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.
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Objectives 1. Compute the potential impact of long. After studying this term borrowing on the earnings per you should share of achapter, corporation. be able to: 2. Describe the characteristics of bonds. 3. Compute the present value of bonds payable. 4. Journalize entries for bonds payable. 5. Describe bond sinking funds.
Objectives 6. Journalize entries for bond redemptions. 7. Journalize entries for the purchase, interest, discount, and premium amortization, and sale of bond investments. 8. Prepare a corporation balance sheet. 9. Compute and interpret the number of times interest charges are earned.
Characteristics of Bonds Payable ü A bond contract is called a bond indenture or trust indenture. ü Long-term debt—repayable 10, 20, or 30 years after date of issuance. ü Issued in face (principal) amounts of $1, 000, or multiples of $1, 000. ü Contract interest rate is fixed for term (life) of the bond. ü Face amount of bond repayable at maturity date.
Characteristics of Bonds Payable 4 When all bonds of an issue mature at the same time, they are called term bonds. If the maturity dates are spread over several dates, they are called serial bonds. 4 Bonds that may be exchanged for other securities are called convertible bonds. 4 Bonds that a corporation reserves the right to redeem before maturity are callable bonds. 4 Bonds issued on the basis of the general credit of the corporations are debenture bonds.
The Present-Value Concept and Bonds Payable When a corporation issues bonds, the price that buyers are willing to pay depends upon three factors: 1. The face amount of the bonds, which is the amount due at the maturity date. 2. The periodic interest to be paid on the bonds. This is called the contract rate or the coupon rate. 3. The market or effective rate of interest.
The Present-Value Concept and Bonds Payable MARKET RATE = CONTRACT RATE Sell price of bond = $1, 000 10% payable annually
The Present-Value Concept and Bonds Payable MARKET RATE > CONTRACT RATE Sell price of bond < $1, 000 10% payable annually – Discount
The Present-Value Concept and Bonds Payable MARKET < CONTRACT RATE Sell price of bond > $1, 000 10% payable annually + Premium
A $1, 000, 10% bond is purchased. It pays interest annually and will mature in two years. $100 Today Interest payment Interest 10% payable payment annually End of Year 1 End of Year 2 $90. 91 $100 x 0. 90909 $82. 65 $100 x 0. 82645 $826. 45 $1, 000 x 0. 82645 $1, 000. 00 (rounded) $100 $1, 000
The Present-Value Concept and Bonds Payable OR Present value of face value of $1, 000 due in 2 years at 10% compounded annually: $1, 000 x 0. 82645 $ 826. 45 Present value of 2 annual interest payments of 10% compounded annually: $100 x 1. 73554 (PV of annuity of $1 for 2 years at 10%) 173. 55 Total present value of bonds $1, 000. 00
Accounting for Bonds Payable Bonds Issued at Face Amount On January 1, 2005, a corporation issues for cash $100, 000 of 12%, five-year bonds; interest payable semiannually. The market rate of interest is 12%. Present value of face amount of $100, 000 due in 5 years at 12% compounded annually: $100, 000 x 0. 55840 Present value of 10 interest payments of $6, 000 compounded semiannually: $6, 000 x 7. 3609 (PV of annuity of $1 for 10 periods at 6%) Total present value of bonds $ 55, 840 44, 160 $100, 000
Accounting for Bonds Payable Bonds Issued at Face Amount On January 1, 2005, a corporation issues for cash $100, 000 of 12%, five-year bonds; interest payable semiannual. The market rate of interest is 12%. 2005 Jan. 1 Cash 100 00 Bonds Payable Issued $100, 000 bonds payable at face amount. 100 00
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
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