Chapter 15 Bonds Payable and Investments in Bonds
Chapter 15 Bonds Payable and Investments in Bonds Accounting, 21 st Edition Warren Reeve Fess Power. Point Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University © Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electroni presentation is used with the permission of NVTech Inc.
Accounting for Bonds Payable Bonds Issued at Face Amount On June 30, an interest payment of $6, 000 is made ($100, 000 x. 12 x 6/12). June 30 Interest Expense Cash Paid six months’ interest on bonds. 6 000 00
Accounting for Bonds Payable Bonds Issued at Face Amount The bond matured on December 31, 2009. At this time, the corporation paid the face amount to the bondholder. 2009 Dec. 31 Bonds Payable Cash 100 000 00 Paid bond principal at maturity date.
Accounting for Bonds Payable Bonds Issued at a Discount Assume that the market rate of interest is 13% on the $100, 000 bond rather than 12%. Present value of face amount of $100, 000 due in 5 years at 13% compounded semiannually: $100, 000 x 0. 53273 (PV of $1 for 10 periods at 6½%) Present value of 10 semiannual interest payments of $6, 000 compounded semiannually: $6, 000 x 7. 18883 (PV of annuity of $1 for 10 periods at 6½%) Total present value of bonds $53, 273 43, 133 $96, 406
Accounting for Bonds Payable Bonds Issued at a Discount On January 1, 2005, the firm issued $100, 000 bonds for $96, 406 (a discount of $3, 594). 2005 Jan. 1 Cash 96 406 00 Discount on Bonds Payable Issued $100, 000 bonds at discount. 3 594 00 100 00
Accounting for Bonds Payable Bonds Issued at a Discount On June 30, 2005, six-months’ interest is paid and the bond discount is amortized using the straight-line method. 2005 June 30 Interest Expense Discount on Bonds Payable Cash 6 359 40 6 000 00 Paid semiannual interest and amortized 1/10 of discount. $3, 594 ÷ 10
Accounting for Bonds Payable Bonds Issued at a Premium If the market rate of interest is 11% and the contract rate is 12%, the bond would sell for $103, 769. Present value of face amount of $100, 000 due in 5 years at 11% compounded annually: $100, 000 x 0. 58543 (PV of $1 for 10 periods at 5½%) $ 58, 543 Present value of 10 semiannual interest payments of $6, 000 at 11%compounded semiannually: $6, 000 x 7. 53763 (PV of annuity of $1 for 10 periods at 5½%) 45, 226 Total present value of bonds $103, 769
Accounting for Bonds Payable Bonds Issued at a Premium Sold $100, 000 of bonds for $103, 769 (a premium of $3, 769). 2005 Jan. 1 Cash 103 769 00 Bonds Payable Premium on Bonds Payable Issued $100, 000 bonds at a premium. 100 00 3 769 00
Accounting for Bonds Payable Bonds Issued at a Premium On June 30, paid the semiannual interest and amortized the premium. 2005 June 30 Interest Expense Premium on Bonds Payable 5 623 10 376 90 Cash Paid semiannual interest and amortized 1/10 of bond premium. 6 000 00 $3, 769 x 1/10
Accounting for Bonds Payable Zero-Coupon Bonds Zero-coupon bonds do not provide for interest payments. Only the face amount is paid at maturity. Assume market rate is 13% at date of issue. Present value of $100, 000 due in 5 years at 13% compounded semi annually: $100, 000 x 0. 53273 (PV of $1 for 10 periods at 6½%) $53, 273
Accounting for Bonds Payable Zero-Coupon Bonds On January 1, 2005, Issue 5 -year, $100, 000 zero-coupon bonds when the market rate of interest is 13%. 2005 Jan. 1 Cash 53 273 00 Discount on Bonds Payable Issued $100, 000 zerocoupon bonds. 46 727 00 100 00
The bond indenture may require that a fund for the payments of the face value of the bonds at maturity be set aside over the life of the bonds. This special fund is called a bond sinking fund.
Bond Redemption On June 30, a corporation has a bond issue of $100, 000 outstanding on which there is an unamortized premium of $4, 000. The corporation purchases one-fourth of the bonds for $24, 000. 2005 June 30 Bonds Payable Premium on Bonds Payable Cash Gain on redemption of Bonds Retired bonds for $24, 000. 25 000 00 1 000 00 24 000 00 2 000 00
Bond Redemption Instead, assume that the firm reacquired all of the bonds, paying $105, 000. 2005 June 30 Bonds Payable 100 00 Premium on Bonds Payable 4 000 00 Loss on Redemption of Bonds 1 000 00 Cash Retired bonds for $105, 000. 105 000 00
Investments in Bonds are purchased directly from the issuing corporation or through an organized bond exchange. Bond prices are quoted as a percentage of the face amount. A premium or discount on a bond investment is recorded in a single investment account and is amortized over the remaining life of the bonds.
Investments in Bonds On April 2, 2005, Purchased a $1, 000 Lewis Company bond at 102 plus a brokerage fee of $5. 30 and accrued interest of $10. 2005 Apr. 2 Investment in Lewis Co. Bonds. Interest Revenue Cash 1 025 30 10 20 1 035 50 Invested in a Lewis Company bond. Note that the brokerage fee is added to the cost of the investment.
Investments in Bonds To assist your understanding, let’s look at an extended illustration for Crenshaw, Inc.
Investments in Bonds On July 1, 2005, Crenshaw Inc. purchases $50, 000 of 8% bonds of Deitz Corporation due in 8 3/4 years. The effective interest rate is 11%. The purchase price is $41, 706 plus interest of $1, 000 accrued from April 1, 2005 July 1 Investment in Deitz Corp. Bonds. Interest Revenue Cash Purchased investment in bonds, plus accrued interest. 41 706 00 1 000 00 42 706 00 $50, 000 x 8% x 3/12
Investments in Bonds Received semiannual interest for April 1 to October 1 ($50, 000 x 8% x 6/12). Oct. 1 Cash 2 000 00 Interest Revenue Received semiannual interest for April 1 to October 1. 2 000 00
Investments in Bonds Adjusting entry for interest accrued from October 1 to December 31 ($50, 000 x 8% x 3/12). Dec. 31 Interest Receivable Interest Revenue Adjusting entry for interest accrued from October 1 to December 31. 1 000 00
Investments in Bonds Adjusting entry for amortization of discount for July 1 to December 31: ($50, 000 –$41, 706)/105 x 6 months. Dec. 31 Investment in Deitz Corp. Bonds Interest Revenue Adjusting entry for amortization of discount from July 1 to December 31. 474 00 Rounded to nearest dollar ($79 a month)
Investments in Bonds Investment Revenue July 1 1, 000 Oct. 1 Dec. 31 31 Bal. 2, 474 2, 000 1, 000 474 3, 474
Investments in Bonds The Deitz bonds are sold on June 30, 2012 for $47, 350 plus accrued interest. It has been six months since the last amortization entry, so amortization for the current year must be recorded (6 months). 2012 June 30 Investment in Deitz Corp. Bonds 474 00 Interest Revenue Amortized discount for current year. 474 00 $79 x 6
Investments in Bonds Investment in Deitz Corporation Bonds 2005 July 1 Dec. 31 2006 Dec. 31 2007 Dec. 31 2008 Dec. 31 2009 Dec. 31 2010 Dec. 31 2011 Dec. 31 2012 June 30 48, 342 41, 706 474 948 948 948 474 The investment $79 x 6 account after all $79 x 12 amortization entries have been made, including the June 30, 2012 adjusting entry.
Investments in Bonds This investment was sold on June 30, 2009 for $47, 350 plus accrued interest. It has been six months since the last amortization entry, so amortization for the current year $50, 000 must be recorded (6 months). x 8% x 2012 June 30 Cash Loss on Sale of Investment Interest Revenue Investment in Deitz Corp. Bonds 48 350 00 3/12 992 00 1 000 00 48 342 00
Financial Analysis and Interpretation Number of Times Interest Charges Earned
Solvency Measures—The Long-Term Creditor Number of Times Interest Charges Earned Income before income tax Add interest expense Amount available for interest 2006 2005 $ 900, 000 $ 800, 000 300, 000 250, 000 $1, 200, 000 $1, 050, 000 Income before income tax + Interest expense Interest Expense 2005 $800, 000 + $250, 000 = 4. 2 times $250, 000
Solvency Measures—The Long-Term Creditor Number of Times Interest Charges Earned Income before income tax Add interest expense Amount available for interest 2006 2005 $ 900, 000 $ 800, 000 300, 000 250, 000 $1, 200, 000 $1, 050, 000 Income before income tax + Interest expense Interest Expense 2006 $900, 000 + $300, 000 = 4. 0 times $300, 000
The purpose of the ratio is to assess the risk to debtholders in terms of number of times interest charges were earned.
Chapter 15 The End
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