 12 and market rate of
  interest of 11. Interest of 6,000 is paid
  semiannually.

20
Example 3
PV ( 100,000, r11/2, p 10) 100,000 X .58543
58,543 PV(6,000,
r11/2, p10) 6,000 X 7.53763
45,226 Selling price
103,769 Face
100,000 Premium 3,769
21
Example 3

• Cash 103,769
• Premium 3,769
• Bonds payable 100,000

22
Example 4

• PV( 200,000, p10, r 5)
• 200,000 .61391 122,782
• PV(11,000, p 10, r)
• 11,000 7.72174 89,939
• Selling price
  207,721
• Face 200,000
• Premium 7,721

23
Entry

• Cash 207,721
• Premium 7,721
• Bonds payable 200,000

24
Premium Amortization

• Straight line method
• Amortized Premium/ of interest payment
• Example 5
• Amortized 3594/10 360
• Interest exp 5640
• Premium 360
• Cash 6,000

25
Example 6

• Amortized 7800/10 780
• Interest exp 7020
• Premium 780
• Cash 7800

26
Homework

• EX 13-8
• EX 13-9
• Ex 13-11
• EX 13-12
• EX 13-13

27
Update

• Wed 12/3 Review
• Test Three
• Differential analysis
• Capital investment analysis
• Cash flows
• Bonds
• Multiple choice/ short problems

• Monday 12/8
• Homework due
• Test three
• Wednesday 12/10
• Review for final examination
• Monday 12/15
• Final Examination