Chapter FAR 5-3: Bonds and Payables Flashcards Preview

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Flashcards in Chapter FAR 5-3: Bonds and Payables Deck (35):
1

What is a

bond rate
stated rate
nominal rate
coupon rate???

Bond rate = coupon rate = stated rate = nominal rate

All these words (above) means the same thing.
All them mean the "interest rate" printed on the Bond itself.

It's the INTEREST paid to the INVESTORS.

2

Define Discount

Discount =

when bond (coupon; stated) rate is less than market rate.

3

Define Premium

Premium =

when bond (coupon; stated) rate is > Market (effective) interest rate

Example:
Bond's coupon or stated rate = 0.06
Market rate = 0.04

0.06 bond rate > 0.04 market rate = Discount

4

Define Market (effective) interest raet

Market (effective) interest rate = the actual rate that the BONDHOLDER receives.

It's the rate of return for comparable contracts on the date the bonds are issued.

5

What is the bond's carrying value?

What happens to bond's carrying value when it reaches maturity?

How is the bond carrying value calculated when dealing with Unamortized premium and Unamortized discounts?

Bond carrying value = it's the bond's current value before reaching maturity.

When bond reaches maturity >> Carry value will = Face value.

Bond carrying value calculation:
Face value
+ Unamortized premium
-----------------------
= Bond Carrying value

Also:

Face value
- Unamortized discount
--------------------------
= Bond carrying value

6

US GAAP:


What are bond issue costs?

What is the accounting treatment on bond issue costs?

What is the Journal entries on bond issue costs?

Bond issue costs = transaction costs in selling/issing the bond.

Bond issue costs includes: iegal fees, accounting fees, underwriting commissions, and printing.

Accounting treatment on Bond issue costs
= Debited as an Asset on Date of Issuance

Then over time from Date of issuance till (whenever)
>> Amortized it via Straight-line method
>> report the Amortized amount each period as
Debit Bond Interest Expense
or
Debit Bond Issue Expense

JOURNAL ENTRY
----------------------------
Dr. Cash
Dr. Discount
Dr. Bond Issue costs (asset)
Cr. Bonds payable


7

Bond issue costs are typically paid directly by the ____ and are repaid to the ___ by the ____ through the proceeds of the bond issue, which means that the issuing company receives bond proceeds ___ of the bond issue costs.

Bond issue costs are typically paid directly by the BROKER and are repaid to the BROKER by the COMPANY through the proceeds of the bond issue, which means that the issuing company receives bond proceeds NET of the bond issue costs.

Other words the company gets the following bond proceeds (for example):
$1,000,000 cash from sell bond
- $400,000 bond issue costs
-------------------
= $600,000 actual bond issue proceeds

8

IFRS
---------

How are bond issue costs reported?

What is the journal entry on bond issue costs at premium?
At discount?

IFRS on bond issue costs:

Bond issue costs = NOT recorded as separate asset

Bond issue costs are DEDUCTED from the liability's carrying value, added to the "Discount" and this Discount is amortized using the effective interest method.

Example at Discount:

$1,000,000 bond is sold at 98 = $980,000 and costs of $50,000 are Incurred for issue. The discount here is $20,000 (1,000,000 - 980,000). The bond issue costs increase the discount and it's amortized using the effective interest method.

Therefore:
$980,000 carry value
$20,000 discount

$980,000 - $50,000 issue costs = $930,000 new carry value
And
$50,000 + $20,000 discount = $70,000 Discount

Dr. Cash $930,000
Dr. Discount 70,000
Cr. Bond payable 1,000,000


Example at Discount:

$1,000,000 bond is sold at 106 = $1,060,000
And costs of $50,000 are Incurred for issue.

The Premium here is $60,000 (1,000,000 - 1,060,000). The bond issue costs DECREASE the premium and it's amortized using the effective interest method.

Therefore:
$1,060,000 carry value
$60,000 Premium

$1,060,000 - $50,000 issue costs = $1,010,000 new carry value
And
$60,000 - $50,000 issue costs = $10,000 Premium

Dr. Cash $1,010,000
Cr. Premium 10,000
Cr. Bond payable 1,000,000

9

US GAAP

what is the amortization period on a bond discount or bond premium?

Amortization period =

From: the date the bonds are sold (issued dated)
TO: maturity date

FYI - Example:
A 5-year bond dated January 1 doesn't actually sell until November 1. In this case.
Therefore: Amortization period = 50 months
(Not 60 months (5 years x 12 months)).

So: Amortization period is from Nov/01/ Y1 to 12/31/Y5

10

IFRS

what is the amortization period on a bond discount or bond premium?

IFRS:
Amortization is done over the expected life of the bond, not the contractual life of the bond.

Example:
A 5-year bond dated January 1 doesn't actually sell until November 1. In this case.
Therefore: Amortization period = 60 months (contract life of bond from Jan 1 Y1 to Dec 31 Y5

11

What are the two method to Amortize discount or premium?

Straight-line
or
Effective interest method

12

How do you use the straight-line method to amortize premium or discount?

This method of amortization results in a ____ dollar amount of interest each period.

How is the INTEREST EXPENSE calculated when using the straight-line method?

The straight-line method is ___ GAAP but is ____ under U.S. GAAP if the results are ___ materially ____ from the
effective Interest method.

[Premium / # of periods bond is outstanding] = Amortized amount per each period

or

[Discount / # of periods bond is outstanding] = Amortized amount per each period

This method of amortization results in a CONSTANT dollar amount of interest each period.
Meaning: each period it reports the same Amortized $$ amount.

Interest expense
----------------------------

(Face value X Stated interest rate)
- Premium amortization or plus discount amortization
-----------------------------
= Interest expense


The straight-line method is NOT GAAP but is ALLOWED under U.S. GAAP if the results are NOT materially DIFFERENT from the effective Interest method.

13

IFRS:

Is straight-line method allowed for Amortizing Premium or discount?

IFRS does not allow Straight-line amortization on Discount or premium.

14

What is the effective interest method?

How do you use the effective interest method to calculate the amortization on Premiums or Discount?

How about getting the new carry value on bond when using the Amortized Premium or Amortized discount amount?

US GAAP and IFRS-allowed method on amortizing Premium or Discount.

Calculation:
beginning carry value (on bond)
x Effective interest (market) rate
---------------
= Interest expense

Then:

To amortized premium:
--------------------------------

(Face value x Coupon rate)
- interest expense
------------------------------
= Amortized Premium amount

to amortizing Discount:
----------------------

Interest expense
- (Face value x coupon rate)
-------------
= Amortized Discount amount

New bond carry value
----------------------------------

When amortizing the Premium:

Old Bond carry value (it's large amount)
- Amortized Premium amount
----------------------------
= new bond carry value

When amortizing the discount:

Old bond carry value (it's small amount)
+ Amortized Discount amount
-----------
= New bond carry value




15

On what date to what date you:

a) report interest expense?
b) report Interest payable?

a) Issue date (starting date) to Balance sheet date = interest expense.
>> Not Issue date to bond payment date.

b) After Payment date to balance sheet date = interest payable

16

How to calculate interest expense

a) within any months in 1 year?
b) beyond 1 year?

a) Within 1 year:

$$ bond carrying value x % interest rate x n / 12 months

b) Beyond 1 year like 2 years, 3 years:
$$ bond value x % interest rate x [(12 + n) / ((12 x a) + n)]

Note:
* N = # of months in year 1 to Dec 31
* a = periods left so far on the bond

Example:
Issue bond on Oct 1 Year 1
Matures on Dec 31 Year 8

$$ bond value x % interest rate x [(12 + 3) / ((12 x 6) + 3)]
$$ bond value x % interest rate x [15 / 75 months]

* the 3 is from (oct 1, nov 1, to Dec 31).

17

How to amortize bond issue costs?

$$ bond issue costs x 1 / total periods in bond x (n / 12 months)

= Amortized bond issue cost amount

18

How to calculate the new bond issue cost amount at a later date?

$$ Beginning bond issue costs
- $$ Amortized bond issue cost
-----------------------
= $$ new bond issue cost amount

or

$$ Beginning bond issue costs
- [$$ bond issue costs x 1 / total periods in bond x (n / 12 months)]
-----------------------
= $$ new bond issue cost amount

19

What are the two methods in bond conversion?

Book value method

Market effective interest rate method

20

How to calculate the bond conversion via Book value method:

a) when have a premium?
b) when have a discount?

No gain or loss is recorded

PREMIUM
------------------
Convert bond when have premium (bond carry value > bond face value):

Dr. bond payable (at FACE value)
Dr. Bond Premium (Carry value - face value)
Cr. Common Stock (# shares x $ par value)
Cr. APIC << (Bond Carry value - C/S PAR)

Example:
Converting $1,000,000 bond face value to 20,000 share at $2 Par value.
Bond carry value @ Conversion date = 1,200,000
* Here: premium = 200,000 (1,000,000 - 1,200,000)
* Here C/S @ par = 40,000 (20,000 shs x $2 par)
* Here: APIC = 1,200,000 - 40,000 = $1,160,000

Therefore @ CONVERSION DATE:
Dr. Bond Payable 1,000,000 (face value)
Dr. Bond Premium 200,000
Cr. Common stock 40,000
Cr. APIC 1,160,000

DISCOUNT
----------------
Converting bond to stock when have discount (bond carry value < bond face value)

Example:
Converting $1,000,000 bond face value to 100,000 shares at $1 par
Unamortized discount = $100,000

Thus, $1,000,000 bond face - $100,000 unamortized discount = $900,000 carry value

Therefore:
Dr. Bond payable 1,000,000
Cr. Discount 100,000
Cr. Common Stock 900,000

21

What is the effect of Bond conversion to stock (convertible bonds) using the BOOK VALUE METHOD?

Book value method:

Convert bond to stock effect
= Reallocate Bond value to Common Stock at Par and APIC
= Therefore it increases the Stockholders' Equity
= & Decrease Bond payable & Decrease any Bond premiums.

Usually Converting bonds to stock has:
a) No effect on the APIC (when Bond's book value = Common Stock par value)
OR
b) INCREASES APIC and thus increase Stockholder's equity

22

What is a bond sinking fund?

How to calculate bond sinking fund >> i.e. how to calculate the non-current investment for bond sinking fund requirements?

Bond sinking fund
= A non-current (restricted) asset on the Issuer (bond-seller)'s financial statement.
= Holds dividend/interest income (revenue on investments) and additional investment money to pay off bonds upon maturity
= It's an appropriation of Retained Earnings to tell shareholders that portion of retained earnings are being accumulated to pay down the bond

Calculation:
Beginning balance
+ Additional investment
+ Dividend revenue
+ Interest revenue
- Admin Costs
-----------------------
= new balance (non-current) on bond sinking fund

23

How is bond sinking fund disclosed in the financial statements?

Disclosed in the footnotes on the amount of bond sinking fund.

This is because Current maturities amount on Long-term debt does NOT include annual sinking fund requirements.

24

How to calculate the Annual Stated Rate for debenture bonds (unsecured bonds)?

How about GAAP interest rate?

Annual stated rate for Debenture bonds
--------------------------------------------------------------

[Cash payment / bond face value] x # of payments made in a year

Example:
[12,000 cash / 200,000] x 2 payments in the year
= 6% x 2 payments
= 12% stated rate on the bond

GAAP interest rate
-------------------------------------
[GAAP interest expense / Beginning carry value] = Periodic interest rate X # of payments in the year

Example:
[$13,016 interest / 185,953 carry value]
= 7% x 2 payments (semi-annual)
= 14% GAAP interest rate


25

When debt is issued on discount, the interest expense over debt's term = _______________________.


When debt is issued on premium, the interest expense over debt's term = _______________________.

Debt on discount:
>> Interest expense = Interest cash paid + Amortized Discount

Debt on premium:
>> Interest expense = Interest cash paid - Amortized Premium

26

When you are amortizing the discount, you are ___ carry valuing back to face value.

When you are amortizing the premium, you are ___ carry valuing back to face value.

Amortize discount = Add or increase the Carry value back to Face value

Amortize Premium = Subtract or decrease the Carry value back to Face value

27

Convertible debt securities:

a) Interest rate on convertible securities is generally ____ than non-convertible debt because of the value of the ____ feature.

b) Conversion price is generally ____ than the market value of Common Stock at issuance date.

Convertible debt securities:

a) INTEREST RATE on convertible securities is generally LOWER than non-convertible debt because of the value of the CONVERSION feature.

b) Conversion price is generally GREATER than the Market value of Common Stock at issuance date.

28

How each of the interest types is treated:

Pension cost interEst
Amortization of discount note
Deferred compensation plan interest
Interest incurred to finance software development for internal use

Pension cost interest
= used to calculate Net periodic pension cost.
= It's NOT a separate interest expense item on Income Statement

Amortization on discount note = Amortized discount increases Interest expense for the period.

Deferred compensation plan interest
= reported inside the "Deferred Compensation plan expense"
= It's NOT a separate interest expense item on Income Statement

Interest incurred to finance software development for internal use
= It's CAPITALIZED as component of computer software development costs
= It's NOT a separate interest expense item on Income Statement


29

Company issued bond with Stated Interest Rate Effective interest (market) rate:

Bond is issued at a _______________.
____ is amortized
Interest expense is _____ than cash payment to bond holder.

Company issued bond with Stated Interest Rate Effective interest (market) rate:

Bond is issued at a PREMIUM.
PREMIUM is amortized
Interest expense is LESS THAN than cash payment to bond holder.

30

There are types of convertible bonds.

What are they?

Nondetachable warrants = Bond must convert into common stock.

Detachable warrants = bond with a separate stock warrant attach.

>> When exercise the detachable warrant, the bond is NOT surrendered. Only the warrants + cash = Warrants exercise price to exercise the warrants.

The warrants can be bought/sold separately from the bonds.

31

(IFRS)

Defines convertible debt as.

Convertible Debt (IFRS rules):

At issue date (when issue convertible bond):
--> Recognize separately:
The Liability (bond)
And
Equity component (conversion feature)

Liability = report at Fair value
Component of equity = Actual bond proceeds - Bond Fair value

32

US GAAP

Define convertible debt as:

US GAAP

Reports convertible debt the same way as non-convertible debt.

There is no SEPARATE reporting on the liability and the conversion feature when issuing convertible debt.

33

R corp. issued bonds with a face amount of $200,000. Each $1 ,000 bond contained detachable stock warrants for 100 shares of Ray's common stock. Total proceeds from the issue amounted to $240,000. The market value of each warrant was $2, and the market value of the bonds without the warrants was $196,000. The bonds were issued at a discount of:

Approach:
(1) Allocate amount received separately to bonds and detachable warrants according to their relative FV's at date of issuance.

Example:
Calculate the warrants FV:
= $2 mkt value x ($200,000 / $1,000 per bond) x 100 warrants
= $2 mkt value x (200 bonds) x 100 warrants
= $40,000 FV warrants

Fair Value bonds (market value) = $196,000

Total Fair Value (bond and warrants)
= $40,000 Fair Value warrants + $196,000 Fair Value bonds
= $236,000

Allocating % on Bonds Fair Value
= $196,000 bond / $236,000 total
= 0.83 or 83%

Allocating % on Warrants Fair Value
= 40,000 warrant / 236,000 total
= 16.9%

(2) Amount allocated to detachable warrants is paid-in capital.

$240,000 total issue proceeds x .169 (or 16.9 %)
= $40,678 APIC - warrants (credit account)

Note: Amount allocated based on % on bonds
$240,000 total issue proceeds x 0.83 = 199,322

(3) The difference between the amount allocated to the bonds and face value (par) should be debited or credited to "discount or premium on bonds payable."

$200,000 Face value on bond
- $199,322
----------------
= $678 discount

34

Journal entry to record Bonds issued on Premium

Journal entry to record bonds issued on discoutn

Journal entry - Bonds Premium via Example:

Dr. Cash $230,000
Cr. Premium on bonds Payable $30,000
Cr. Bonds payable $200,000


Journal entry - bonds discount via example:


Dr. Cash $170,000
Dr. Discount $30,000
Cr. Bonds Payable $200,000

35

Bond Premium Amortization and Interest Expense
----------------------------------------------------
Market Rate = 0.06
Bond stated rate = 0.10


(a) How to calculate Bond Interest expense for First year, 7 months ending July 31, Year 1?

(b) How to calculate Cash payment for First year, ending 7 months ending on July 31, year 1?

(c) Premium amortization amount (the amount to reduce the premium)

(d) Bond interest expense: First year, last 5 months on Dec 31, year 1


(e) Bond Premium amortized: First year, last 5 months on Dec. 31 year 1

---------------

(f) Calculate Bond interest expense for year 2, 7 months ended on July 31, Year 2

(a) Bond Interest expense for First year, 7 months:

Bond issued proceeds x market interest rate x 7 / 12 months

Example: $230,000 (at premium) x 0.06 market rate x 7/12 months
= 8,050 bond interest expense (or cost)

(b) Cash payment (first year, ending 7 months): Bonds Payable face amount x stated interest rate (bond interest rate):

Example: $200,000 x 0.10 stated rate x 7/12 = 11,667 cash payment

(c) Bond premium amortization amount

Example: $11,667 cash payment - $8,050 interest
= $3,616 Amortized premium

(d) Bond interest expense: First year, last 5 months on Dec 31, year 1

example: [($230,000 - $3,616 amortized premium) x 0.06 market rate x 5/12]
= 226,384 x 0.06 market x 5/12
= $5,659 bond interest (First year, last 5 months)

(e) Bond Premium amortized: First year, last 5 months on Dec. 31 year 1

Example: [($200,000 face amount x 0.10 stated rate) x 5/12 months] - 4,653
= [$20,000 face amount x 5/12 months] - 5,659 interest
= $8,333 cash payment - 5,659 interest
= 2,674 Premium Amortized

-----------Year 2----------

(f) year 2 bond interest expense (First 7 months)

Example:
($230,000 - 2,674 amort. prem - $5,659 interest) x 0.06 market rate x 7/12
= 7,758 interest (for Year 2 interest (first 7 months))

(g) year 2 bond premium amortization (first 7 months):

($200,000 x 0.10) x 7/12 - (7,758 interest)
= 11,667 cash payment - 7,758 interest
= 3,908 bond premium amortized amount
*(reduce the premium by this amount)

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