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


Bond


Annual amount

of interest paid

Par value Stated of the x rate of bond interest

=

Bonds


Bonds


Bond Types


. . .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.


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



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


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


Issuing Bonds Between Interest Dates


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.



Stated Issue 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.



Stated Issue 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


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


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



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.



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


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.


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


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.


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


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


Issuing Bonds at a Premiume


Bond Retirements


Retirement of Bonds at Maturity


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


Retirement of Bonds before Maturity


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


Retirement of Bonds by Conversion to Shares


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


Interest expense for the period =

Interest rate on the note x

Beginning-of-period balance

Long Term Notes Payable


Long Term Notes Payable


Mortgage Notes

Module 10 Bonds and Long Term Notes Payable. SAP 2007 / SAP University Alliances Introductory...

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