Corporate finance accounting 14e by warren reeve duchac chapter 11

Chapter

11

Liabilities: Bonds Payable

Corporate
Financial
Accounting
14e
Warren
Reeve
Duchac
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Nature of Bonds Payable

•

A bond is a form of interest-bearing note. Like a
note, a bond requires periodic interest
payments, with the face amount to be repaid at
the maturity date.

•

As creditors of the corporation, bondholder
claims on the corporation’s assets rank ahead of
stockholders.

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Bond Characteristics and Terminology
(slide 1 of 2)

•

A bond issue is normally divided into a number of
individual bonds.

•

The face amount of each bond, called the principal, is
usually $1,000 or a multiple of $1,000. The principal
must be repaid on the dates the bonds mature.

•

The interest on bonds may be payable annually,
semiannually, or quarterly.
o

•

Most bonds pay interest semiannually.

The underlying contract between the company issuing
bonds and the bondholders is called a bond indenture.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Bond Characteristics and Terminology
(slide 2 of 2)

•

•

The two most common types of bonds are term bonds
and serial bonds.
o

When all bonds of an issue mature at the same time, they are
called term bonds.

o

If the bonds mature over several dates, they are called serial
bonds.

There are also a variety of more complicated bond
structures.
o

Bonds that may be exchanged for shares of common stock are
called convertible bonds.

o

Bonds that may be redeemed by the corporation prior to maturity
are called callable bonds.
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Proceeds from Issuing Bonds
(slide 1 of 5)

•

When a corporation issues bonds, the proceeds
received for the bonds depend on:
o

The face amount of the bonds, which is the amount
due at the maturity date.

o

The interest rate on the bonds.

o

The market rate of interest for similar bonds.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Proceeds from Issuing Bonds

(slide 2 of 5)

•

The face amount and the interest rate on the bonds are
identified in the bond indenture.

•

The interest rate to be paid on the face amount of the
bond is called the contract rate or coupon rate.

•

The market rate of interest, sometimes called the
effective rate of interest, is the rate determined from
sales and purchases of similar bonds.
o

The market rate of interest is affected by a variety of factors,
including investors’ expectations of current and future economic
conditions.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Proceeds from Issuing Bonds
(slide 3 of 5)

•

By comparing the market and contract rates of
interest, it can be determined whether the bonds
will sell for more than, less than, or at their face
amount.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Proceeds from Issuing Bonds
(slide 4 of 5)

•

If the market rate equals the contract rate, bonds
will sell at the face amount.

•

If the market rate is greater than the contract
rate, the bonds will sell for less than their face
value.
o

•

The face amount of the bonds less the selling price is
called a discount.

If the market rate is less than the contract rate,

the bonds will sell for more than their face value.
o

The selling price of the bonds less the face amount is
called a premium.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Proceeds from Issuing Bonds
(slide 5 of 5)

•

The price of a bond is quoted as a percentage of
the bond’s face value.
o

For example, a $1,000 bond quoted at 98 could be
purchased or sold for $980 ($1,000 × 0.98).

o

Likewise, bonds quoted at 109 could be purchased or
sold for $1,090 ($1,000 × 1.09).

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Accounting for Bonds Payable

•

When bonds are issued at less or more than
their face amount, the discount or premium must
be amortized over the life of the bonds. At the
maturity date, the face amount must be repaid.

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Bonds Issued at Face Amount
(slide 1 of 3)

•

Assume that on January 1, Year 1, Eastern
Montana Communications Inc. issued the
following bonds:

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Bonds Issued at Face Amount
(slide 2 of 3)

•

Since the contract rate of interest and the market
rate of interest are the same, the bonds will sell
at their face amount. The entry to record the

issuance of the bonds is as follows:

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Bonds Issued at Face Amount
(slide 3 of 3)

•

Every six months (on June 30 and December 31) after the bonds
are issued, interest of $6,000 ($100,000 × 12% × ½ year) is paid.
The first interest payment on June 30, Year 1, is recorded as
follows:

•

At the maturity date, the payment of the principal of $100,000 is
recorded as follows:

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Bonds Issued at a Discount
(slide 1 of 2)

•

Assume that on January 1, Year 1, Western
Wyoming Distribution Inc. issued the following

bonds:

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Bonds Issued at a Discount
(slide 2 of 2)

•

Because the contract rate of interest is less than the
market rate of interest, the bonds will sell at less than
their face amount. Assuming the bonds sell for $96,406,
the entry to record the issuance of the bonds is as
follows:

Discount on Bonds Payable is a contra account to Bonds Payable and has a normal
debit balance. It is subtracted from Bonds Payable to determine the carrying amount (or
book value) of the bonds payable. The carrying amount of bonds payable is the face
amount of the bonds less any unamortized discount or plus any unamortized premium.
Thus, the carrying amount of the bonds payable is $96,406 ($100,000 – $3,594).
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Amortizing a Bond Discount
(slide 1 of 4)

•

Every period, a portion of the bond discount

must be reduced and added to interest expense
to reflect the passage of time. This process,
called amortization, increases the contract rate
of interest on a bond to the market rate of
interest that existed on the date the bonds were
issued.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Amortizing a Bond Discount
(slide 2 of 4)

•

The entry to amortize a bond discount is as follows:

•

The preceding entry may be made annually as an
adjusting entry, or it may be combined with the
semiannual interest payment.
o

In the latter case, the entry would be as follows:

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Amortizing a Bond Discount

(slide 3 of 4)

•

The two methods of computing the amortization
of a bond discount are:
o

Straight-line method

o

Effective interest rate method, sometimes called the
interest method

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Amortizing a Bond Discount
(slide 4 of 4)

•

The effective interest rate method is required
by generally accepted accounting principles.

•

However, the straight-line method may be used if
the results do not differ significantly from the

effective interest method.

•

The straight-line method of amortization
provides equal amounts of discount (or
premium) to be written off to interest expense
each period.

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Bonds Issued at a Premium
(slide 1 of 2)

•

Assume that on January 1, Year 1, Northern
Idaho Transportation Inc. issued the following
bonds:

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Bonds Issued at a Premium
(slide 2 of 2)

•

Because the contract rate of interest is more than the

market rate of interest, the bonds will sell for more than
their face amount. Assuming the bonds sell for $103,769,
the entry to record the issuance of the bonds is as
follows:

Premium on Bonds Payable has a normal credit balance. It is added to Bonds Payable
to determine the carrying amount (or book value) of the bonds payable. Thus, the
carrying amount of the bonds payable is $103,769 ($100,000 + $3,769).

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Amortizing a Bond Premium
(slide 1 of 2)

•

Like bond discounts, a bond premium must be
amortized over the life of the bond. The
amortization of a bond premium decreases the
contract rate of interest on a bond to the market
rate of interest that existed on the date the
bonds were issued.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Amortizing a Bond Premium
(slide 2 of 2)

•

The entry to amortize a bond premium is as follows:

•

The preceding entry may be made annually as an
adjusting entry, or it may be combined with the
semiannual interest payment.
o

In the latter case, the entry would be as follows:

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Bond Redemption
(slide 1 of 2)

•

•

A corporation may redeem or call bonds before
they mature.
o

This is often done when the market rate of interest
declines below the contract rate of interest.

o

In such cases, the corporation may issue new bonds
at a lower interest rate and use the proceeds to
redeem the original bond issue.

Callable bonds can be redeemed by the issuing
corporation within the period of time and at the
price stated in the bond indenture.
o

Normally, the call price is above the face value.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Bond Redemption
(slide 2 of 2)

•

A corporation usually redeems its bonds at a price
different from the carrying amount (or book value) of the
bonds.

•

A gain or loss may be realized on a bond redemption as
follows:

•

o

A gain is recorded if the price paid for redemption is below the
bond carrying amount.

o

A loss is recorded if the price paid for the redemption is above
the carrying amount.

Gains and losses on the redemption of bonds are
reported in the Other income (loss) section of the income
statement.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.